Attached files

file filename
EX-32.2 - EXHIBIT 32.2 - Elevate Credit, Inc.exhibit32209-30x2018.htm
EX-32.1 - EXHIBIT 32.1 - Elevate Credit, Inc.exhibit32109-30x2018.htm
EX-31.2 - EXHIBIT 31.2 - Elevate Credit, Inc.exhibit31209-30x2018.htm
EX-31.1 - EXHIBIT 31.1 - Elevate Credit, Inc.exhibit31109-30x2018.htm
EX-10.5 - EXHIBIT 10.5 - Elevate Credit, Inc.a105fourthamendmenttofinan.htm
EX-10.4 - EXHIBIT 10.4 - Elevate Credit, Inc.a104fourthamendedandrestat.htm
EX-10.3 - EXHIBIT 10.3 - Elevate Credit, Inc.a103firstamendmenttoleasea.htm
EX-10.2 - EXHIBIT 10.2 - Elevate Credit, Inc.a102amendmenttoaddisonsubl.htm
EX-10.1 - EXHIBIT 10.1 - Elevate Credit, Inc.a101addisonsubleaseagreeme.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q

(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018
or
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________

Commission file number 001-37680

elevatelogoa23.jpg
 ELEVATE CREDIT, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
 
 
 
46-4714474
State or Other Jurisdiction of
Incorporation or Organization
 
 
 
I.R.S. Employer Identification Number
 
 
 
 
 
4150 International Plaza, Suite 300
Fort Worth, Texas 76109
 
 
 
76109
Address of Principal Executive Offices
 
 
 
Zip Code
 
 
(817) 928-1500
 
 
Registrant’s Telephone Number, Including Area Code
 
 
 
 
 
Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
Yes
x
No
o
Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files).
Yes
x
No
o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
o
Non-accelerated filer
x
Accelerated filer
o
Smaller reporting company
o
Emerging growth company
x
 
 




1



If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act. x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x

The number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
Class
 
Outstanding at November 7, 2018
Common Shares, $0.0004 par value
 
43,197,206





2



TABLE OF CONTENTS
 
Part I - Financial Information
 
Item 1.
Financial Statements
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
Item 3.
 
Item 4.
Part II - Other Information
 
Item 1.
 
Item 1A.
 
Item 6.





3



NOTE ABOUT FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act") that are based on our management’s beliefs and assumptions and on information currently available to our management. The forward-looking statements are contained throughout this Quarterly Report on Form 10-Q, including in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Forward-looking statements include information concerning our strategy, future operations, future financial position, future revenues, projected expenses, margins, prospects and plans and objectives of management. Forward-looking statements include all statements that are not historical facts and can be identified by terms such as “anticipate,” “believe,” “could,” “seek,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would” or similar expressions and the negatives of those terms. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about:
our future financial performance, including our expectations regarding our revenue, cost of revenue, growth rate of revenue, cost of borrowing, credit losses, marketing costs, net charge-offs, gross profit or gross margin, operating expenses, operating margins, loans outstanding, credit quality, ability to generate cash flow and ability to achieve and maintain future profitability;
the availability of debt financing, funding sources and disruptions in credit markets;
our ability to meet anticipated cash operating expenses and capital expenditure requirements;
anticipated trends, growth rates, seasonal fluctuations and challenges in our business and in the markets in which we operate;
our ability to anticipate market needs and develop new and enhanced or differentiated products, services and mobile apps to meet those needs, and our ability to successfully monetize them;
our expectations with respect to trends in our average portfolio effective annual percentage rate;
our anticipated growth and growth strategies and our ability to effectively manage that growth;
our anticipated expansion of relationships with strategic partners;
customer demand for our product and our ability to rapidly grow our business in response to fluctuations in demand;
our ability to attract potential customers and retain existing customers and our cost of customer acquisition;
the ability of customers to repay loans;
interest rates and origination fees on loans;
the impact of competition in our industry and innovation by our competitors;
our ability to attract and retain necessary qualified directors, officers and employees to expand our operations;
our reliance on third-party service providers;
our access to the automated clearinghouse system;
the efficacy of our marketing efforts and relationships with marketing affiliates;
our anticipated direct marketing costs and spending;
the evolution of technology affecting our products, services and markets;
continued innovation of our analytics platform, including our expectation that we will implement new technology and credit models beginning in the fourth quarter of 2018, with full benefits realized by the second quarter of 2019;
our ability to prevent security breaches, disruption in service and comparable events that could compromise the personal and confidential information held in our data systems, reduce the attractiveness of the platform or adversely impact our ability to service loans;
our ability to detect and filter fraudulent or incorrect information provided to us by our customers or by third parties;
our ability to adequately protect our intellectual property;
our compliance with applicable local, state, federal and foreign laws;

4



the impact of increased claims by claims management companies (“CMCs”) on our business, our accrual amounts related to such claims, and our expectation that the Financial Conduct Authority, a regulator in the UK financial services industry, will begin regulating the CMCs in April 2019;
our compliance with, and the effects on our business and results of operations from, current or future applicable regulatory developments and regulations, including developments or changes from the Consumer Financial Protection Bureau ("CFPB") and developments or changes in state law such as recently passed legislation in Ohio regarding interest rate caps;
regulatory developments or scrutiny by agencies regulating our business or the businesses of our third-party partners;
public perception of our business and industry;
the anticipated effect on our business of litigation or regulatory proceedings to which we or our officers are a party;
the anticipated effect on our business of natural or man-made catastrophes;
the increased expenses and administrative workload associated with being a public company;
failure to maintain an effective system of internal controls necessary to accurately report our financial results and prevent fraud;
our liquidity and working capital requirements;
the estimates and estimate methodologies used in preparing our consolidated financial statements;
the utility of non-GAAP financial measures;
the future trading prices of our common stock and the impact of securities analysts’ reports on these prices;
our anticipated development and release of certain products and applications and changes to certain products;
our anticipated investing activity; and
trends anticipated to continue as our portfolio of loans matures.
We caution you that the foregoing list may not contain all of the forward-looking statements made in this Quarterly Report on Form 10-Q.
Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. We discuss these risks in greater detail elsewhere in this Quarterly Report on Form 10-Q. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our management’s beliefs and assumptions only as of the date of this Quarterly Report on Form 10-Q. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

5

Elevate Credit, Inc. and Subsidiaries


PART I - FINANCIAL INFORMATION
Item 1. Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share and per share amounts)
 
September 30,
2018
 
December 31,
2017
 
 
(unaudited)
 
 
ASSETS
 
 
 
 
Cash and cash equivalents*
 
$
54,794

 
$
41,142

Restricted cash
 
1,593

 
1,595

Loans receivable, net of allowance for loan losses of $89,422 and $87,946, respectively*
 
542,976

 
524,619

Prepaid expenses and other assets*
 
13,217

 
10,306

Receivable from CSO lenders
 
17,846

 
22,811

Receivable from payment processors*
 
28,519

 
21,126

Deferred tax assets, net
 
21,499

 
23,545

Property and equipment, net
 
36,738

 
24,249

Goodwill
 
16,027

 
16,027

Intangible assets, net
 
1,856

 
2,123

Derivative assets at fair value (cost basis of $436 and $0, respectively)*
 
1,238

 

Total assets
 
$
736,303

 
$
687,543

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
Accounts payable and accrued liabilities ($45 and $95 payable to Think Finance at September 30, 2018 and December 31, 2017, respectively)*
 
$
44,955

 
$
42,213

State and other taxes payable
 
696

 
884

Deferred revenue*
 
30,639

 
33,023

Notes payable, net*
 
548,960

 
513,295

Derivative liability
 

 
1,972

Total liabilities
 
625,250

 
591,387

COMMITMENTS, CONTINGENCIES AND GUARANTEES (Note 10)
 

 

STOCKHOLDERS’ EQUITY
 
 
 
 
Preferred stock; $0.0004 par value; 24,500,000 authorized shares; None issued and outstanding at September 30, 2018 and December 31, 2017.
 

 

Common stock; $0.0004 par value; 300,000,000 authorized shares; 43,191,526 and 42,165,524 issued and outstanding, respectively
 
17

 
17

Additional paid-in capital
 
180,610

 
174,090

Accumulated deficit
 
(70,657
)
 
(79,954
)
Accumulated other comprehensive income, net of tax benefit of $1,257 and $2,273, respectively*
 
1,083

 
2,003

Total stockholders’ equity
 
111,053

 
96,156

Total liabilities and stockholders’ equity
 
$
736,303

 
$
687,543

* These balances include certain assets and liabilities of a variable interest entity (“VIE”) that can only be used to settle the liabilities of that VIE. All assets of the Company are pledged as security for the Company’s outstanding debt, including debt held by the VIE. For further information regarding the assets and liabilities included in our consolidated accounts, see Note 4—Variable Interest Entity.

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
6


Elevate Credit, Inc. and Subsidiaries


CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Dollars in thousands, except share and per share amounts)
2018
 
2017
 
2018
 
2017
Revenues
 
$
201,480

 
$
172,851

 
$
579,394

 
$
479,689

Cost of sales:
 
 
 
 
 
 
 
 
      Provision for loan losses
 
113,896

 
96,203

 
294,636

 
251,293

      Direct marketing costs
 
21,280

 
20,242

 
64,155

 
50,322

      Other cost of sales
 
7,997

 
5,834

 
20,892

 
14,367

Total cost of sales
 
143,173

 
122,279

 
379,683

 
315,982

Gross profit
 
58,307

 
50,572

 
199,711

 
163,707

Operating expenses:
 
 
 
 
 
 
 
 
Compensation and benefits
 
24,380

 
19,502

 
70,187

 
60,854

Professional services
 
9,789

 
8,618

 
26,475

 
25,045

Selling and marketing
 
2,170

 
2,042

 
7,525

 
6,662

Occupancy and equipment
 
4,553

 
3,227

 
13,302

 
10,003

Depreciation and amortization
 
3,490

 
2,656

 
9,167

 
7,657

Other
 
1,233

 
1,085

 
4,018

 
3,095

Total operating expenses
 
45,615

 
37,130

 
130,674

 
113,316

Operating income
 
12,692

 
13,442

 
69,037

 
50,391

Other income (expense):
 
 
 
 
 
 
 
 
      Net interest expense
 
(19,810
)
 
(17,261
)
 
(58,286
)
 
(54,602
)
      Foreign currency transaction (loss) gain
 
(325
)
 
536

 
(800
)
 
2,820

      Non-operating gain (loss)
 

 
(106
)
 
(38
)
 
2,407

Total other expense
 
(20,135
)
 
(16,831
)
 
(59,124
)
 
(49,375
)
Income (loss) before taxes
 
(7,443
)
 
(3,389
)
 
9,913

 
1,016

Income tax expense (benefit)
 
(3,209
)
 
(3,979
)
 
1,536

 
(4,262
)
Net income (loss)
 
$
(4,234
)
 
$
590

 
$
8,377

 
$
5,278

 
 
 
 
 
 
 
 
 
Basic earnings (loss) per share
 
$
(0.10
)
 
$
0.01

 
$
0.20

 
$
0.17

Diluted earnings (loss) per share
 
$
(0.10
)
 
$
0.01

 
$
0.19

 
$
0.16

Basic weighted average shares outstanding
 
43,182,208

 
41,717,231

 
42,653,947

 
31,211,084

Diluted weighted average shares outstanding
 
43,182,208

 
43,158,515

 
44,354,376

 
32,660,537




The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
7

Elevate Credit, Inc. and Subsidiaries


CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
(Dollars in thousands)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
2018
 
2017
 
2018
 
2017
Net income (loss)
 
$
(4,234
)
 
$
590

 
$
8,377

 
$
5,278

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
 
Foreign currency translation adjustment, net of tax of $0 for all periods
 
(305
)
 
676

 
(707
)
 
770

Reclassification of certain deferred tax effects
 

 

 
(920
)
 

Change in derivative valuation, net of tax of $67 and $0 for the three months ended 2018 and 2017, respectively, and $96 and $0 for the nine months ended 2018 and 2017, respectively
 
(384
)
 

 
707

 

Total other comprehensive income (loss), net of tax
 
(689
)
 
676

 
(920
)
 
770

Total comprehensive income (loss)
 
$
(4,923
)
 
$
1,266

 
$
7,457

 
$
6,048



The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
8

Elevate Credit, Inc. and Subsidiaries


CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED)
For the periods ended September 30, 2018 and 2017
(Dollars in thousands except share amounts)
 
Preferred Stock
 
 
 
Common Stock
 
Series A
Convertible
Preferred
 
Series B
Convertible
Preferred
 
Additional
paid-in
capital
 
Accumu-lated
deficit
 
Accumulated
other
comprehensive
income
 
Total
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
Balances at December 31, 2016
 

 

 
13,001,216

 
$
5

 
2,957,059

 
$
3

 
2,682,351

 
$
3

 
$
88,854

 
$
(76,385
)
 
$
1,087

 
$
13,567

Share-based compensation
 

 

 

 

 

 

 

 

 
4,436

 

 

 
4,436

Exercise of stock options
 

 

 
358,738

 

 

 

 

 

 
104

 

 

 
104

Tax benefit of equity issuance costs
 

 

 

 

 

 

 

 

 
(1,843
)
 

 

 
(1,843
)
Issuance of common stock net of deferred costs
 

 

 
14,285,000

 
6

 

 

 

 

 
80,188

 

 

 
80,194

Conversion of preferred shares
 

 

 
5,639,410

 
6

 
(2,957,059
)
 
(3
)
 
(2,682,351
)
 
(3
)
 

 

 

 

2.5-for-1 common stock split on converted preferred shares
 

 

 
8,459,109

 

 

 

 

 

 

 

 

 

Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency translation adjustment net of tax expense of $0
 

 

 

 

 

 

 

 

 

 

 
770

 
770

Cumulative effect of change in accounting
 

 

 

 

 

 

 

 

 

 
3,347

 

 
3,347

Net income
 

 

 

 

 

 

 

 

 

 
5,278

 

 
5,278

Balances at September 30, 2017
 

 

 
41,743,473

 
$
17

 

 
$

 

 
$

 
$
171,739

 
$
(67,760
)
 
$
1,857

 
$
105,853

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balances at December 31, 2017
 

 

 
42,165,524

 
17

 

 

 

 

 
174,090

 
(79,954
)
 
2,003

 
96,156

Share-based compensation
 

 

 

 

 

 

 

 

 
6,005

 

 

 
6,005

Exercise of stock options
 

 

 
271,891

 

 

 

 

 

 
997

 

 

 
997

Vesting of restricted stock units
 

 

 
692,115

 

 

 

 

 

 
(216
)
 

 

 
(216
)
ESPP shares issued
 

 

 
61,996

 

 

 

 

 

 
408

 

 

 
408

Tax benefit of equity issuance costs
 

 

 

 

 

 

 

 

 
(674
)
 

 

 
(674
)
Comprehensive loss:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency translation adjustment net of tax expense of $0
 

 

 

 

 

 

 

 

 

 

 
(707
)
 
(707
)
Change in derivative valuation net of tax expense of $96
 

 

 

 

 

 

 

 

 

 

 
707

 
707

Reclassification of certain deferred tax effects
 

 

 

 

 

 

 

 

 

 
920

 
(920
)
 

Net income
 

 

 

 

 

 

 

 

 

 
8,377

 

 
8,377

Balances at September 30, 2018
 

 

 
43,191,526

 
$
17

 

 
$

 

 
$

 
$
180,610

 
$
(70,657
)
 
$
1,083

 
$
111,053


The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
9

Elevate Credit, Inc. and Subsidiaries


CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(Dollars in thousands)
Nine Months Ended September 30,
2018
 
2017
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
8,377

 
$
5,278

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
9,167

 
7,657

Provision for loan losses
294,636

 
251,293

Share-based compensation
6,005

 
4,436

Amortization of debt issuance costs
280

 
410

Amortization of loan premium
4,583

 
3,933

Amortization of convertible note discount
138

 
3,241

Amortization of derivative assets
931

 

Deferred income tax expense, net
1,276

 
(4,848
)
Unrealized gain from foreign currency transactions
800

 
(2,820
)
Non-operating (gain) loss
38

 
(2,407
)
Changes in operating assets and liabilities:
 
 
 
Prepaid expenses and other assets
(2,473
)
 
(1,941
)
Receivables from payment processors
(7,688
)
 
(3,584
)
Receivables from CSO lenders
5,176

 
(3,881
)
Interest receivable
(72,818
)
 
(60,870
)
State and other taxes payable
(162
)
 
(50
)
Deferred revenue
5,332

 
8,370

Accounts payable and accrued liabilities
3,552

 
5,411

Net cash provided by operating activities
257,150

 
209,628

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Loans receivable originated or participations purchased
(1,000,059
)
 
(837,047
)
Principal collections and recoveries on loans receivable
749,145

 
576,007

Participation premium paid
(4,740
)
 
(4,227
)
Purchases of property and equipment
(21,437
)
 
(12,503
)
Net cash used in investing activities
(277,091
)
 
(277,770
)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
10

Elevate Credit, Inc. and Subsidiaries


 
 
Nine Months Ended September 30,
(Dollars in thousands)
 
2018
 
2017
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
 
Proceeds from notes payable
 
$
35,932

 
$
67,500

Payments of notes payable
 

 
(84,950
)
Cash paid for interest rate caps
 
(1,367
)
 

Settlement of derivative liability
 
(2,010
)
 

Payment of capital lease obligations
 

 
(21
)
Debt issuance costs paid
 
(25
)
 
(865
)
Equity issuance costs paid
 

 
(1,731
)
ESPP shares issued
 
408

 

Proceeds from issuance of common stock
 

 
86,699

Proceeds from stock option exercises
 
997

 
933

Taxes paid related to net share settlement of equity awards
 
(216
)
 
(422
)
Net cash provided by financing activities
 
33,719

 
67,143

Effect of exchange rates on cash
 
(128
)
 
753

Net increase in cash, cash equivalents and restricted cash
 
13,650

 
(246
)
 
 
 
 
 
Cash and cash equivalents, beginning of period
 
41,142

 
53,574

Restricted cash, beginning of period
 
1,595

 
1,785

Cash, cash equivalents and restricted cash, beginning of period
 
42,737

 
55,359

 
 
 
 
 
Cash and cash equivalents, end of period
 
54,794

 
53,473

Restricted cash, end of period
 
1,593

 
1,640

Cash, cash equivalents and restricted cash, end of period
 
$
56,387

 
$
55,113

 
 
 
 
 
Supplemental cash flow information:
 
 
 
 
Interest paid
 
$
56,818

 
$
51,340

Taxes paid
 
$
342

 
$
563

 
 
 
 
 
Non-cash activities:
 
 
 
 
CSO fees charged-off included in Deferred revenues and Loans receivable
 
$
7,716

 
$
8,027

Derivative debt discount on convertible term notes
 
$

 
$
2,517

Prepaid expenses accrued but not yet paid
 
$
582

 
$
937

Property and equipment accrued but not yet paid
 
$
209

 
$

Impact on deferred tax assets of adoption of ASU 2016-09
 
$

 
$
3,347

Impact on OCI and retained earnings of adoption of ASU 2018-02
 
$
920

 
$

Changes in fair value of interest rate caps
 
$
803

 
$

Deferred IPO costs included in Additional paid-in capital
 
$

 
$
6,708

Tax benefit of equity issuance costs included in Additional paid-in capital
 
$
674

 
$
1,843




The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
11

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
For the three and nine months ended September 30, 2018 and 2017


NOTE 1 - BASIS OF PRESENTATION AND ACCOUNTING CHANGES

Business Operations
Elevate Credit, Inc. (the “Company”) is a Delaware corporation. The Company provides technology-driven, progressive online credit solutions to non-prime consumers. The Company uses advanced technology and proprietary risk analytics to provide more convenient and more responsible financial options to its customers, who are not well-served by either banks or legacy non-prime lenders. The Company currently offers unsecured online installment loans and lines of credit in the United States (the “US”) and the United Kingdom (the “UK”). The Company’s products, Rise, Elastic and Sunny, reflect its mission of “Good Today, Better Tomorrow” and provide customers with access to competitively priced credit and services while helping them build a brighter financial future with credit building and financial wellness features. In the UK, the Company directly offers unsecured installment loans via the internet through its wholly owned subsidiary, Elevate Credit International (UK), Limited, (“ECI”) under the brand name of Sunny.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements as of September 30, 2018 and for the three and nine month periods ended September 30, 2018 and 2017 include the accounts of the Company, its wholly owned subsidiaries and a variable interest entity ("VIE") where the Company is the primary beneficiary. See Note 4—Variable Interest Entities for more information. All significant intercompany transactions and accounts have been eliminated.
The unaudited condensed consolidated financial information included in this report has been prepared in accordance with accounting principles generally accepted in the US (“US GAAP”) for interim financial information and Article 10 of Regulation S-X and conform, as applicable, to general practices within the finance company industry. The principles for interim financial information do not require the inclusion of all the information and footnotes required by US GAAP for complete financial statements. Therefore, these unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements for the year ended December 31, 2017 in the Company's Annual Report on Form 10-K, filed with the U.S. Securities and Exchange Commission ("SEC") on March 9, 2018. In the opinion of the Company’s management, the unaudited condensed consolidated financial statements include all adjustments, all of which are of a normal recurring nature, necessary for a fair presentation of the results for the interim periods. Our business is seasonal in nature so the results of operations for the three and nine months ended September 30, 2018 are not necessarily indicative of the results to be expected for the full year.
Initial Public Offering and Share-Based Compensation
On April 11, 2017, the Company completed its initial public offering (“IPO”) in which it issued and sold 12,400,000 shares of common stock at a price of $6.50 per share to the public. In connection with the closing, the underwriters exercised their option to purchase in full for an additional 1,860,000 shares. On April 6, 2017, the Company's stock began trading on the New York Stock Exchange ("NYSE") under the symbol “ELVT.” The aggregate net proceeds received by the Company from the IPO, net of underwriting discounts and commissions and estimated offering expenses, were approximately $80.2 million.
Immediately prior to the closing of the IPO, all then outstanding shares of the Company's convertible preferred stock were converted into 5,639,410 shares of common stock (or 14,098,519 shares of common stock after the 2.5 to 1 stock split described below). The related carrying value of shares of preferred stock, in the aggregate amount of approximately $6 thousand, was reclassified as common stock. Additionally, the Company amended and restated its certificate of incorporation, effective April 11, 2017 to, among other things, change the authorized number of shares of common stock to 300,000,000 and the authorized number of shares of preferred stock to 24,500,000, each with a par value of $0.0004 per share.
Stock options granted to certain employees vest upon the satisfaction of the earlier of either a service condition or a liquidity condition. The service condition for these awards is generally satisfied over four years. The liquidity condition is satisfied upon the occurrence of a qualifying event, defined as the completion of the IPO, which occurred on April 11, 2017. The satisfaction of this vesting condition accelerated the expense attribution period for those stock options, and the Company recognized a cumulative share-based compensation expense for the portion of those stock options that met the liquidity condition.




12

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017



Stock Split
On December 11, 2015, the Board of Directors approved the ratio to effect a 2.5-for-1 forward stock split of the Company's common stock. The stock split became effective in connection with the completion of the Company’s IPO. The Company's IPO and resulting stock split had the following effect on the Company's equity as of September 30, 2018:
Convertible Preferred Stock: In April 2017, as a result of the IPO, all then outstanding shares of the Company's convertible preferred stock (5,639,410) were converted on a one-to-one basis without additional consideration into an aggregate of 5,639,410 shares of common stock and, thereafter, into 14,098,519 shares of common stock after the application of the 2.5-for-1 forward stock split.
Common Stock: The IPO and resulting stock split caused an adjustment to the par value for the common stock, from $0.001 per share to $0.0004 per share, and caused a two-and-a-half times increase in the number of authorized and outstanding shares of common stock. The number of shares of common stock and per share common stock data in the accompanying unaudited condensed consolidated financial statements and related notes have been retroactively adjusted to reflect a 2.5-for-1 forward stock split for all periods presented.
Share-Based Compensation: The IPO and resulting stock split decreased the exercise price for stock options by two-and-a-half times per share and reflected a two-and-a-half times increase in the number of stock options and restricted stock units ("RSUs") outstanding. The number of stock options and RSUs and per share common stock data in the accompanying unaudited condensed consolidated financial statements and related notes have been adjusted to reflect a 2.5-for-1 forward stock split for all periods presented.

Use of Estimates
The preparation of the unaudited condensed consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the unaudited condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.
Significant items subject to such estimates and assumptions include the valuation of the allowance for loan losses, goodwill, long-lived and intangible assets, deferred revenues, contingencies, the fair value of derivatives, the income tax provision, valuation of share-based compensation and the valuation allowance against deferred tax assets. The Company bases its estimates on historical experience, current data and assumptions that are believed to be reasonable. Actual results in future periods could differ from those estimates.
Property and Equipment, net
Property and equipment are stated at cost, net of accumulated depreciation and amortization. The following table summarizes the components of net property and equipment.
(Dollars in thousands)
 
September 30, 2018

 
December 31, 2017

Property and equipment, gross
 
$
89,886

 
$
69,927

Accumulated depreciation and amortization
 
(53,148
)
 
(45,678
)
Property and equipment, net
 
$
36,738

 
$
24,249

Equity Issuance Costs
Costs incurred related to the Company's IPO were deferred and included in Prepaid expenses and other assets in the unaudited condensed consolidated financial statements and were charged against the gross proceeds of the IPO (i.e., charged against Additional paid-in capital in the accompanying unaudited condensed consolidated financial statements) as of the closing of the IPO on April 11, 2017. The balance of these equity issuance costs that were recorded against Additional paid-in capital in the unaudited Condensed Consolidated Balance Sheet at September 30, 2017 was approximately $6.7 million.




13

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


Interest Rate Caps
The Company applies the provisions of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 815, Derivatives and Hedging ("ASC 815"). On January 11, 2018, the Company entered into two interest rate cap transactions with a counterparty to mitigate the floating rate interest risk on a portion of the debt underlying the Rise and Elastic portfolios. See Note 5—Notes Payable for additional information. The interest rate caps are designated as cash flow hedges against expected future cash flows attributable to future interest payments on debt facilities held by each entity. The Company initially reports the gains or losses related to the hedges as a component of Accumulated other comprehensive income in the Condensed Consolidated Balance Sheets in the period incurred and subsequently reclassifies the interest rate caps’ gains or losses to interest expense when the hedged expenses are recorded. The Company excludes the change in the time value of the interest rate caps in its assessment of their hedge effectiveness. The Company presents the cash flows from cash flow hedges in the same category in the Condensed Consolidated Statements of Cash Flows as the category for the cash flows from the hedged items. The interest rate caps do not contain any credit risk related contingent features. The Company’s hedging program is not designed for trading or speculative purposes.
For additional information related to derivative instruments, see Note 8—Fair Value Measurements.

Recently Adopted Accounting Standards
In March 2018, the FASB issued Accounting Standards Update ("ASU") No. 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 ("ASU 2018-05"). The purpose of ASU 2018-05 is to incorporate the guidance pronounced through Staff Accounting Bulletin No. 118 ("SAB 118"). The Company has adopted all of the amendments of ASU 2018-05 on a prospective basis as of January 1, 2018. The adoption of ASU 2018-05 did not have a material impact on the Company's condensed consolidated financial statements.
In February 2018, the FASB issued ASU No. 2018-02, Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income ("ASU 2018-02"). The purpose of ASU 2018-02 is to allow an entity to elect to reclassify the stranded tax effects related to the Tax Cuts and Jobs Act from Accumulated other comprehensive income into Retained earnings. The amendments in ASU 2018-02 are effective for all entities for fiscal years beginning after December 15, 2018, and for interim periods within those fiscal years. Early adoption is permitted. The Company adopted all amendments of ASU 2018-02 on a prospective basis as of January 1, 2018 and elected to reclassify the stranded tax effects resulting from the Tax Cuts and Jobs Act from Accumulated other comprehensive income to Accumulated deficit. The amount of the reclassification for the three and nine months ended September 30, 2018 was $0 and $920 thousand, respectively.
In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815)—Targeted Improvements to Accounting for Hedging Activities ("ASU 2017-12"). The purpose of ASU 2017-12 is to improve the financial reporting of hedging relationships to better portray the economic results of an entity's risk management activities in its financial statements. In addition, ASU 2017-12 makes certain targeted improvements to simplify the application of the hedge accounting guidance. This guidance is effective for public companies for fiscal years beginning after December 15, 2018, and for interim periods within those fiscal years. Early adoption is permitted. The Company has adopted all of the amendments of ASU 2017-12 on a prospective basis as of January 1, 2018. Since the Company did not have derivatives accounted for as hedges prior to December 31, 2017, there was no cumulative-effect adjustment needed to Accumulated other comprehensive income and Accumulated deficit. The adoption of ASU 2017-12 did not have a material impact on the Company's condensed consolidated financial statements.




14

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


In May 2017, the FASB issued ASU No. 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting ("ASU 2017-09"). The purpose of ASU 2017-09 is to provide clarity and reduce both the diversity in practice and the cost and complexity when applying the guidance to a change to the terms or conditions of a share-based payment award. Under this new guidance, an entity should account for the effects of a modification unless all of the following are met: (1) The fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the modified award is the same as the fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the original award immediately before the original award is modified. If the modification does not affect any of the inputs to the valuation technique that the entity uses to value the award, the entity is not required to estimate the value immediately before and after the modification. (2) The vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified. (3) The classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified. The guidance is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. The Company adopted all amendments of ASU 2017-09 on a prospective basis as of January 1, 2018. The adoption of ASU 2017-09 did not have a material impact on the Company's financial condition, results of operations or cash flows.
In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash a consensus of the FASB Emerging Issues Task Force ("ASU 2016-18"). The purpose of ASU 2016-18 is to reduce diversity in practice related to the classification and presentation of changes in restricted cash on the statement of cash flows. Under this new guidance, the statement of cash flows during the reporting period must explain the change in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. ASU 2016-18 is effective for public entities for fiscal years beginning after December 15, 2017 and for interim periods within those fiscal years. The Company adopted all amendments of ASU 2016-18 on a retrospective basis as of January 1, 2018. Upon adoption, the Company included any restricted cash balances as part of cash and cash equivalents in its Condensed Consolidated Statements of Cash Flows and did not present the change in restricted cash balances as a separate line item under investing activities. The amount of the reclassification for the nine months ended September 30, 2018 and 2017 was immaterial for both periods.
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments ("ASU 2016-15"). ASU 2016-15 is intended to reduce diversity in practice for certain cash receipts and cash payments that are presented and classified in the statement of cash flows. For public entities, ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company adopted all amendments of ASU 2016-15 on a prospective basis as of January 1, 2018. The adoption of ASU 2016-15 did not have a material impact on the Company's condensed consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). ASU 2014-09 is a comprehensive new revenue recognition model that requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. ASU 2014-09 also requires 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. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of Effective Date ("ASU 2015-14"), which defers the effective date of this guidance by one year, to the annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. A reporting entity may choose to early adopt the guidance as of the original effective date. In April 2016, the FASB issued ASU 2016-10, Revenues from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing ("ASU 2016-10"), which clarifies the guidance related to identifying performance obligations and licensing implementation. The Company adopted all amendments of ASU 2016-10 using the alternative transition method, which requires the application of the guidance only to contracts that are uncompleted on the date of initial application. As a result of the scope exception for financial contracts, the Company's management determined that there are no material changes to the nature, extent or timing of revenues and expenses; additionally, the adoption of ASU 2014-09 did not have a significant impact to pretax income upon adoption as of September 30, 2018.




15

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017



Accounting Standards to be Adopted in Future Periods
In August 2018, the FASB issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract ("ASU 2018-15"). The purpose of ASU 2018-15 is to provide additional guidance on the accounting for costs of implementation activities performed in a cloud computing arrangement that is a service contract. This guidance is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The Company is still assessing the potential impact of ASU 2018-15 on the Company's condensed consolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement ("ASU 2018-13"). The purpose of ASU 2018-13 is to modify the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement. This guidance is effective for public companies for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years and requires both a prospective and retrospective approach to adoption based on amendment specifications. Early adoption of any removed or modified disclosures is permitted. Additional disclosures may be delayed until their effective date. The Company does not expect ASU 2018-13 to have a material impact on the Company's condensed consolidated financial statements.
In July 2018, the FASB issued ASU No. 2018-09, Codification Improvements ("ASU 2018-09"). The purpose of ASU 2018-09 is to clarify, correct errors in, or make minor improvements to the Codification. Among other revisions, the amendments clarify that an entity should recognize excess tax benefits or tax deficiencies for share compensation expense that is taken on an entity’s tax return in the period in which the amount of the deduction is determined. This portion of the guidance is effective for public companies for fiscal years beginning after December 15, 2018 and requires a modified retrospective approach to adoption. The Company does not expect ASU 2018-09 to have a material impact on the Company's condensed consolidated financial statements.
In January 2017, the FASB issued ASU No. 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment ("ASU 2017-04"). The purpose of ASU 2017-04 is to simplify the subsequent measurement of goodwill. The amendments modify the concept of impairment from the condition that exists when the carrying amount of goodwill exceeds its implied fair value to the condition that exists when the carrying amount of a reporting unit exceeds its fair value. An entity no longer will determine goodwill impairment by calculating the implied fair value of goodwill by assigning the fair value of a reporting unit to all of its assets and liabilities as if that reporting unit had been acquired in a business combination. This guidance is effective for public companies for goodwill impairment tests in fiscal years beginning after December 15, 2019. The Company is still assessing the potential impact of ASU 2017-04 on the Company's condensed consolidated financial statements.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"). ASU 2016-13 is intended to replace the incurred loss impairment methodology in current US GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates to improve the quality of information available to financial statement users about expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. For public entities, ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is still assessing the potential impact of ASU 2016-13 on the Company's condensed consolidated financial statements. The internal financial controls processes in place for the Company's loan loss reserve process are expected to be impacted. The Company expects to complete its analysis of the impact in 2018.




16

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) ("ASU 2016-02"). ASU 2016-02 is intended to improve the reporting of leasing transactions to provide users of financial statements with more decision-useful information. ASU 2016-02 will require organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. In July 2018, the FASB issued ASU No. 2018-10, Codification Improvements to Topic 842, Leases (“ASU 2018-10”), which clarifies certain matters in the codification with the intention to correct unintended application of the guidance. Also in July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements (“ASU 2018-11”), which provides entities with an additional (and optional) transition method whereby the entity applies the new lease standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Additionally, under the new transition method, an entity’s reporting for the comparative periods presented in the financial statements in which it adopts the new lease standard will continue to be in accordance with current US GAAP (Topic 840, Leases). ASU 2016-02, as amended, is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Company expects to adopt the transition method in ASU 2018-11 by applying the practical expedient prospectively and by using the retrospective approach at the beginning of the period of adoption through cumulative-effect adjustment. The Company is still assessing the potential impact of ASU 2016-02 on the Company's condensed consolidated financial statements. The Company is progressing as planned for implementation on January 1, 2019. The Company expects adoption of the standard to result in the recognition of significant additional right of use assets and liabilities for operating leases, but to not have a material impact on the Condensed Consolidated Statements of Operations.




17

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


NOTE 2 - EARNINGS PER SHARE

In April 2017, the Company effected a 2.5-for-1 forward stock split of its common stock in connection with the completion of the IPO, which has been retroactively applied to previously reported share and earnings per share amounts. 
Basic earnings per share ("EPS") is computed by dividing net income (loss) by the weighted average number of common shares outstanding ("WASO") during each period. Also, basic EPS includes any fully vested stock and unit awards that have not yet been issued as common stock. There are no unissued fully vested stock and unit awards at September 30, 2018 and 2017.

Diluted EPS is computed by dividing net income (loss) by the WASO during each period plus any unvested stock option awards granted, vested unexercised stock options and unvested RSUs using the treasury stock method but only to the extent that these instruments dilute earnings per share.
The computation of earnings (loss) per share was as follows for three and nine months ended September 30, 2018 and 2017:
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Dollars in thousands, except share and per share amounts)
 
2018
 
2017
 
2018
 
2017
Numerator (basic):
 
 
 
 
 
 
 
 
Net income (loss)
 
$
(4,234
)
 
$
590

 
$
8,377

 
$
5,278

 
 
 
 
 
 
 
 
 
Numerator (diluted):
 
 
 
 
 
 
 
 
Net income (loss)
 
$
(4,234
)
 
$
590

 
$
8,377

 
$
5,278

 
 
 
 
 
 
 
 
 
Denominator (basic):
 
 
 
 
 
 
 
 
Basic weighted average number of shares outstanding
 
43,182,208

 
41,717,231

 
42,653,947

 
31,211,084

 
 
 
 
 
 
 
 
 
Denominator (diluted):
 
 
 
 
 
 
 
 
Basic weighted average number of shares outstanding
 
43,182,208

 
41,717,231

 
42,653,947

 
31,211,084

Effect of potentially dilutive securities:
 
 
 
 
 
 
 
 
Employee share plans (options, RSUs and ESPP)
 

 
1,441,284

 
1,700,429

 
1,449,453

Diluted weighted average number of shares outstanding
 
43,182,208

 
43,158,515

 
44,354,376

 
32,660,537

 
 
 
 
 
 
 
 
 
Basic and diluted earnings per share:
 
 
 
 
 
 
 
 
Basic earnings (loss) per share
 
$
(0.10
)
 
$
0.01

 
$
0.20

 
$
0.17

Diluted earnings (loss) per share
 
$
(0.10
)
 
$
0.01

 
$
0.19

 
$
0.16


For the three months ended September 30, 2018 and 2017, the Company excluded the following potential common shares from its diluted earnings per share calculation because including these shares would be anti-dilutive:
2,323,839 and 777,275 common shares issuable upon exercise of the Company's stock options; and
3,360,382 and 27,057 common shares issuable upon vesting of the Company's RSUs.

For the nine months ended September 30, 2018 and 2017, the Company excluded the following potential common shares from its diluted earnings per share calculation because including these shares would be anti-dilutive:
131,859 and 420,324 common shares issuable upon exercise of the Company's stock options; and
699,318 and 1,196,858 common shares issuable upon vesting of the Company's RSUs.





18

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


ASC Topic 260, “Earnings Per Share” (“ASC Topic 260”) requires companies with participating securities to utilize a two-class method for the computation of net income per share attributable to the Company. The two-class method requires a portion of net income attributable to the Company to be allocated to participating securities. Net losses are not allocated to participating securities unless those securities are obligated to participate in losses. The Company did not have any participating securities for the three and nine month periods ended September 30, 2018 and 2017.
NOTE 3 - LOANS RECEIVABLE AND REVENUE
Revenues generated from the Company’s consumer loans for the three and nine months ended September 30, 2018 and 2017 were as follows:
 
 
Three Months Ended September 30,
(Dollars in thousands)
 
2018
 
2017
Finance charges
 
$
119,147

 
$
104,495

CSO fees
 
15,593

 
13,662

Lines of credit fees
 
65,676

 
52,261

Other
 
1,064

 
2,433

Total revenues
 
$
201,480

 
$
172,851


 
 
Nine Months Ended September 30,
(Dollars in thousands)
 
2018
 
2017
Finance charges
 
$
348,162

 
$
294,436

CSO fees
 
44,029

 
42,526

Lines of credit fees
 
183,877

 
137,841

Other
 
3,326

 
4,886

Total revenues
 
$
579,394

 
$
479,689


The Company's portfolio consists of both installment loans and lines of credit, which are considered the portfolio segments at September 30, 2018 and December 31, 2017. The following reflects the credit quality of the Company’s loans receivable as of September 30, 2018 and December 31, 2017 as delinquency status has been identified as the primary credit quality indicator. The Company classifies its loans as either current or past due. A customer in good standing may request a 16 day grace period when or before a payment becomes due and, if granted, the loan is considered current during the grace period. Installment loans and lines of credit are considered past due if a grace period has not been requested and a scheduled payment is not paid on its due date. All impaired loans that were not accounted for as a troubled debt restructuring ("TDR") as of September 30, 2018 and December 31, 2017 have been charged off.
 
 
September 30, 2018
(Dollars in thousands)
 
Rise and Sunny
 
Elastic
 
Total
Current loans
 
$
275,678

 
$
270,756

 
$
546,434

Past due loans
 
58,156

 
25,306

 
83,462

Total loans receivable
 
333,834

 
296,062

 
629,896

Net unamortized loan premium
 

 
2,502

 
2,502

Less: Allowance for loan losses
 
(54,888
)
 
(34,534
)
 
(89,422
)
Loans receivable, net
 
$
278,946

 
$
264,030

 
$
542,976





19

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


 
 
December 31, 2017
(Dollars in thousands)
 
Rise and Sunny
 
Elastic
 
Total
Current loans
 
$
298,964

 
$
237,797

 
$
536,761

Past due loans
 
52,379

 
21,076

 
73,455

Total loans receivable
 
351,343

 
258,873

 
610,216

Net unamortized loan premium
 

 
2,349

 
2,349

Less: Allowance for loan losses
 
(59,076
)
 
(28,870
)
 
(87,946
)
Loans receivable, net
 
$
292,267

 
$
232,352

 
$
524,619

Total loans receivable includes approximately $36.7 million and $36.6 million of interest receivable at September 30, 2018 and December 31, 2017, respectively. The carrying value for Loans receivable, net of the allowance for loan losses approximates the fair value due to the short-term nature of the loans receivable.
The changes in the allowance for loan losses for the three and nine months ended September 30, 2018 and 2017 are as follows:
 
 
 
Three Months Ended September 30, 2018
(Dollars in thousands)
 
Rise and Sunny
 
Elastic
 
Total
Balance beginning of period
 
$
51,137

 
$
29,394

 
$
80,531

Provision for loan losses
 
75,653

 
38,243

 
113,896

Charge-offs
 
(72,987
)
 
(35,832
)
 
(108,819
)
Recoveries of prior charge-offs
 
5,745

 
2,729

 
8,474

Effect of changes in foreign currency rates
 
(150
)
 

 
(150
)
Total
 
59,398

 
34,534

 
93,932

Accrual for CSO lender owned loans
 
(4,510
)
 

 
(4,510
)
Balance end of period
 
$
54,888

 
$
34,534

 
$
89,422


 
 
Three Months Ended September 30, 2017
(Dollars in thousands)
 
Rise and Sunny
 
Elastic
 
Total
Balance beginning of period
 
$
49,154

 
$
20,686

 
$
69,840

Provision for loan losses
 
64,396

 
31,807

 
96,203

Charge-offs
 
(61,837
)
 
(26,727
)
 
(88,564
)
Recoveries of prior charge-offs
 
6,296

 
2,036

 
8,332

Effect of changes in foreign currency rates
 
258

 

 
258

Total
 
58,267

 
27,802

 
86,069

Accrual for CSO lender owned loans
 
(5,097
)
 

 
(5,097
)
Balance end of period
 
$
53,170

 
$
27,802

 
$
80,972






20

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


 
 
Nine Months Ended September 30, 2018
(Dollars in thousands)
 
Rise and Sunny
 
Elastic
 
Total
Balance beginning of period
 
$
64,919

 
$
28,870

 
$
93,789

Provision for loan losses
 
197,694

 
96,942

 
294,636

Charge-offs
 
(220,181
)
 
(98,877
)
 
(319,058
)
Recoveries of prior charge-offs
 
17,316

 
7,599

 
24,915

Effect of changes in foreign currency rates
 
(350
)
 

 
(350
)
Total
 
59,398

 
34,534

 
93,932

Accrual for CSO lender owned loans
 
(4,510
)
 

 
(4,510
)
Balance end of period
 
$
54,888

 
$
34,534

 
$
89,422


 
 
Nine Months Ended September 30, 2017
(Dollars in thousands)
 
Rise and Sunny
 
Elastic
 
Total
Balance beginning of period
 
$
62,987

 
$
19,389

 
$
82,376

Provision for loan losses
 
174,250

 
77,043

 
251,293

Charge-offs
 
(197,519
)
 
(74,022
)
 
(271,541
)
Recoveries of prior charge-offs
 
17,757

 
5,392

 
23,149

Effect of changes in foreign currency rates
 
792

 

 
792

Total
 
58,267

 
27,802

 
86,069

Accrual for CSO lender owned loans
 
(5,097
)
 

 
(5,097
)
Balance end of period
 
$
53,170

 
$
27,802

 
$
80,972



As of September 30, 2018 and December 31, 2017, respectively, estimated losses of approximately $4.5 million and $5.8 million for the CSO owned loans receivable guaranteed by the Company of approximately $41.4 million and $45.5 million, respectively, are initially recorded at fair value and are included in Accounts payable and accrued liabilities in the Condensed Consolidated Balance Sheets.

Troubled Debt Restructurings
In certain circumstances, the Company modifies the terms of its finance receivables for borrowers experiencing financial difficulties. Modifications may include principal and interest forgiveness. A modification of finance receivable terms is considered a TDR if the Company grants a concession to a borrower for economic or legal reasons related to the borrower’s financial difficulties that would not otherwise have been considered. Management considers TDRs to include all installment and line of credit loans that were granted principal and interest forgiveness as a part of a loss mitigation strategy for Rise and Elastic that began in October 2017. Once a loan has been classified as a TDR, it is assessed for impairment based on the present value of expected future cash flows discounted at the loan's original effective interest rate considering all available evidence. There were no loans that were modified as TDRs prior to October 2017.





21

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


The following table summarizes the financial effects, excluding impacts related to credit loss allowance and impairment, of TDRs for the three and nine months ended September 30, 2018:

 
 
Three Months Ended 
 September 30, 2018
(Dollars in thousands)
 
Installment loans and lines of credit
Outstanding recorded investment before TDR
 
$
1,752

Outstanding recorded investment after TDR
 
1,437

Total principal and interest forgiveness included in charge-offs within the Allowance for loan losses
 
$
315


 
 
Nine Months Ended 
 September 30, 2018
(Dollars in thousands)
 
Installment loans and lines of credit
Outstanding recorded investment before TDR
 
$
6,850

Outstanding recorded investment after TDR
 
5,229

Total principal and interest forgiveness included in charge-offs within the Allowance for loan losses
 
$
1,621



A loan that has been classified as a TDR remains classified as a TDR until it is liquidated through payoff or charge-off. The table below presents the Company's average outstanding recorded investment and interest income recognized on TDR loans for the three and nine months ended September 30, 2018:

 
Three Months Ended 
 September 30, 2018
(Dollars in thousands)
Installment loans and lines of credit
Average outstanding recorded investment(1)
$
2,813

Interest income recognized
$
640

1. Simple average based on the number of days between the modification date
      and the earlier of the liquidation date or September 30, 2018.

 
Nine Months Ended 
 September 30, 2018
(Dollars in thousands)
Installment loans and lines of credit
Average outstanding recorded investment(1)
$
3,930

Interest income recognized
$
3,454

1. Simple average based on the number of days between the modification date
      and the earlier of the liquidation date or September 30, 2018.






22

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


The table below presents the Company's loans modified as TDRs as of September 30, 2018 and December 31, 2017:

 
 
Installment loans and lines of credit
(Dollars in thousands)
 
September 30, 2018
 
December 31, 2017
Current outstanding investment
 
$
960

 
$
2,661

Delinquent outstanding investment
 
1,795

 
2,445

Outstanding recorded investment
 
2,755

 
5,106

Less: Impairment
 
(538
)
 
(459
)
Outstanding recorded investment, net of impairment
 
$
2,217

 
$
4,647


A TDR is considered to have defaulted upon charge-off when it is over 60 days past due or earlier if deemed uncollectible. There were approximately $1.3 million and $8.4 million loan restructurings accounted for as TDRs that subsequently defaulted for the three and nine months ended September 30, 2018, respectively. The Company had commitments to lend additional funds of approximately $0.1 million to customers with available and unfunded lines of credit as of September 30, 2018.


NOTE 4—VARIABLE INTEREST ENTITIES

The Company is involved with four entities that are deemed to be a VIE: Elastic SPV, Ltd. and three Credit Services Organization ("CSO") lenders. Under ASC 810-10-15, Variable Interest Entities, a VIE is an entity that: (1) has an insufficient amount of equity investment at risk to permit the entity to finance its activities without additional subordinated financial support by other parties; (2) the equity investors are unable to make significant decisions about the entity’s activities through voting rights or similar rights; or (3) the equity investors do not have the obligation to absorb expected losses or the right to receive residual returns of the entity. The Company is required to consolidate a VIE if it is determined to be the primary beneficiary, that is, the enterprise has both (1) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and (2) the obligation to absorb losses of the entity that could potentially be significant to the VIE. The Company evaluates its relationships with VIEs to determine whether it is the primary beneficiary of a VIE at the time it becomes involved with the entity and it re-evaluates that conclusion each reporting period.
Elastic SPV, Ltd.
On July 1, 2015, the Company entered into several agreements with a third-party lender and Elastic SPV, Ltd. (“ESPV”), an entity formed by third party investors for the purpose of purchasing loan participations from the third-party lender. Per the terms of the agreements, the Company provides customer acquisition services to generate loan applications submitted to the third-party lender. In addition, the Company licenses loan underwriting software and provides services to the third party lender to evaluate the credit quality of those loan applications in accordance with the third-party lender’s credit policies. ESPV accounts for the loan participations acquired in accordance with ASC 860-10-40, Transfers and Services, Derecognition, as the lines of credit acquired meet the criteria of a participation interest.
Once the third-party lender originates the loan, ESPV has the right, but not the obligation, to purchase a 90% interest in each Elastic line of credit. Victory Park Management, LLC (“VPC”) entered into an agreement (the "ESPV Facility") under which it loans ESPV all funds necessary up to a maximum borrowing amount to purchase such participation interests in exchange for a fixed return (see Note 5—Notes Payable—ESPV Facility). The Company entered into a separate credit default protection agreement with ESPV whereby the Company agreed to provide credit protection to the investors in ESPV against Elastic loan losses in return for a credit premium. The Company does not hold a direct ownership interest in ESPV, however, as a result of the credit default protection agreement, ESPV was determined to be a VIE and the Company qualifies as the primary beneficiary.




23

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


The following table summarizes the assets and liabilities of the VIE that are included within the Company’s Condensed Consolidated Balance Sheets at September 30, 2018 and December 31, 2017:
 
(Dollars in thousands)
September 30,
2018
 
December 31,
2017
ASSETS
 
 
 
Cash and cash equivalents
$
14,377

 
$
14,928

Loans receivable, net of allowance for loan losses of $34,534 and $28,869, respectively
264,030

 
232,353

Prepaid expenses and other assets ($64 and $50, respectively, eliminates upon consolidation)
168

 
50

Derivative asset at fair value (cost basis of $206 and $0, respectively)
587

 

Receivable from payment processors
12,620

 
9,889

Total assets
$
291,782

 
$
257,220

LIABILITIES AND SHAREHOLDER’S EQUITY
 
 
 
Accounts payable and accrued liabilities ($5,305 and $7,606, respectively, eliminates upon consolidation)
$
15,713

 
$
13,922

Deferred revenue
5,572

 
4,363

Reserve deposit liability ($35,250 and $31,200, respectively, eliminates upon consolidation)
35,250

 
31,200

Notes payable, net
234,867

 
207,735

Accumulated other comprehensive income
380

 

Total liabilities and shareholder’s equity
$
291,782

 
$
257,220

CSO Lenders
The three CSO lenders are considered VIE's of the Company; however, the Company does not have any ownership interest in the CSO lenders, does not exercise control over them, and is not the primary beneficiary, and therefore, does not consolidate the CSO lenders’ results with its results.





24

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


NOTE 5—NOTES PAYABLE
The Company has two debt facilities with VPC. The Rise SPV, LLC ("RSPV," a subsidiary of the Company) credit facility (the "VPC Facility") and the ESPV Facility.
VPC Facility
The VPC Facility provides the following term notes:
A maximum borrowing amount of $350 million at a base rate (defined as the 3-month LIBOR, with a 1% floor) plus 11% used to fund the Rise loan portfolio (“US Term Note”). The blended interest rate on the outstanding balance at September 30, 2018 and December 31, 2017 was 12.75% and 12.64%, respectively. The Company entered into an interest rate cap on January 11, 2018 to mitigate the floating rate interest risk on the aggregate $240 million outstanding as of September 30, 2018. See Note 8—Fair Value Measurements.
A maximum borrowing amount of $48 million at a base rate (defined as the 3-month LIBOR) plus 14% used to fund the UK Sunny loan portfolio (“UK Term Note”) as of September 30, 2018. As of December 31, 2017, the maximum borrowing amount was $48 million bearing interest at a base rate (defined as the 3-month LIBOR) plus 16%. The blended interest rate at September 30, 2018 and December 31, 2017 was 16.32% and 17.64%, respectively.
A maximum borrowing amount of $35 million at a base rate (defined as the 3-month LIBOR, with a 1% floor) plus 13% (“4th Tranche Term Note”) as of September 30, 2018. As of December 31, 2017, the maximum borrowing amount was $25 million bearing interest at the greater of 18% or a base rate (defined as the 3-month LIBOR, with a 1% floor) plus 17%. The blended interest rate at September 30, 2018 and December 31, 2017 was 15.32% and 18.64%, respectively.
A maximum borrowing amount of $0 and $10 million as of September 30, 2018 and December 31, 2017, respectively. As of December 31, 2017, the interest rate was the greater of 10% or a base rate (defined as the 3-month LIBOR, with a 1% floor) plus 9% (“Convertible Term Notes”). The blended interest rate at December 31, 2017 was 10.64%.
As of January 30, 2018, the balance of the Convertible Term Notes was converted into the 4th Tranche Term Notes.

In August 2018, the maturity date of $75 million outstanding under the US Term Note, which previously had a maturity date of August 13, 2018, was automatically extended to February 1, 2021 per the terms of the agreement. As a result of this extension, all amounts outstanding under the US Term Note, the UK Term Note and the 4th Tranche Term Note have a maturity date of February 1, 2021. The Convertible Term Note had a maturity date of January 30, 2018 but became a part of the 4th Tranche Term Note on that date. There are no principal payments due or scheduled until the maturity date. All assets of the Company are pledged as collateral to secure the VPC Facility. The VPC Facility contains certain financial covenants that require, among other things, maintenance of minimum amounts and ratios of working capital; minimum amounts of tangible net worth; maximum ratio of indebtedness; and maximum ratios of charge-offs. The Company was in compliance with all covenants related to the VPC Facility as of September 30, 2018 and December 31, 2017.

2017 Convertible Term Notes

The Convertible Term Notes were convertible, at the lender's option, into common stock upon the completion of specific defined liquidity events including certain equity financings, certain mergers and acquisitions or the sale of substantially all of the Company's assets, or during the period from the receipt of notice of the anticipated commencement of a roadshow in connection with the Company's IPO until immediately prior to the effectiveness of the Registration Statement in connection with such IPO. The Convertible Term Notes were convertible into common stock at the market value (or a set discount to market value) of the shares on the date of conversion and since the Convertible Term Notes included a conversion option that continuously reset as the underlying stock price increased or decreased and provided a fixed value of common stock to the lender, it was considered share-settled debt. The Company did not elect and was not required to measure the Convertible Term Notes at fair value; as such, the Company measured the Convertible Term Notes at the accreted value, determined using the effective interest method. The conversion rights were not exercised, and the Convertible Term Notes became a part of the 4th Tranche Term Note on January 30, 2018.





25

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


The Convertible Term Notes contained embedded features that were required to be assessed as derivatives. The Company determined that two of the features it assessed were required to be bifurcated and accounted for under derivative accounting as follows: (i) An embedded redemption feature upon conversion into common shares of the Company's stock ("Share-Settlement Feature") that includes a provision for the adjustment to the conversion price to a price less than the transaction-date fair value price per share if the Company is a party to certain qualifying liquidity or equity financing transactions. The incremental undiscounted present value of the embedded redemption feature is $6.25 million. (ii) An embedded redemption feature that requires the Company to pay an amount up to $5 million ("Redemption Premium Feature") upon a cash redemption at maturity or upon a redemption caused by certain events of default.

These two embedded features have been accounted for together as a single compound derivative. The Company estimated the fair value of the compound derivative using a probability-weighted valuation scenario model. The assumptions included in the calculations are highly subjective and subject to interpretation. The fair value of the single compound derivative was recognized as principal draw-downs were made and in proportion to the amount of principal draw-downs to the maximum borrowing amount. The initial fair value of the single compound derivative is recognized and presented as a debt discount and a derivative liability. The debt discount is amortized using the effective interest method from the principal draw-down date(s) through the maturity date. The derivative liability is accounted for in the same manner as a freestanding derivative pursuant to ASC 815, with subsequent changes in fair value recorded in earnings each period.

During the period from the receipt of notice from the Company to VPC of the anticipated commencement of the roadshow in connection with its IPO until immediately prior to the effectiveness of the Registration Statement, VPC had the option to convert the Convertible Term Notes, in whole or in part, into that number of shares of the Company's common stock determined by the outstanding principal balance of and accrued, but unpaid, interest on the Convertible Term Notes divided by the product of (a) 0.8 multiplied by (b) the IPO price per share. VPC did not elect to exercise its right to convert; however, VPC purchased 2.3 million shares in the offering at the IPO price, and the Company used the proceeds from that purchase, approximately $14.9 million, to reduce an equivalent amount of indebtedness under the Convertible Term Notes. Accordingly, the Company released $2.0 million of the debt discount associated with this repayment into Net interest expense on the Condensed Consolidated Statements of Operations.

Additionally, upon the effectiveness of the Registration Statement, VPC's option to convert was terminated, and the Convertible Term Notes were no longer convertible in whole or in part into shares of the Company's common stock. Furthermore, VPC agreed to waive approximately $3 million of the Redemption Premium Feature associated with the $14.9 million of Convertible Term Notes the Company repaid. The remaining fair value of the derivative recognized by the Company at December 31, 2017 relates to the Redemption Premium Feature. See Note 8—Fair Value Measurements for additional information. The debt discount on the Convertible Term Notes was fully amortized and the exit premium under the Convertible Term Notes of $2.0 million was due and paid on January 30, 2018.

ESPV Facility

The ESPV Facility is used to purchase loan participations from a third-party lender and has a $250 million commitment amount. Interest is charged at a base rate (defined as the greater of the 3 month LIBOR rate or 1% per annum) plus 13% for the outstanding balance up to $50 million, plus 12% for the outstanding balance greater than $50 million up to $100 million, plus 13.5% for any amounts greater than $100 million up to $150 million, and plus 12.75% for borrowing amounts greater than $150 million. All of the tiered rates will decrease by 1% effective July 1, 2019. In August 2018, the maturity date of $49 million outstanding under the ESPV Facility, which previously had a maturity date of August 13, 2018, was automatically extended to July 1, 2021 per the terms of the agreement. As a result of this extension, all amounts outstanding under the ESPV Facility have a maturity date of July 1, 2021. The blended interest rate at September 30, 2018 and December 31, 2017 was 14.60% and 14.45%, respectively. The Company entered into an interest rate cap on January 11, 2018 to mitigate the floating rate interest risk on an aggregate $216 million outstanding as of September 30, 2018. See Note 8—Fair Value Measurements.




26

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


There are no principal payments due or scheduled until the respective maturity dates. All assets of the Company and ESPV are pledged as collateral to secure the ESPV Facility. The ESPV Facility contains financial covenants, including a borrowing base calculation and certain financial ratios. ESPV was in compliance with all covenants related to the ESPV Facility as of September 30, 2018 and December 31, 2017.

VPC and ESPV Facilities:
The outstanding balances of Notes payable, net of debt issuance costs, are as follows:
(Dollars in thousands)
 
September 30,
2018
 
December 31,
2017
US Term Note bearing interest at 3-month LIBOR +11%
 
$
240,000

 
$
240,000

UK Term Note bearing interest at 3-month LIBOR + 14% (2018) + 16% (2017)
 
39,481
 
31,210

4th Tranche Term Note bearing interest at 3-month LIBOR + 13% (2018) + 17% (2017)
 
35,050

 
25,000

Convertible Term Notes bearing interest at 3-month LIBOR + 9%
 

 
10,050

ESPV Term Note bearing interest at 3-month LIBOR + 12-13.5%
 
235,000

 
208,000

Debt discount and issuance costs
 
(571
)
 
(965
)
Total
 
$
548,960

 
$
513,295


The Company has evaluated the interest rates for its debt and believes they represent market rates based on the Company’s size, industry, operations and recent amendments. As a result, the carrying value for the debt approximates the fair value.
Future debt maturities as of September 30, 2018 are as follows:
Year (dollars in thousands)
September 30, 2018
Remainder of 2018
$

2019

2020

2021
549,531

2022

Total
$
549,531






27

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


NOTE 6—GOODWILL AND INTANGIBLE ASSETS
The carrying value of goodwill at September 30, 2018 and December 31, 2017 was approximately $16 million. There were no changes to goodwill during the three and nine months ended September 30, 2018. Goodwill represents the excess purchase price over the estimated fair market value of the net assets acquired by the predecessor parent company, Think Finance, Inc. ("Think Finance") related to the Elastic and UK reporting units. Of the total goodwill balance, approximately $0.5 million is deductible for tax purposes.
The carrying value of acquired intangible assets as of September 30, 2018 is presented in the table below:
(Dollars in thousands)
 
Cost
 
Accumulated
Amortization
 
Net
Assets subject to amortization:
 
 
 
 
 
 
Acquired technology
 
$
946

 
(946
)
 
$

Non-compete
 
3,404

 
(2,228
)
 
1,176

Customers
 
126

 
(126
)
 

Assets not subject to amortization:
 
 
 
 
 
 
Domain names
 
680

 

 
680

Total
 
$
5,156

 
$
(3,300
)
 
$
1,856

The carrying value of acquired intangible assets as of December 31, 2017 is presented in the table below:
(Dollars in thousands)
 
Cost
 
Accumulated
Amortization
 
Net
Assets subject to amortization:
 
 
 
 
 
 
Acquired technology
 
$
946

 
$
(946
)
 
$

Non-compete
 
3,404

 
(1,961
)
 
1,443

Customers
 
126

 
(126
)
 

Assets not subject to amortization:
 
 
 
 
 
 
Domain names
 
680

 

 
680

Total
 
$
5,156

 
$
(3,033
)
 
$
2,123


In May 2018, a party to a non-compete agreement terminated employment with the Company. The terms of the non-compete agreement expire one year after termination. The Company determined that the useful life of the non-compete agreement should coincide with its expiration and will therefore amortize the remaining carrying value on a straight line basis through May 2019. As of September 30, 2018, the non-compete agreement has a carrying value of $304 thousand.
Total amortization expense recognized for the three months ended September 30, 2018 and 2017 was approximately $144 thousand and $45 thousand, respectively. Total amortization expense recognized for the nine months ended September 30, 2018 and 2017 was approximately $267 thousand and $136 thousand, respectively. The weighted average remaining amortization period for the intangible assets was 5.5 years at September 30, 2018.
Estimated amortization expense relating to intangible assets subject to amortization for each of the five succeeding fiscal years is as follows:
Year (dollars in thousands)
Amount
2019
$
310

2020
120

2021
120

2022
120

2023
120






28

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


NOTE 7—SHARE-BASED COMPENSATION
Share-based compensation expense recognized for the three months ended September 30, 2018 and 2017 totaled approximately $2.4 million and $1.6 million, respectively. Share-based compensation expense recognized for the nine months ended September 30, 2018 and 2017 totaled approximately $6.0 million and $4.4 million, respectively.
2016 Omnibus Incentive Plan
The 2016 Omnibus Incentive Plan ("2016 Plan") was adopted by the Company’s Board of Directors on January 5, 2016 and approved by the Company’s stockholders thereafter. The 2016 Plan became effective on June 23, 2016. The 2016 Plan provides for the grant of incentive stock options to the Company’s employees, and for the grant of non-qualified stock options, stock appreciation rights, restricted stock, RSUs, dividend equivalent rights, cash-based awards (including annual cash incentives and long-term cash incentives), and any combination thereof to the Company’s employees, directors and consultants. In connection with the 2016 Plan, the Company has reserved but not issued 6,474,914 shares of common stock, which includes shares that would otherwise return to the 2014 Equity Incentive Plan (the "2014 Plan") as a result of forfeiture, termination, or expiration of awards previously granted under the 2014 Plan and outstanding when the 2016 Plan became effective.
The 2016 Plan will automatically terminate 10 years following the date it became effective, unless the Company terminates it sooner. In addition, the Company’s Board of Directors has the authority to amend, suspend or terminate the 2016 Plan provided such action does not impair the rights under any outstanding award.
As of September 30, 2018, the total number of shares available for future grants under the 2016 Plan was 845,986 shares.
The Company has in the past and may in the future make grants of share-based compensation as inducement awards to new employees who are outside the 2016 Plan. The Company's board may rely on the employment inducement exception under NYSE Rule 303A.08 in order to approve the grants.
2014 Equity Incentive Plan
The Company adopted the 2014 Plan on May 1, 2014. The 2014 Plan permitted the grant of incentive stock options, nonstatutory stock options, and restricted stock. On April 27, 2017, the Company's Board of Directors terminated the 2014 Plan as to future awards and confirmed that underlying shares corresponding to awards under the 2014 Plan that were outstanding at the time the 2016 Plan became effective, that are forfeited, terminated or expired, will become available for issuance under the 2016 Plan.
For the nine months ended September 30, 2018, the Company had the following activity related to outstanding share-based awards:
Stock Options
Stock options are awarded to encourage ownership of the Company's common stock by employees and to provide increased incentive for employees to render services and to exert maximum effort for the success of the Company. The Company's stock options generally permit net-share settlement upon exercise. The option exercise price, vesting schedule and exercise period are determined for each grant by the administrator of the applicable plan. The Company's stock options generally have a 10-year contractual term and vest over a 4-year period.




29

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


A summary of stock option activity as of and for the nine months ended September 30, 2018 is presented below:
Stock Options
 
Shares
 
Weighted Average
Exercise Price
 
Weighted Average Remaining Contractual Life (in years)
Outstanding at December 31, 2017
 
2,528,925

 
$
4.48

 
 
Granted
 
89,731

 
6.27

 
 
Exercised
 
(271,891
)
 
3.67

 
 
Forfeited
 
(16,598
)
 
6.45

 
 
Outstanding at September 30, 2018
 
2,330,167

 
4.63

 
5.05
Options exercisable at September 30, 2018
 
2,172,363

 
$
4.49

 
4.81
On March 9, 2018, the Company began offering a Save as You Earn Plan ("SAYE") to eligible UK employees. The Company granted 89,731 SAYE options under the 2016 Plan for the nine months ended September 30, 2018.
At September 30, 2018, there was approximately $0.4 million of unrecognized compensation cost related to non-vested stock options which is expected to be recognized over a weighted average period of 1.9 years. The total intrinsic value of options exercised for the nine months ended September 30, 2018 was $1.2 million.
Restricted Stock Units
RSUs are awarded to serve as a key retention tool for the Company to retain its executives and key employees. RSUs will transfer value to the holder even if the Company’s stock price falls below the price on the date of grant, provided that the recipient provides the requisite service during the period required for the award to “vest.”
The weighted-average grant-date fair value for RSUs granted under the 2016 Plan during the nine months ended September 30, 2018 was $8.39. These RSUs primarily vest 25% on the first anniversary of the effective date, and 25% each year thereafter, until full vesting on the fourth anniversary of the effective date.
A summary of RSU activity as of and for the nine months ended September 30, 2018 is presented below:
RSUs
 
Shares
 
Weighted Average
Grant-Date Fair Value
 
Weighted Average Remaining Contractual Life (in years)
Nonvested at December 31, 2017
 
2,784,524

 
$
7.55

 
 
Granted
 
1,545,393

 
8.35

 
 
Vested
 
(717,225
)
 
7.56

 
 
Forfeited
 
(246,730
)
 
7.59

 
 
Nonvested at September 30, 2018
 
3,365,962

 
7.91

 
9.06
Expected to vest at September 30, 2018
 
2,650,330

 
$
7.89

 
9.04
Included in the above grants, the Company entered into an RSU Agreement with a certain employee in January 2018 whereby 67,204 RSUs at a weighted average grant date fair value of $7.44 were authorized and granted as an inducement award outside the 2016 Plan. This award has a contractual term of 10 years and vests 25% on the first anniversary of the effective date, and 25% each year thereafter, until full vesting on the fourth anniversary of the effective date.
At September 30, 2018, there was approximately $17.7 million of unrecognized compensation cost related to non-vested RSUs which is expected to be recognized over a weighted average period of 2.9 years. During the nine months ended September 30, 2018, the total vest-date fair value of RSUs was approximately $5.4 million. As of September 30, 2018, the aggregate intrinsic value of the vested and expected to vest RSUs was approximately $21.4 million.




30

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


Employee Stock Purchase Plan
The Company offers an Employee Stock Purchase Plan ("ESPP") to eligible US employees. There are currently 946,655 shares authorized and 804,750 reserved for the ESPP. There have been 61,996 shares purchased under the ESPP for the nine months ended September 30, 2018. Within share-based compensation expense for the three and nine months ended September 30, 2018, $147 thousand and $415 thousand, respectively, relates to the ESPP. There was $166 thousand of ESPP expense for both the three and nine months ended September 30, 2017.
NOTE 8—FAIR VALUE MEASUREMENTS
The accounting guidance on fair value measurements establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to measurements involving significant unobservable inputs (Level 3 measurements).

The Company groups its assets and liabilities measured at fair value in three levels of the fair value hierarchy, based on the fair value measurement technique, as described below:
Level 1—Valuation is based upon quoted prices (unadjusted) for identical assets and liabilities in active exchange markets that the Company has the ability to access at the measurement date.
Level 2—Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques with significant assumptions and inputs that are observable in the market or can be derived principally from or corroborated by observable market data.
Level 3—Valuation is derived from model-based techniques that use inputs and significant assumptions that are supported by little or no observable market data. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of pricing models, discounted cash flow models and similar techniques.

The Company monitors the market conditions and evaluates the fair value hierarchy levels at least quarterly. For any transfers in and out of the levels of the fair value hierarchy, the Company discloses the fair value measurement at the beginning of the reporting period during which the transfer occurred. For the nine month periods ended September 30, 2018 and 2017, there were no significant transfers between levels.

The level of fair value hierarchy within which a fair value measurement in its entirety falls is based on the lowest-level input that is most significant to the fair value measurement in its entirety. In the determination of the classification of assets and liabilities in Level 2 or Level 3 of the fair value hierarchy, the Company considers all available information, including observable market data, indications of market conditions, and its understanding of the valuation techniques and significant inputs used. Based upon the specific facts and circumstances, judgments are made regarding the significance of the Level 3 inputs to the fair value measurements of the respective assets and liabilities in their entirety. If the valuation techniques that are most significant to the fair value measurements are principally derived from assumptions and inputs that are corroborated by little or no observable market data, the asset or liability is classified as Level 3.
Financial Assets and Liabilities Not Measured at Fair Value
The Company has evaluated Loans receivable, net of allowance for loan losses, Receivable from CSO lenders, Receivable from payment processors and Accounts payable and accrued expenses and believes the carrying value approximates the fair value due to the short-term nature of these balances. The Company has also evaluated the interest rates for Notes payable, net and believes they represent market rates based on the Company’s size, industry, operations and recent amendments. As a result, the carrying value for Notes payable, net approximates the fair value. The Company classifies its fair value measurement techniques for the fair value disclosures associated with Loans receivable, net of allowance for loan losses, Receivable from CSO lenders, Receivable from payment processors, Accounts payable and accrued liabilities and Notes payable, net as Level 3 in accordance with ASC 820-10, Fair Value Measurements and Disclosures (“ASC 820-10”).




31

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


Fair Value Measurements on a Recurring Basis

As previously discussed, the Company's Convertible Term Notes had embedded features that were required to be assessed as derivatives. This liability was considered to be Level 3 in accordance with ASC 820-10 and was measured at fair value on a recurring basis. See Note 5—Notes Payable for additional information.

On January 11, 2018, the Company entered into two interest rate cap transactions with a counterparty to mitigate the floating rate interest risk on a portion of the debt under the VPC Facility and the ESPV Facility. On January 16, 2018, the Company paid fixed premiums of $719 thousand and $648 thousand for the interest rate caps on the US Term Note (under the VPC Facility) and the ESPV Facility, respectively. The interest rate caps qualify for hedge accounting as cash flow hedges. Gains and losses on the interest rate caps are recognized in Accumulated other comprehensive income in the period incurred and are subsequently reclassified to Interest expense when the hedged expenses are recorded. The interest rate caps have a maturity date of February 1, 2019; therefore the Company expects all of the gains to be recognized in Interest expense in the next twelve months.

The Company uses model-derived valuations that discount the future expected cash receipts that would occur if variable interest rates rise above the strike price of the caps. The variable interest rates used in the calculation of projected receipts on the caps are based on an expectation of future interest rates derived from observable market interest rate curves and volatilities in active markets (Level 2). The following tables summarize these interest rate caps as of and for the three and nine months ended September 30, 2018 (dollars in thousands):
        
Contract date
Maturity date
Hedged interest rate payments' related note payable
Strike rate
Notional amount
 
Fair value
January 11, 2018
February 1, 2019
US Term Note
1.75
%
$
240,000

 
$
652

January 11, 2018
February 1, 2019
ESPV Facility
1.75
%
216,000

 
586

 
 
 
 
$
456,000

 
$
1,238


Unrealized gains (losses) recognized in Accumulated other comprehensive income
 
As of September 30, 2018
 
 
US Term Note interest rate cap
 
$
423

 
 
ESPV Facility interest rate cap
 
380

 
 
 
 
$
803

 
 
 
 
 
 
 
Gains recognized in Interest expense
 
Three months ended
September 30, 2018
 
Nine months ended
September 30, 2018
US Term Note interest rate cap
 
$
358

 
$
766

ESPV Facility interest rate cap
 
322

 
690

 
 
$
680

 
$
1,456







32

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


The Company has no derivative amounts subject to enforceable master netting arrangements that are offset on the Condensed Consolidated Balance Sheets. The Derivative liability related to the Convertible Term Notes is measured at fair value on a recurring basis. The changes in the Derivative liability for the three and nine months ended September 30, 2018 and 2017 are shown in the following table:

(Dollars in thousands)
 
Embedded Derivative Liability in Convertible Term Notes
Balance, December 31, 2016
 
$
1,750

Additional derivative recognized upon $15.0 million draw on the underlying Convertible Term Note
 
2,517

Fair value adjustment (Non-Operating expense in the Condensed Consolidated Statements of Operations)
 
133

Balance, March 31, 2017
 
$
4,400

Reduction of derivative due to $14.9 million repayment of the underlying Convertible Term Note (Non-Operating expense in the Condensed Consolidated Statements of Operations)
 
(2,746
)
Fair value adjustment (Non-Operating expense in the Condensed Consolidated Statements of Operations)
 
100

Balance, June 30, 2017
 
$
1,754

Fair value adjustment (Non-Operating expense in the Condensed Consolidated Statements of Operations)
 
106

Balance, September 30, 2017
 
$
1,860

 
 
 
Balance, December 31, 2017
 
$
1,972

Settlement of derivative due to conversion of the underlying Convertible Term Note to 4th Tranche Term Note
 
(2,010
)
Fair value adjustment (Non-Operating expense in the Condensed Consolidated Statements of Operations)
 
38

Balance, March 31, 2018
 
$

Balance, June 30, 2018
 
$

Balance, September 30, 2018
 
$








33

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


The Company’s derivative liability associated with its Convertible Term Notes was measured at fair value using a probability-weighted valuation scenario model based on the likelihood of the Company successfully completing an IPO or other qualified financing. The inputs and assumptions included in the calculations were highly subjective and subject to interpretation and included inputs and assumptions including estimates of redemption and conversion behaviors. Significant unobservable estimates of redemption and conversion behaviors prior to the IPO included (i) the 75% cumulative probability for the Company’s successful achievement of an IPO or other qualified financing prior to January 31, 2018 and (ii) the 90% probability that the Convertible Term Notes would be required to be redeemed at their maturation on January 31, 2018 (i.e., the holder would opt-out of converting the Convertible Term Notes into shares of the Company's common stock). The floating rate was based on the three-month LIBOR rate. The risk-free interest rate was based on the implied yield available on US Treasury zero-coupon issues over the expected life of the Convertible Term Notes. The expected life was impacted by all of the underlying assumptions and calibration of the Company’s model. Significant increases or decreases in inputs would result in significantly lower or higher fair value measurements. The ranges of significant inputs and assumptions used in measuring the fair value of the embedded derivative liability in the Convertible Term Notes as of December 31, 2017 were as follows: 
 
 
December 31, 2017
Expected life (months)
 
1

Conversion discount percentage
 
N/A

Floating rate
 
10.69% - 10.77%

Risk-free rate
 
1.58
%
Market yield
 
23.81
%
Non-marketability discount
 
N/A

Non-marketability discount volatility
 
N/A


NOTE 9—INCOME TAXES
Income tax expense for the three and nine months ended September 30, 2018 and 2017 consists of the following:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Dollars in thousands)
 
2018
 
2017
 
2018
 
2017
Current income tax expense (benefit):
 
 
 
 
 
 
 
 
Federal
 
$

 
$
72

 
$
(5
)
 
$
227

State
 
117

 
(57
)
 
150

 
359

Foreign
 

 

 
115

 

Total current income tax expense
 
117

 
15

 
260

 
586

 
 
 
 
 
 
 
 
 
Deferred income tax expense (benefit):
 
 
 
 
 
 
 
 
Federal
 
(1,903
)
 
(3,029
)
 
2,844

 
(2,464
)
State
 
(402
)
 
(842
)
 
502

 
(767
)
Stock options
 
41

 
(68
)
 
(213
)
 
(758
)
Deductible IPO costs
 

 
(55
)
 

 
(859
)
R&D credits
 
(1,062
)
 

 
(1,857
)
 

Total deferred income tax expense (benefit)
 
(3,326
)
 
(3,994
)
 
1,276

 
(4,848
)
 
 
 
 
 
 
 
 
 
Total income tax expense (benefit)
 
$
(3,209
)
 
$
(3,979
)
 
$
1,536

 
$
(4,262
)





34

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


On December 22, 2017, the Tax Cuts and Jobs Act (the "Act", or "Tax Reform") was enacted into law. The Act contains several changes to the US federal tax law including a reduction to the US federal corporate tax rate from 35% to 21%, an acceleration of the expensing of certain business assets, a reduction to the amount of executive pay that could qualify as a tax deduction, the addition of a repatriation tax on any accumulated offshore earnings and profit and a new minimum tax on certain non-US earnings, irrespective of the territorial system of taxation. In addition, it generally allows for the repatriation of future earnings of foreign subsidiaries without incurring additional US taxes by transitioning to a territorial system of taxation (Global Intangible Low-Taxed Income or “GILTI”). The Act is unclear in many respects and could be subject to potential amendments and technical correction, as well as interpretations and implementing regulations by the Treasury Department and Internal Revenue Service (the “IRS”), any of which could affect the estimates included in these financial statements. In addition, it is unclear how these US federal income tax changes will affect state and local taxation, which often uses federal taxable income as a starting point for computing state and local tax liabilities. The Company will continue to evaluate if any adjustment is required, and if any adjustment is required, it will be reflected as an additional expense or benefit in the 2018 financial statements, as allowed by SEC Staff Accounting Bulletin No. 118 ("SAB 118").

On December 22, 2017, the SEC issued SAB 118, which provides guidance on accounting for tax effects of the Tax Reform. SAB 118 provides a measurement period of up to one year from the enactment date to complete the accounting. The Company has completed its accounting of the impact of the reduction in the corporate tax rate and the remeasurement of certain deferred tax assets and liabilities based on the rate at which they are expected to reverse in the future, which is generally 21%. The ultimate impact may differ from the amounts recorded, possibly materially, due to, among other things, additional analysis, changes in interpretations and assumptions the Company has made and additional regulatory guidance that may be issued. Any adjustments made to provisional amounts under SAB 118 will be recorded as discrete adjustments in the period identified, not to extend beyond the one-year measurement period provided in SAB 118. During the three and nine months ended September 30, 2018, the Company recorded benefits of $0 and $50 thousand, respectively, to its provisional amounts related to Tax Reform, which had no material impact to the consolidated and the US effective tax rates for the nine months ended September 30, 2018.

The Company also continues to evaluate the impact of the GILTI provisions under the Tax Reform, which are complex and subject to continuing regulatory interpretation by the IRS. The Company is required to make an accounting policy election of either (1) treating taxes due on future US inclusions in taxable income related to GILTI as a current period expense when incurred (the “period cost method”) or (2) factoring such amounts into the Company’s measurement of its deferred taxes (the “deferred method”). The Company’s accounting policy election with respect to the new GILTI tax rules will depend, in part, on analyzing its consolidated income to determine whether it can reasonably estimate the tax impact. In addition, the Company is awaiting further interpretive guidance in connection with the computation of the GILTI tax. While the Company has included an estimate of GILTI in its estimated effective tax rate for 2018, it has not completed its analysis and is not yet able to determine which method to elect. Adjustments related to the amount of GILTI tax recorded in its consolidated financial statements may be required based on the outcome of this election.

The Company's tax provision for interim periods is determined using an estimate of its annual effective tax rate, adjusted for discrete items arising in that quarter. In each quarter, the Company updates its estimate of the annual effective tax rate, and if the estimated annual effective tax rate changes, the Company would make a cumulative adjustment in that quarter.

The Company’s consolidated effective tax rates for the nine months ended September 30, 2018 and 2017, including discrete items, were 15% and negative 419%, respectively, while the US effective tax rates were 10% and 153%, respectively. For the nine months ended September 30, 2018 and 2017, the Company’s effective tax rate differed from the standard corporate federal income tax rate of 21% and 35% for the US, respectively, and 19% for the UK primarily due to its permanent non-deductible and discrete tax items. In addition, the US effective tax rate is impacted by the Company's corporate state tax obligations in the states where it has lending activities. The Company's US cash effective tax rate was approximately 1%.
For purposes of evaluating the need for a deferred tax valuation allowance, significant weight is given to evidence that can be objectively verified. The following provides an overview of the assessment that was performed for both the domestic and foreign deferred tax assets, net.




35

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017



US deferred tax assets, net
At September 30, 2018 and December 31, 2017, the Company did not establish a valuation allowance for its US deferred tax assets (“DTA”) based on management’s expectation of generating sufficient taxable income in a look forward period over the next three to five years. The unutilized net operating loss ("NOL") carryforward from US operations at September 30, 2018 and December 31, 2017 was approximately $43.4 million for both periods. The NOLs were generated prior to January 1, 2018 and can be carried forward until 2034. The ultimate realization of the resulting deferred tax asset is dependent upon generating sufficient taxable income. The Company considered the following positive and negative factors when making their assessment regarding the ultimate realizability of the deferred tax assets.
Significant positive factors included the following:
The Company is in a forecasted 3-year cumulative pre-tax income position through December 31, 2018. The Company had incurred pre-tax losses in prior years with the pre-tax loss narrowing each year due to the growth in the products and scaling of the business since the spin-off date.
In 2017, the Company continued to grow its operating income (from $48 million in 2016 to $71 million in 2017). The US-only pre-tax loss decreased from $10.4 million in 2016 to $4.5 million in 2017, a 57% improvement from prior year. The US only pre-tax loss is attributed to slower loan growth for Rise early in the year, due to a delay in the tax refund season, coupled with slower loan growth for Elastic, in September and October, due to the impact of the hurricanes in Texas and Florida.
In 2018, the Company is forecasting US pre-tax income as it continues to grow its business and generate even greater operating income and is in a forecasted three-year cumulative pre-tax income position. The continued growth of the loan portfolio within the credit quality and marketing cost targets will drive improved gross margins for the Company. The Company's operating expenses are within targeted efficiency ratios and are expected to hold flat. The Company used the IPO proceeds to pay down its debt balances, as well as re-negotiated its debt facilities to lower interest rates, which will drive improved profitability from lower interest costs in future years. Various forecast scenarios have been performed with the results reflecting usage of approximately 13% of the US NOL in 2018 and the balance during 2019. The Company's operating income for the nine months ended September 30, 2018 was $69.0 million, a 37% improvement over the prior year period.
Management’s success in developing accurate forecasts and management’s track record of launching new and successful products is another source of positive evidence which was evaluated. The Company believes that the unique circumstance of the 2014 spin-off from a company that was successful prior to the spin-off provides it with several positive objectively verifiable factors that would not normally be available to a new company with a limited operating history.
There were no significant negative factors.
The Company has given due consideration to all the factors and believes the positive evidence outweighs the negative evidence and has concluded that the US deferred tax asset is expected to be realized based on management’s expectation of generating sufficient pre-tax income over the next three to five years. Although realization is not assured, management believes it is more likely than not that all of the recorded deferred tax assets will be realized. The amount of the deferred tax assets considered realizable, however, could be adjusted in the future if estimates of future taxable income change.




36

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


UK deferred tax assets, net
At September 30, 2018 and December 31, 2017, the Company recognized a full valuation allowance for its foreign deferred tax assets due to the lack of sufficient objective evidence regarding the realization of these assets in the foreseeable future. The Company assesses the UK deferred tax assets on a quarterly basis, and, as a result, there have been no changes as of September 30, 2018. Regardless of the deferred tax valuation allowance recognized at September 30, 2018 and December 31, 2017, the Company continues to retain NOL carryforwards for foreign income tax purposes of approximately $59.4 million, available to offset future foreign taxable income. To the extent that the Company generates taxable income in the future to utilize the tax benefits of the related deferred tax assets, subject to certain potential limitations, it may be able to reduce its effective tax rate by reducing the valuation allowance. The Company’s foreign NOL carryforward of approximately $59.4 million at September 30, 2018 and December 31, 2017 can be carried forward indefinitely.

NOTE 10—COMMITMENTS, CONTINGENCIES AND GUARANTEES
Contingencies
Currently and from time to time, the Company may become a defendant in various legal and regulatory actions that arise in the ordinary course of business. The Company generally cannot predict the eventual outcome, the timing of the resolution or the potential losses, fines or penalties of such legal and regulatory actions. Actual outcomes or losses may differ materially from the Company's current assessments and estimates, which could have a material adverse effect on the Company's business, financial condition and results of operation.
In accordance with applicable accounting guidance, the Company establishes an accrued liability for litigation, regulatory matters and other legal proceedings when those matters present material loss contingencies that are both probable and reasonably estimable. Even when an accrual is recorded, the Company may be exposed to loss in excess of any amounts accrued.
UK Claims Accrual:
During the three months ended September 30, 2018, the Company's UK business began to receive an increased number of customer complaints initiated by claims management companies ("CMCs") related to the affordability assessment of certain loans. If the Company's evidence supports the affordability assessment and the Company rejects the claim, the customer has the right to take the complaint to the Financial Ombudsman Service for further adjudication. The CMCs' campaign against the high cost lending industry increased significantly during the third quarter of 2018 resulting in a significant increase in affordability claims against all companies in the industry during this period. The Company believes that many of the increased claims against it are without merit and reflect the use of abusive and deceptive tactics by the CMCs. The Financial Conduct Authority, a regulator in the UK financial services industry, expects to begin regulating the CMCs in April 2019 in order to ensure that the methods used by the CMCs are in the best interests of the consumer and the industry.
As of September 30, 2018, the Company accrued approximately $947 thousand for the claims that were determined to be probable and reasonably estimable based on the Company's historical loss rates related to these claims. This accrual is recognized as Other cost of sales in the Statement of Operations and as Accounts payable and accrued liabilities on the Condensed Consolidated Balance Sheets. There was no expense accrued in the prior year. The outcomes of the adjudication of these claims may differ from the Company's estimates, and as a result, the Company's estimates may change in the near term and the effect of any such change could be material to the financial statements. The Company continues to monitor the matters for further developments that could affect the amount of the accrued liability recognized.
Commitments
The Elastic product, which offers lines of credit to consumers, had approximately $254.6 million and $198.9 million in available and unfunded credit lines at September 30, 2018 and December 31, 2017, respectively. In May 2017, the Rise product began offering lines of credit to consumers in certain states and had approximately $9.4 million and $3.5 million at September 30, 2018 and December 31, 2017, respectively, in available and unfunded credit lines. While these amounts represented the total available unused credit lines, the Company has not experienced and does not anticipate that all line of credit customers will access their entire available credit lines at any given point in time. The Company has not recorded a loan loss reserve for unfunded credit lines as the Company has the ability to cancel commitments within a relatively short timeframe.




37

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


Effective June 2017, the Company entered into a seven year lease agreement for office space in California. Upon the commencement of the lease, the Company was required to provide the lessor with an irrevocable and unconditional $500 thousand letter of credit. Provided the Company is not in default of any terms of the lease agreement, the outstanding required balance of the letter of credit will be reduced by $100 thousand per year beginning on the second anniversary of the lease commencement and ending on the fifth anniversary of the lease agreement. The minimum balance of the letter of credit will be at least $100 thousand throughout the duration of the lease. At both September 30, 2018 and December 31, 2017, the Company had $500 thousand of cash balances securing the letter of credit which is included in Restricted cash within the Condensed Consolidated Balance Sheets.
Guarantees
In connection with its CSO programs, the Company guarantees consumer loan payment obligations to CSO lenders and is required to purchase any defaulted loans it has guaranteed. The guarantee represents an obligation to purchase specific loans that go into default.
Indemnification
In the ordinary course of business, the Company may indemnify customers, vendors, lessors, investors, and other parties for certain matters subject to various terms and scopes. For example, the Company's may indemnify certain parties for losses due to the Company's breach of certain agreements or due to certain services it provides. The Company has not incurred material costs to settle claims related to such indemnification provisions as of September 30, 2018 and December 31, 2017. The fair value of these liabilities is immaterial; accordingly, there are no liabilities recorded for these agreements as of September 30, 2018 and December 31, 2017.

NOTE 11—OPERATING SEGMENT INFORMATION
The Company determines operating segments based on how its chief operating decision-maker manages the business, including making operating decisions, deciding how to allocate resources and evaluating operating performance. The Company's chief operating decision-maker is its Chief Executive Officer, who reviews its consolidated operating results on a monthly basis.
The Company has one reportable segment, which provides online credit products for non-prime consumers, which is composed of the Company’s operations in the US and the UK. The Company has aggregated all components of its business into a single reportable segment based on the similarities of the economic characteristics, the nature of the products and services, the distribution methods, the type of customers, and the nature of the regulatory environments.
Information related to each reportable segment is outlined below. Segment revenue is used to measure performance because management believes that this information is the most relevant in evaluating the results of the respective segments relative to other entities that operate in the same industry.




38

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


The following tables summarize the allocation of net revenues and long-lived assets based on geography:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Dollars in thousands)
 
2018
 
2017
 
2018
 
2017
Revenues
 
 
 
 
 
 
 
 
United States
 
$
169,468

 
$
146,904

 
$
487,683

 
$
403,990

United Kingdom
 
32,012

 
25,947

 
91,711

 
75,699

Total
 
$
201,480

 
$
172,851

 
$
579,394

 
$
479,689

 
 
 
 
 
 
 
 
 
 
 
September 30,
2018
 
December 31,
2017
 
 
 
 
Long-lived assets
 
 
 
 
 
 
 
 
United States
 
$
38,300

 
$
29,317

 
 
 
 
United Kingdom
 
16,321

 
13,082

 
 
 
 
Total
 
$
54,621

 
$
42,399

 
 
 
 

NOTE 12—RELATED PARTIES
The Company has entered into sublease agreements with Think Finance for office space that expire beginning in 2018 through 2019. Total rent and utility payments made to Think Finance for office space were approximately $233 thousand and $219 thousand for the three months ended September 30, 2018 and 2017, respectively, and approximately $818 thousand and $678 thousand for the nine months ended September 30, 2018 and 2017, respectively. Rent and utility expense is included in Occupancy and equipment within the Condensed Consolidated Statements of Operations. There were no expenses for equipment for each of the three months ended September 30, 2018 and 2017, and approximately $0 thousand and $42 thousand for the nine months ended September 30, 2018 and 2017, respectively. Equipment payments were included as a reduction of the capital lease liability included in Accounts payable and accrued liabilities within the Condensed Consolidated Balance Sheets and as interest expense included in Net interest expense within the Condensed Consolidated Statements of Operations.
At September 30, 2018 and December 31, 2017, the Company had approximately $45 thousand and $95 thousand, respectively, due to Think Finance related to reimbursable costs, which is included in Accounts payable and accrued liabilities within the Condensed Consolidated Balance Sheets.
Expenses related to our board of directors, including board fees, travel reimbursements, share-based compensation, and a consulting arrangement with a related party for the three and nine months ended September 30, 2018 and 2017 are included in Professional services within the Condensed Consolidated Statements of Operations and were as follows:
 
 
Three Months Ended September 30,
(Dollars in thousands)
 
2018
 
2017
Fees and travel expenses
 
$
126

 
$
134

Stock compensation
 
386

 
254

Consulting
 
75

 
75

Total board related expenses
 
$
587

 
$
463





39

Elevate Credit, Inc. and Subsidiaries
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For the three and nine months ended September 30, 2018 and 2017


 
 
Nine Months Ended September 30,
(Dollars in thousands)
 
2018
 
2017
Fees and travel expenses
 
$
410

 
$
404

Stock compensation
 
897

 
582

Consulting
 
225

 
225

Total board related expenses
 
$
1,532

 
$
1,211

In addition to amounts due to Think Finance as disclosed above, at September 30, 2018 and December 31, 2017, the Company had approximately $119 thousand and $65 thousand, respectively, due to related parties, which is included in Accounts payable and accrued liabilities within the Condensed Consolidated Balance Sheets.
NOTE 13—SUBSEQUENT EVENTS
The Company evaluated subsequent events as of the date these financial statements are made available and determined there has been no material subsequent events that required recognition or additional disclosure in these condensed consolidated financial statements.






40



Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis of our financial condition and results of operations together with our unaudited condensed consolidated financial statements and the related notes and other financial information included elsewhere in this Quarterly Report on Form 10-Q. Some of the information contained in this discussion and analysis, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. You should review the "Note About Forward-Looking Statements" section of this Quarterly Report on Form 10-Q for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. We generally refer to loans, customers and other information and data associated with each of Rise, Elastic and Sunny as Elevate’s loans, customers, information and data, irrespective of whether Elevate directly originates the credit to the customer or whether such credit is originated by a third party.
OVERVIEW
We provide online credit solutions to consumers in the US and the UK who are not well-served by traditional bank products and who are looking for better options than payday loans, title loans, pawn and storefront installment loans. Non-prime consumers now represent a larger market than prime consumers but are risky to underwrite and serve with traditional approaches. We’re succeeding at it - and doing it responsibly - with best-in-class advanced technology and proprietary risk analytics honed by serving more than 2.1 million customers with $6.3 billion in credit. Our current online credit products, Rise, Elastic, Sunny, and the recently introduced Today Card (which is our new credit card product that is currently in pilot mode with an immaterial loan balance) reflect our mission to provide customers with access to competitively priced credit and services while helping them build a brighter financial future with credit building and financial wellness features. We call this mission "Good Today, Better Tomorrow."
We earn revenues on the Rise and Sunny installment loans and on the Rise and Elastic lines of credit. For all three products, our revenues, which primarily consist of finance charges, are driven by our average loan balances outstanding and by the average annual percentage rate (“APR”) associated with those outstanding loan balances. We calculate our average loan balances by taking a simple daily average of the ending loan balances outstanding for each period. We present certain key metrics and other information on a “combined” basis to reflect information related to loans originated by us and loans originated by Republic Bank, as well as loans originated by third-party lenders pursuant to CSO programs, which loans originated through CSO programs are not recorded on our balance sheet in accordance with US GAAP. See “—Key Financial and Operating Metrics” and “—Non-GAAP Financial Measures.”
We have experienced rapid growth since launching our current generation of product offerings in 2013. Since their introduction, through September 30, 2018, Rise, Elastic and Sunny, together, have provided approximately $4.9 billion in credit to more than 1.3 million customers and generated strong growth in revenues and loans outstanding. Our revenues for the year ended December 31, 2017 grew 16% compared to revenues for 2016 and revenues for the nine months ended September 30, 2018 grew 21% compared to the nine months ended September 30, 2017. Our combined loan principal balances grew 15% from $548.9 million as of September 30, 2017 to $634.0 million as of September 30, 2018. For additional information about our combined loan balances please see “—Non-GAAP Financial Measures—Combined loan information.” Effective October 2018, we launched a partnership with FinWise Bank ("FinWise") through which FinWise licenses the Rise brand to market Rise installment loans in an additional 18 states in which we do not currently offer the Rise installment loans under our state-license model (where we are the direct lender). FinWise will utilize Elevate's marketing and underwriting expertise for the Rise-branded loans it originates.




41



Despite strong year-to-date growth in revenue and stable credit quality, we experienced a $4.2 million net loss for the three months ended September 30, 2018, primarily due to increased net charge-offs and an increase in loan loss provision. We experienced delays in rolling out new technology and credit models that are needed to drive continued improvements in credit quality for our US products. As a result of these and other issues, new customer acquisition and credit quality were both relatively flat with the prior year and anticipated improvements in margins were not realized. Additionally, we experienced a significant increase in UK costs related to complaints by claims management companies as well as higher legal costs related to several company initiatives. We expect to implement the new technology and credit models beginning in the fourth quarter of 2018, with full benefits realized by the second quarter of 2019.
We use our working capital, funds provided by third-party lenders pursuant to CSO programs and our credit facility with Victory Park Management, LLC ("VPC”) to fund the loans we make to our customers. Prior to January 2014, we funded all of our loans to customers out of our existing cash flows. On January 30, 2014, we entered into an agreement with VPC to provide a credit facility (“VPC Facility”) in order to fund our Rise and Sunny products and provide working capital. Since originally entering into the VPC Facility, it has been amended several times to increase the maximum total borrowing amount available from the original amount of $250 million to $433 million at September 30, 2018. See “—Liquidity and Capital Resources—Debt facilities.”
The Elastic line of credit product is originated by a third-party lender, Republic Bank, which initially provides all of the funding for that product. Republic Bank retains 10% of the balances of all loans originated and sells a 90% loan participation in the Elastic lines of credit. We purchased these loan participations ourselves through June 30, 2015 and thus earned 90% of the revenues and incurred 90% of the losses associated with the Elastic product through that date. Due to the significant growth in Elastic, commencing July 1, 2015, a new structure was implemented such that the loan participations are sold by Republic Bank to Elastic SPV, Ltd. (“Elastic SPV”) and Elastic SPV receives its funding from VPC in a separate financing facility (the “ESPV Facility”), which was finalized on July 13, 2015. We do not own Elastic SPV, but we have a credit default protection agreement with Elastic SPV whereby we provide credit protection to the investors in Elastic SPV against Elastic loan losses in return for a credit premium. Per the terms of this agreement, under US GAAP, the Company is the primary beneficiary of Elastic SPV and is required to consolidate the financial results of Elastic SPV as a variable interest entity in its consolidated financial results.

The ESPV Facility has been amended several times and the original commitment amount of $50 million has grown to $250 million as of September 30, 2018. See “—Liquidity and Capital Resources—Debt facilities.”

Our management assesses our financial performance and future strategic goals through key metrics based primarily on the following three themes:

Revenue growth.   Revenues increased by $28.6 million, or 17%, from $172.9 million for the three months ended September 30, 2017 to $201.5 million for the three months ended September 30, 2018. For the nine months ended September 30, 2018, our total revenues increased 21% as compared to the same prior year period, increasing from $479.7 million to $579.4 million. Key metrics related to revenue growth that we monitor by product include the ending and average combined loan balances outstanding, the effective APR of our product loan portfolios, the total dollar value of loans originated, the number of new customer loans made, the ending number of customer loans outstanding and the related customer acquisition costs (“CAC”) associated with each new customer loan made. We include CAC as a key metric when analyzing revenue growth (rather than as a key metric within margin expansion) as we do not intend to lower our CAC over future periods. Instead, as we improve customer acquisition efficiency, we intend to increase spending on direct marketing to acquire a broader customer base to drive further revenue growth.
Stable credit quality.    Since the time they were managing our legacy US products, our management team has maintained stable credit quality across the loan portfolio they were managing. Additionally, in the periods covered in this Management's Discussion and Analysis of Financial Condition and Results of Operations, we have continued to maintain stable credit quality. The credit quality metrics we monitor include net charge-offs as a percentage of revenues, net charge-offs as a percentage of average combined loans receivable - principal, the combined loan loss reserve as a percentage of outstanding combined loans, total provision for loan losses as a percentage of revenues and the percentage of past due combined loans receivable – principal.




42



Margin expansion.    We expect that our operating margins will continue to expand over the near term as we lower our direct marketing costs and operating expense as a percentage of revenues while continuing to maintain our stable credit quality levels. Over the next several years, as we continue to scale our loan portfolio, we anticipate that our direct marketing costs primarily associated with new customer acquisitions will decline to approximately 10% of revenues and our operating expenses will decline to approximately 20% of revenues. We aim to manage our business to achieve a long-term operating margin of 20%, and do not expect our operating margin to increase beyond that level, as we intend to pass on any improvements over our targeted margins to our customers in the form of lower APRs. We believe this is a critical component of our responsible lending platform and over time will also help us continue to attract new customers and retain existing customers.
KEY FINANCIAL AND OPERATING METRICS
As discussed above, we regularly monitor a number of metrics in order to measure our current performance and project our future performance. These metrics aid us in developing and refining our growth strategies and in making strategic decisions.
Certain of our metrics are non-GAAP financial measures. We believe that such metrics are useful in period-to-period comparisons of our core business. However, non-GAAP financial measures are not an alternative to any measure of financial performance calculated and presented in accordance with US GAAP. See “—Non-GAAP Financial Measures” for a reconciliation of our non-GAAP measures to US GAAP.

Revenue growth
 
 
 
As of and for the three months ended September 30,
 
As of and for the nine months ended September 30,
Revenue growth metrics (dollars in thousands, except as noted)
 
2018
 
2017
 
2018
 
2017
Revenues
 
$
201,480

 
$
172,851

 
$
579,394

 
$
479,689

Period-over-period revenue growth
 
17
%
 
12
%
 
21
%
 
17
%
Ending combined loans receivable – principal(1)
 
633,961

 
548,888

 
633,961

 
548,888

Average combined loans receivable – principal(1)(2)
 
616,362

 
523,452

 
596,574

 
481,260

Total combined loans originated – principal
 
414,816

 
364,268

 
1,104,507

 
920,592

Average customer loan balance (in dollars)(3)
 
1,579

 
1,673

 
1,579

 
1,673

Number of new customer loans
 
94,526

 
91,081

 
249,807

 
210,522

Number of loans outstanding
 
401,436

 
325,579

 
401,436

 
325,579

Customer acquisition costs (in dollars)
 
225

 
222

 
257

 
239

Effective APR of combined loan portfolio
 
129
%
 
129
%
 
129
%
 
132
%
_________
(1)
Combined loans receivable is defined as loans owned by the Company plus loans originated and owned by third-party lenders pursuant to our CSO programs. See “—Non-GAAP financial measures” for more information and for a reconciliation of combined loans receivable to loans receivable, net, the most directly comparable financial measure calculated in accordance with US GAAP.
(2)
Average combined loans receivable – principal is calculated using an average of daily principal balances.
(3)
Average customer loan balance is a weighted average of all three products and is calculated for each product by dividing the ending combined loans receivable – principal by the number of loans outstanding at period end.
Revenues.    Our revenues are composed of Rise finance charges, Rise CSO fees (which are fees we receive from customers who obtain a loan through the CSO program for the credit services, including the loan guaranty, we provide), finance charges on Sunny installment loans and revenues earned on the Rise and Elastic lines of credit. See “—Components of our Results of Operations—Revenues.”




43



Ending and average combined loans receivable – principal.    We calculate the average combined loans receivable – principal by taking a simple daily average of the ending combined loans receivable – principal for each period. Key metrics that drive the ending and average combined loans receivable – principal include the amount of loans originated in a period and the average customer loan balance. All loan balance metrics include only the 90% participation in the related Elastic line of credit advances (we exclude the 10% held by Republic Bank), but include the full loan balances on CSO loans, which are not presented on our balance sheet.
Total combined loans originated – principal.    The amount of loans originated in a period is driven primarily by loans to new customers as well as new loans to prior customers, including refinancings of existing loans to customers in good standing.
Average customer loan balance and effective APR of combined loan portfolio.    The average loan amount and its related APR are based on the product and the underlying credit quality of the customer. Generally, better credit quality customers are offered higher loan amounts at lower APRs. Additionally, new customers have more potential risk of loss than prior or existing customers due to lack of payment history and the potential for fraud. As a result, newer customers typically will have lower loan amounts and higher APRs to compensate for that additional risk of loss. The effective APR is calculated based on the actual amount of finance charges generated from a customer loan divided by the average outstanding balance for the loan, and can be lower than the stated APR on the loan due to waived finance charges and other reasons. For example, a Rise customer may receive a $2,000 installment loan with a term of 24 months and a stated rate of 180%. In this example, the customer’s monthly installment loan payment would be $310.86. As the customer can prepay the loan balance at any time with no additional fees or early payment penalty, the customer pays the loan in full in month eight. The customer’s loan earns interest of $2,337.81 over the eight month period and has an average outstanding balance of $1,948.17. The effective APR for this loan is 180% over the eight month period calculated as follows:
 
($2,337.81 interest earned / $1,948.17 average balance outstanding) x 12 months per year = 180%
8 months
In addition, as an example for Elastic, if a customer makes a $2,500 draw on the customer’s line of credit and this draw required bi-weekly minimum payments of 5% (equivalent to 20 bi-weekly payments), and if all minimum payments are made, the draw would earn finance charges of $1,148. The effective APR for the line of credit in this example is 109% over the payment period and is calculated as follows:

($1,148.00 fees earned / $1,369.05 average balance outstanding) x 26 bi-weekly periods per year = 109%
20 payments
The actual amount of revenue we realize on a loan portfolio is also impacted by the amount of prepayments and charged-off customer loans in the portfolio. For a single loan, on average, we typically expect to realize approximately 60% of the revenues that we would otherwise realize if the loan were to fully amortize at the stated APR. From the Rise example above, if we waived $400 of interest for this customer, the effective APR for this loan would decrease to 149%.
Number of new customer loans.    We define a new customer loan as the first loan made to a customer for each of our products (so a customer receiving a Rise installment loan and then at a later date taking their first cash advance on an Elastic line of credit would be counted twice). The number of new customer loans is subject to seasonal fluctuations. New customer acquisition is typically slowest during the first six months of each calendar year, primarily in the first quarter, compared to the latter half of the year, as our existing and prospective US customers usually receive tax refunds during this period and, thus, have less of a need for loans from us. Further, many US customers will use their tax refunds to prepay all or a portion of their loan balance during this period, so our overall loan portfolio typically decreases during the first quarter of the calendar year. Overall loan portfolio growth and the number of new customer loans tends to accelerate during the summer months (typically June and July), at the beginning of the school year (typically late August to early September) and during the winter holidays (typically late November to early December).




44



Customer acquisition costs.    A key expense metric we monitor related to loan growth is our CAC. This metric is the amount of direct marketing costs incurred during a period divided by the number of new customer loans originated during that same period. New loans to former customers are not included in our calculation of CAC (except to the extent they receive a loan through a different product) as we believe we incur no material direct marketing costs to make additional loans to a prior customer through the same product.
The following tables summarize the changes in customer loans by product for the three and nine months ended September 30, 2018 and 2017.
 
 
Three Months Ended September 30, 2018
 
 
Rise
 
Elastic
 
Total Domestic
 
Sunny
 
Total
Beginning number of combined loans outstanding
 
130,897

 
149,140

 
280,037

 
92,555

 
372,592

New customer loans originated
 
33,608

 
34,247

 
67,855

 
26,671

 
94,526

Former customer loans originated
 
23,434

 
390

 
23,824

 

 
23,824

Attrition
 
(47,721
)
 
(16,732
)
 
(64,453
)
 
(25,053
)
 
(89,506
)
Ending number of combined loans outstanding
 
140,218

 
167,045

 
307,263

 
94,173

 
401,436

Customer acquisition cost
 
$
261

 
$
217

 
$
239

 
$
190

 
$
225

Average customer loan balance
 
$
2,135

 
$
1,714

 
$
1,906

 
$
512

 
$
1,579

 
 
Three Months Ended September 30, 2017
 
 
Rise
 
Elastic
 
Total Domestic
 
Sunny
 
Total
Beginning number of combined loans outstanding
 
105,309

 
106,737

 
212,046

 
74,291

 
286,337

New customer loans originated
 
38,242

 
34,511

 
72,753

 
18,328

 
91,081

Former customer loans originated
 
18,725

 

 
18,725

 

 
18,725

Attrition
 
(38,298
)
 
(14,571
)
 
(52,869
)
 
(17,695
)
 
(70,564
)
Ending number of combined loans outstanding
 
123,978

 
126,677

 
250,655

 
74,924

 
325,579

Customer acquisition cost
 
$
240

 
$
168

 
$
206

 
$
287

 
$
222

Average customer loan balance
 
$
2,269

 
$
1,764

 
$
2,014

 
$
532

 
$
1,673

 
 
Nine Months Ended September 30, 2018
 
 
Rise
 
Elastic
 
Total Domestic
 
Sunny
 
Total
Beginning number of combined loans outstanding
 
140,790

 
140,672

 
281,462

 
80,510

 
361,972

New customer loans originated
 
83,022

 
81,432

 
164,454

 
85,353

 
249,807

Former customer loans originated
 
61,633

 
606

 
62,239

 

 
62,239

Attrition
 
(145,227
)
 
(55,665
)
 
(200,892
)
 
(71,690
)
 
(272,582
)
Ending number of combined loans outstanding
 
140,218

 
167,045

 
307,263

 
94,173

 
401,436

Customer acquisition cost
 
$
295

 
$
237

 
$
267

 
$
238

 
$
257

Average customer loan balance
 
$
2,135

 
$
1,714

 
$
1,906

 
$
512

 
$
1,579





45



 
 
Nine Months Ended September 30, 2017
 
 
Rise
 
Elastic
 
Total Domestic
 
Sunny
 
Total
Beginning number of combined loans outstanding
 
121,996

 
89,153

 
211,149

 
78,044

 
289,193

New customer loans originated
 
74,174

 
79,159

 
153,333

 
57,189

 
210,522

Former customer loans originated
 
52,238

 

 
52,238

 

 
52,238

Attrition
 
(124,430
)
 
(41,635
)
 
(166,065
)
 
(60,309
)
 
(226,374
)
Ending number of combined loans outstanding
 
123,978

 
126,677

 
250,655

 
74,924

 
325,579

Customer acquisition cost
 
$
302

 
$
166

 
$
232

 
$
259

 
$
239

Average customer loan balance
 
$
2,269

 
$
1,764

 
$
2,014

 
$
532

 
$
1,673

Recent trends.    Our revenues for the three months ended September 30, 2018 totaled $201.5 million, up 17% versus the three months ended September 30, 2017. Additionally, a similar trend occurred for the nine months ended September 30, 2018 as revenues totaled $579.4 million, up 21% versus the prior year period. This growth in revenues was driven by an 18% increase in our average combined loans receivable - principal balance for the three month period and a 24% increase for the nine month period as we continued to expand our customer base, with the number of combined loans outstanding increasing 23% over the prior year amount. Our Rise, Elastic and Sunny products have approximately 13%, 32% and 26% more customer loans outstanding as compared to a year ago, respectively.
The growth in loan balances drove the increase in revenues for the three and nine months ended September 30, 2018. The average effective APR remained flat at 129% during the three months ended September 30, 2018 compared to the prior year period and declined to 129% during the nine months ended September 30, 2018 from 132% during the prior year period, partially offsetting the increase in revenues from growth in loan balances for the year-to-date period. The year-to-date decrease in the average effective APR resulted primarily from a shift in the mix of our loan portfolio. Elastic, which has grown significantly in volume and as a proportion of our portfolio since 2015, had an average effective APR of approximately 97% during the nine months ended September 30, 2018 compared to Rise, which had an average effective APR of approximately 138% during the nine months ended September 30, 2018.
Our CAC was slightly higher in the third quarter of 2018 as compared to the third quarter of 2017, but was still below our targeted range of $250 to $300. New customer acquisition increased only 4% in the third quarter of this year versus the third quarter in the prior year due to a delay in rolling out new credit models that would both increase new customer acquisition fund rates and lower credit losses. We believe both the new credit models to be rolled out beginning in the fourth quarter of 2018 and the FinWise partnership will result in increased new customer Rise loans during the fourth quarter of 2018. Additionally, we believe our CAC in future quarters will remain within or below our normalized range of $250 to $300 as we continue to optimize the efficiency of our marketing channels and experience increased consumer demand for our products during the last quarter of the year.




46



Credit quality
 
 
 
As of and for the three months ended September 30,
 
As of and for the nine months ended September 30,
Credit quality metrics (dollars in thousands)
 
2018
 
2017
 
2018
 
2017
Net charge-offs(1)
 
$
100,345

 
$
80,232

 
$
294,143

 
$
248,392

Additional provision for loan losses(1)
 
13,551

 
15,971

 
493

 
2,901

Provision for loan losses
 
$
113,896

 
$
96,203

 
$
294,636

 
$
251,293

Past due combined loans receivable – principal as a percentage of combined loans receivable – principal(2)(3)
 
11
%
 
11
%
 
11
%
 
11
%
Net charge-offs as a percentage of revenues(1)
 
50
%
 
46
%
 
51
%
 
52
%
Total provision for loan losses as a percentage of revenues
 
57
%
 
56
%
 
51
%
 
52
%
Combined loan loss reserve(4)
 
$
93,932

 
$
86,069

 
$
93,932

 
$
86,069

Combined loan loss reserve as a percentage of combined loans receivable(4)
 
14
%
 
15
%
 
14
%
 
15
%
_________ 
(1)
Net charge-offs and additional provision for loan losses are not financial measures prepared in accordance with US GAAP. Net charge-offs include the amount of principal and accrued interest on loans that are more than 60 days past due, or sooner if we receive notice that the loan will not be collected, such as a bankruptcy notice or identified fraud, offset by any recoveries. Additional provision for loan losses is the amount of provision for loan losses needed for a particular period to adjust the combined loan loss reserve to the appropriate level in accordance with our underlying loan loss reserve methodology. See “—Non-GAAP Financial Measures” for more information and for a reconciliation to provision for loan losses, the most directly comparable financial measure calculated in accordance with US GAAP.
(2)
Combined loans receivable is defined as loans owned by the Company plus loans originated and owned by third-party lenders. See “—Non-GAAP Financial Measures” for more information and for a reconciliation of Combined loans receivable to loans receivable, net, the most directly comparable financial measure calculated in accordance with US GAAP.
(3)
Certain amounts in the prior periods presented here have been reclassified to conform to the current period financial statement presentation related to customers within the 16 day grace period that were reported as past due that were in fact current in accordance with our policy. See Note 3—Loans Receivable and Revenue for more information regarding our policy.
(4)
Combined loan loss reserve is defined as the loan loss reserve for loans originated and owned by the Company plus the loan loss reserve for loans owned by third-party lenders and guaranteed by the Company. See “—Non-GAAP Financial Measures” for more information and for a reconciliation of Combined loan loss reserve to allowance for loan losses, the most directly comparable financial measure calculated in accordance with US GAAP.
Net principal charge-offs as a percentage of average combined loans receivable - principal (1) (2) (3)
 
First Quarter
 
Second Quarter
 
Third Quarter
 
Fourth Quarter
2018
 
13%
 
12%
 
13%
 
NA
2017
 
15%
 
14%
 
12%
 
13%
_________ 
(1)
Net principal charge-offs is comprised of gross principal charge-offs less recoveries.
(2)
Average combined loans receivable - principal is calculated using an average of daily combined loans receivable - principal balances during each quarter.
(3)
Combined loans receivable is defined as loans owned by the Company plus loans originated and owned by third-party lenders pursuant to our CSO programs. See "—Non GAAP Financial Measures" for more information and for a reconciliation of combined loans receivable to loans receivable, net, the most directly comparable financial measure calculated in accordance with US GAAP.
In reviewing the credit quality of our loan portfolio, we break out our total provision for loan losses that is presented on our statement of operations under US GAAP into two separate items—net charge-offs and additional provision for loan losses. Net charge-offs are indicative of the credit quality of our underlying portfolio, while additional provision for loan losses is subject to more fluctuation based on loan portfolio growth, recent credit quality trends and the effect of normal seasonality on our business. The additional provision for loan losses is the amount needed to adjust the combined loan loss reserve to the appropriate amount at the end of each month based on our loan loss reserve methodology.
 




47



Net charge-offs.    Net charge-offs comprise gross charge-offs offset by recoveries on prior charge-offs. Gross charge-offs include the amount of principal and accrued interest on loans that are more than 60 days past due, or sooner if we receive notice that the loan will not be collected, such as a bankruptcy notice or identified fraud. Any payments received on loans that have been charged off are recorded as recoveries and reduce the amount of gross charge-offs. Recoveries are typically less than 10% of the amount charged off, and thus, we do not view recoveries as a key credit quality metric. Historically, we have generally incurred net charge-offs as a percentage of revenues of between 42% and 59%.
Net charge-offs as a percentage of revenues can vary based on several factors, such as whether or not we experience significant growth or lower the APR of our products. Additionally, although a more seasoned portfolio will typically result in lower net charge-offs as a percentage of revenues, we do not intend to drive down this ratio significantly below our historical ratios and would instead seek to offer our existing products to a broader new customer base to drive additional revenues.
Net charge-offs as a percentage of average combined loans receivable-principal allow us to determine credit quality and evaluate loss experience trends across our loan portfolio. Over the past three years, our quarterly net charge-offs as a percentage of average combined loans receivable-principal have remained consistent and ranged from 12% to 15%, with quarterly trends based on seasonal growth of the loan portfolio.
Additional provision for loan losses.    Additional provision for loan losses is the amount of provision for loan losses needed for a particular period to adjust the combined loan loss reserve to the appropriate level in accordance with our underlying loan loss reserve methodology.
Additional provision for loan losses relates to an increase in future inherent losses in the loan portfolio as determined by our loan loss reserve methodology. This increase could be due to a combination of factors such as an increase in the size of the loan portfolio or a worsening of credit quality or increase in past due loans. It is also possible for the additional provision for loan losses for a period to be a negative amount, which would reduce the amount of the combined loan loss reserve needed (due to a decrease in the loan portfolio or improvement in credit quality). The amount of additional provision for loan losses is seasonal in nature, mirroring the seasonality of our new customer acquisition and overall loan portfolio growth, as discussed above. The combined loan loss reserve typically decreases during the first quarter or first half of the calendar year due to a decrease in the loan portfolio from year end. Then, as the rate of growth for the loan portfolio starts to increase during the second half of the year, additional provision for loan losses is typically needed to increase the reserve for future losses associated with the loan growth. Because of this, our provision for loan losses can vary significantly throughout the year without a significant change in the credit quality of our portfolio.
The following provides an example of the application of our loan loss reserve methodology and the break out of the provision for loan losses between the portion associated with replenishing the reserve due to net charge-offs and the amount related to the additional provision for loan losses. If the beginning combined loan loss reserve were $25 million, and we incurred $10 million of net charge-offs during the period and the ending combined loan loss reserve needed to be $30 million according to our loan loss reserve methodology, our total provision for loan losses would be $15 million, comprising $10 million in net charge-offs (provision needed to replenish the combined loan loss reserve) plus $5 million of additional provision related to an increase in future inherent losses in the loan portfolio identified by our loan loss reserve methodology.
 
Example (dollars in thousands)
 
  
 
  
Beginning combined loan loss reserve
 
 
 
$
25,000

Less: Net charge-offs
 
 
 
(10,000
)
Provision for loan losses:
 
 
 
 
Provision for net charge-offs
 
10,000

 
 
Additional provision for loan losses
 
5,000

 
 
Total provision for loan losses
 
 
 
15,000

Ending combined loan loss reserve balance
 
 
 
$
30,000

 




48



Loan loss reserve methodology.    Our loan loss reserve methodology is calculated separately for each product and, in the case of Rise (for non-CSO and CSO program loans), is calculated separately based on the state in which each customer resides to account for varying state license requirements that affect the amount of the loan offered, repayment terms and other factors. For each product, loss factors are calculated based on the delinquency status of customer loan balances: current, 1 to 30 days past due or 31 to 60 days past due. These loss factors for loans in each delinquency status are based on average historical loss rates by product (or state) associated with each of these three delinquency categories. Hence, another key credit quality metric we monitor is the percentage of past due combined loans receivable – principal, as an increase in past due loans will cause an increase in our combined loan loss reserve and related additional provision for loan losses to increase the reserve. For customers that are not past due, we further stratify these loans into loss rates by payment number, as a new customer that is about to make a first loan payment has a significantly higher risk of loss than a customer who has successfully made ten payments on an existing loan with us. Based on this methodology, we have historically seen our combined loan loss reserve as a percentage of combined loans receivable fluctuate between approximately 13% and 24% depending on the overall mix of new, former and past due customer loans.

Recent trends.    Total loan loss provision as a percentage of revenue for the three months ended September 30, 2018 was 57%, which was slightly above our targeted range of 45% to 55% and relatively flat with the 56% for the prior year period due to the strong growth in combined loans receivable - principal that we experienced during the third quarter of 2018. The Company typically experiences strong loan growth and a corresponding increase in total loan loss provision during the third quarter of every year. Total loan loss provision for the nine months ended September 30, 2018 was 51% of revenues, which was within our targeted range and improved slightly from the first nine months of 2017. For the three and nine months ended September 30, 2018, net charge-offs as a percentage of revenues totaled 50% and 51%, respectively, compared to 46% and 52% in the respective prior year periods. The credit quality of the portfolio has remained relatively stable compared to the prior year period. We expect loan loss provision as a percentage of revenues to return to within our targeted range due to ongoing maturation of the loan portfolio and continued improvements in our underwriting process.

The combined loan loss reserve as a percentage of combined loans receivable totaled 14%, 14% and 15% as of September 30, 2018, December 31, 2017 and September 30, 2017, respectively, reflecting consistency in our underwriting process and ongoing maturation of the loan portfolio. Past due loan balances at September 30, 2018 were 11% of total combined loans receivable - principal, consistent with a year ago.

Additionally, we also look at principal loan charge-offs (including both credit and fraud losses) by vintage as a percentage of combined loans originated - principal. As the below table shows, our cumulative principal loan charge-offs through September 30, 2018 for each annual vintage since the 2013 vintage are generally under 30% and continue to generally trend at or slightly below our 25% to 30% targeted range, with 2017 performing the best of our historical vintages. The 2018 loan vintage, while still early in its life cycle, is performing similar to the 2017 loan vintage.




49



cumulativecreditlossa07.jpg
(1) The 2018 vintage is not yet fully mature from a loss perspective.




50



Margins
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Margin metrics (dollars in thousands)
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
Revenues
 
$
201,480

 
$
172,851

 
$
579,394

 
$
479,689

Net charge-offs(1)
 
(100,345
)
 
(80,232
)
 
(294,143
)
 
(248,392
)
Additional provision for loan losses(1)
 
(13,551
)
 
(15,971
)
 
(493
)
 
(2,901
)
Direct marketing costs
 
(21,280
)
 
(20,242
)
 
(64,155
)
 
(50,322
)
Other cost of sales
 
(7,997
)
 
(5,834
)
 
(20,892
)
 
(14,367
)
Gross profit
 
58,307

 
50,572

 
199,711

 
163,707

Operating expenses
 
(45,615
)
 
(37,130
)
 
(130,674
)
 
(113,316
)
Operating income
 
$
12,692

 
$
13,442

 
$
69,037

 
$
50,391

As a percentage of revenues:
 
 
 
 
 
 
 
 
Net charge-offs
 
50
%
 
46
%
 
51
%
 
52
%
Additional provision for loan losses
 
7

 
9

 

 
1

Direct marketing costs
 
11

 
12

 
11

 
10

Other cost of sales
 
4

 
3

 
4

 
3

Gross margin
 
29

 
29

 
34

 
34

Operating expenses
 
23

 
21

 
23

 
24

Operating margin
 
6
%
 
8
%
 
12
%
 
11
%
_________ 
(1)
Non-GAAP measure. See “—Non-GAAP Financial Measures—Net charge-offs and additional provision for loan losses.”
Gross margin is calculated as revenues minus cost of sales, or gross profit, expressed as a percentage of revenues, and operating margin is calculated as operating income expressed as a percentage of revenues. We expect our margins to continue to increase as we continue to grow our business.
Recent operating margin trends.    For the three months ended September 30, 2018, our operating margin was 6%, which was lower than the 8% in the prior year period. The decrease was primarily due to higher operating expenses in the current year period, which we incurred, in part, because of additional compensation and benefits expenses related to the additional headcount associated with growing our business. Additionally, we also incurred approximately $2 million in one-time legal expenses associated with the new FinWise partnership, Today Card, and related debt facilities for those products. For the nine months ended September 30, 2018, our operating margin was 12%, which was an improvement from 11% in the prior year period. This increase was largely due to lower operating expenses as a percentage of revenue, which, in turn, were due to overall improved efficiencies as we continue to grow our business.
Direct marketing costs for the three months ended September 30, 2018 decreased slightly to 11% from 12% in the prior year period. The overall marketing spend increased $1.0 million for the three months ended September 30, 2018 as compared to the same period in 2017, but the efficiency of this spend generated a higher volume of new loans. This resulted in a quarterly CAC of $225, which is below the low end of our targeted range of $250 to $300 but slightly higher than the CAC of $222 for the same period in 2017.

Direct marketing costs increased to 11% of revenues for the nine months ended September 30, 2018 compared to 10% in the prior year period. We increased our marketing spend in the first nine months of this year to drive higher loan and revenue growth for 2018. The year-to-date marketing spend has resulted in the Company funding over 249,000 new customer loans during the first nine months of 2018, up 19% from a year ago, and at a CAC of $257, which is at the lower end of our targeted range of $250 to $300.




51



NON-GAAP FINANCIAL MEASURES
We believe that the inclusion of the following non-GAAP financial measures in this Quarterly Report on Form 10-Q can provide a useful measure for period-to-period comparisons of our core business, provide transparency and useful information to investors and others in understanding and evaluating our operating results, and enable investors to better compare our operating performance with the operating performance of our competitors. Management uses these non-GAAP financial measures frequently in its decision-making because they provide supplemental information that facilitates internal comparisons to the historical operating performance of prior periods and give an additional indication of the Company’s core operating performance. However, non-GAAP financial measures are not a measure calculated in accordance with US generally accepted accounting principles, or US GAAP, and should not be considered an alternative to any measures of financial performance calculated and presented in accordance with US GAAP. Other companies may calculate these non-GAAP financial measures differently than we do.
Adjusted EBITDA and Adjusted EBITDA Margin
Adjusted EBITDA represents our net income (loss), adjusted to exclude:
Net interest expense, primarily associated with notes payable under the VPC Facility and ESPV Facility used to fund our loans;
Share-based compensation;
Foreign currency gains and losses associated with our UK operations;
Depreciation and amortization expense on fixed assets and intangible assets;
Fair value gains and losses included in non-operating losses; and
Income taxes.
Adjusted EBITDA margin is Adjusted EBITDA divided by revenue.
Management believes that Adjusted EBITDA and Adjusted EBITDA margin are useful supplemental measures to assist management and investors in analyzing the operating performance of the business and provide greater transparency into the results of operations of our core business.
Adjusted EBITDA and Adjusted EBITDA margin should not be considered as alternatives to net income (loss) or any other performance measure derived in accordance with US GAAP. Our use of Adjusted EBITDA and Adjusted EBITDA margin has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under US GAAP. Some of these limitations are:
Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and Adjusted EBITDA does not reflect expected cash capital expenditure requirements for such replacements or for new capital assets;
Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs; and
Adjusted EBITDA does not reflect interest associated with notes payable used for funding our customer loans, for other corporate purposes or tax payments that may represent a reduction in cash available to us.




52



The following table presents a reconciliation of net income to Adjusted EBITDA and Adjusted EBITDA margin for each of the periods indicated:
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Dollars in thousands)
 
2018
 
2017
 
2018
 
2017
Net income (loss)
 
$
(4,234
)
 
$
590

 
$
8,377

 
$
5,278

Adjustments:
 
 
 
 
 
 
 
 
Net interest expense
 
19,810

 
17,261

 
58,286

 
54,602

Share-based compensation
 
2,358

 
1,649

 
6,005

 
4,436

Foreign currency transaction loss (gain)
 
325

 
(536
)
 
800

 
(2,820
)
Depreciation and amortization
 
3,490

 
2,656

 
9,167

 
7,657

Non-operating (gain) loss
 

 
106

 
38

 
(2,407
)
Income tax expense (benefit)
 
(3,209
)
 
(3,979
)
 
1,536

 
(4,262
)
Adjusted EBITDA
 
$
18,540

 
$
17,747

 
$
84,209

 
$
62,484

 
 
 
 
 
 
 
 
 
Adjusted EBITDA margin
 
9
%
 
10
%
 
15
%
 
13
%
Free cash flow
Free cash flow (“FCF”) represents our net cash provided by operating activities, adjusted to include:
Net charge-offs – combined principal loans; and
Capital expenditures.
The following table presents a reconciliation of net cash provided by operating activities to FCF for each of the periods indicated:
 
 
 
Nine Months Ended September 30,
(Dollars in thousands)
 
2018
 
2017
 
 
 
Net cash provided by operating activities(1)
 
$
257,150

 
$
209,628

Adjustments:
 
 
 
 
Net charge-offs – combined principal loans
 
(229,487
)
 
(197,388
)
Capital expenditures
 
(21,437
)
 
(12,503
)
FCF
 
$
6,226

 
$
(263
)
 _________ 
(1)
Net cash provided by operating activities includes net charge-offs – combined finance charges.
Net charge-offs and additional provision for loan losses
We break out our total provision for loan losses into two separate items—first, the amount related to net charge-offs, and second, the additional provision for loan losses needed to adjust the combined loan loss reserve to the appropriate amount at the end of each month based on our loan loss provision methodology. We believe this presentation provides more detail related to the components of our total provision for loan losses when analyzing the gross margin of our business.
 
Net charge-offs.    Net charge-offs comprise gross charge-offs offset by recoveries on prior charge-offs. Gross charge-offs include the amount of principal and accrued interest on loans that are more than 60 days past due, or sooner if we receive notice that the loan will not be collected, such as a bankruptcy notice or identified fraud. Any payments received on loans that have been charged off are recorded as recoveries and reduce the amount of gross charge-offs.




53



Additional provision for loan losses.    Additional provision for loan losses is the amount of provision for loan losses needed for a particular period to adjust the combined loan loss reserve to the appropriate level in accordance with our underlying loan loss reserve methodology.
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Dollars in thousands)
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
Net charge-offs
 
$
100,345

 
$
80,232

 
$
294,143

 
$
248,392

Additional provision for loan losses
 
13,551

 
15,971

 
493

 
2,901

Provision for loan losses
 
$
113,896

 
$
96,203

 
$
294,636

 
$
251,293

Combined loan information
The Elastic line of credit product is originated by a third party lender, Republic Bank, which initially provides all of the funding for that product. Republic Bank retains 10% of the balances of all of the loans originated and sells a 90% loan participation in the Elastic lines of credit to a third party SPV, Elastic SPV, Ltd. Elevate is required to consolidate Elastic SPV, Ltd. as a variable interest entity under US GAAP and the consolidated financial statements include revenue, losses and loans receivable related to the 90% of Elastic lines of credit originated by Republic Bank and sold to Elastic SPV.
The information presented in the tables below on a combined basis are non-GAAP measures based on a combined portfolio of loans, which includes the total amount of outstanding loans receivable that we own and that are on our balance sheet plus outstanding loans receivable originated and owned by third parties that we guarantee pursuant to CSO programs in which we participate.
We believe these non-GAAP measures provide investors with important information needed to evaluate the magnitude of potential loan losses and the opportunity for revenue performance of the combined loan portfolio on an aggregate basis. We also believe that the comparison of the combined amounts from period to period is more meaningful than comparing only the amounts reflected on our balance sheet since both revenues and cost of sales as reflected in our financial statements are impacted by the aggregate amount of loans we own and those CSO loans we guarantee.
Our use of total combined loans and fees receivable has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under US GAAP. Some of these limitations are:
Rise CSO loans are originated and owned by a third party lender; and
Rise CSO loans are funded by a third party lender and are not part of the VPC Facility.
As of each of the period ends indicated, the following table presents a reconciliation of:
Loans receivable, net, Company owned (which reconciles to our Condensed Consolidated Balance Sheets included elsewhere in this Quarterly Report on Form 10-Q);
Loans receivable, net, guaranteed by the Company (as disclosed in Note 3 of our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q);
Combined loans receivable (which we use as a non-GAAP measure); and
Combined loan loss reserve (which we use as a non-GAAP measure).
 




54



 
 
2017
 
2018
(Dollars in thousands)
 
September 30
 
December 31
 
March 31
 
June 30
 
September 30
 
 
 
 
 
 
 
 
 
 
 
Company Owned Loans:
 
 
 
 
 
 
 
 
 
 
Loans receivable – principal, current, company owned
 
$
450,891

 
$
514,147

 
$
471,996

 
$
493,908

 
$
525,717

Loans receivable – principal, past due, company owned
 
61,040

 
61,856

 
60,876

 
58,949

 
69,934

Loans receivable – principal, total, company owned
 
511,931

 
576,003

 
532,872

 
552,857

 
595,651

Loans receivable – finance charges, company owned
 
27,625

 
36,562

 
31,181

 
31,519

 
36,747

Loans receivable – company owned
 
539,556

 
612,565

 
564,053

 
584,376

 
632,398

Allowance for loan losses on loans receivable, company owned
 
(80,972
)
 
(87,946
)
 
(80,497
)
 
(76,575
)
 
(89,422
)
Loans receivable, net, company owned
 
$
458,584

 
$
524,619

 
$
483,556

 
$
507,801

 
$
542,976

Third Party Loans Guaranteed by the Company:
 
 
 
 
 
 
 
 
 
 
Loans receivable – principal, current, guaranteed by company
 
$
35,690

 
$
41,220

 
$
33,469

 
$
35,114

 
$
36,649

Loans receivable – principal, past due, guaranteed by company
 
1,267

 
1,152

 
1,123

 
1,494

 
1,661

Loans receivable – principal, total, guaranteed by company(1)
 
36,957

 
42,372

 
34,592

 
36,608

 
38,310

Loans receivable – finance charges, guaranteed by company(2)
 
2,751

 
3,093

 
2,612

 
2,777

 
3,103

Loans receivable – guaranteed by company
 
39,708

 
45,465

 
37,204

 
39,385

 
41,413

Liability for losses on loans receivable, guaranteed by company
 
(5,097
)
 
(5,843
)
 
(3,749
)
 
(3,956
)
 
(4,510
)
Loans receivable, net, guaranteed by company(2)
 
$
34,611

 
$
39,622

 
$
33,455

 
$
35,429

 
$
36,903

Combined Loans Receivable(3):
 
 
 
 
 
 
 
 
 
 
Combined loans receivable – principal, current
 
$
486,581

 
$
555,367

 
$
505,465

 
$
529,022

 
$
562,366

Combined loans receivable – principal, past due
 
62,307

 
63,008

 
61,999

 
60,443

 
71,595

Combined loans receivable – principal
 
548,888

 
618,375

 
567,464

 
589,465

 
633,961

Combined loans receivable – finance charges
 
30,376

 
39,655

 
33,793

 
34,296

 
39,850

Combined loans receivable
 
$
579,264

 
$
658,030

 
$
601,257

 
$
623,761

 
$
673,811

Combined Loan Loss Reserve(3):
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses on loans receivable, company owned
 
$
(80,972
)
 
$
(87,946
)
 
$
(80,497
)
 
$
(76,575
)
 
$
(89,422
)
Liability for losses on loans receivable, guaranteed by company
 
(5,097
)
 
(5,843
)
 
(3,749
)
 
(3,956
)
 
(4,510
)
Combined loan loss reserve
 
$
(86,069
)
 
$
(93,789
)
 
$
(84,246
)
 
$
(80,531
)
 
$
(93,932
)
Percentage past due(1)
 
11
%
 
10
%
 
11
%
 
10
%
 
11
%
Combined loan loss reserve as a percentage of combined loans receivable(3)(4)
 
15
%
 
14
%
 
14
%
 
13
%
 
14
%
Allowance for loan losses as a percentage of loans receivable – company owned
 
15
%
 
14
%
 
14
%
 
13
%
 
14
%
_________ 
(1)
Represents loans originated by third-party lenders through the CSO programs, which are not included in our condensed consolidated financial statements.
(2)
Represents finance charges earned by third-party lenders through the CSO programs, which are not included in our condensed consolidated financial statements.
(3)
Non-GAAP measure.
(4)
Combined loan loss reserve as a percentage of combined loans receivable is determined using period-end balances.

 




55



COMPONENTS OF OUR RESULTS OF OPERATIONS
Revenues
Our revenues are composed of Rise finance charges and CSO fees, finance charges on Sunny installment loans, cash advance fees attributable to the participation in Elastic lines of credit that we consolidate and marketing and licensing fees received from third-party lenders related to the Rise CSO and Elastic products. See “—Overview” above for further information on the structure of Elastic.
Cost of sales
Provision for loan losses.    Provision for loan losses consists of amounts charged against income during the period related to net charge-offs and the additional provision for loan losses needed to adjust the loan loss reserve to the appropriate amount at the end of each month based on our loan loss methodology.
Direct marketing costs.    Direct marketing costs consist of online marketing costs such as sponsored search and advertising on social networking sites, and other marketing costs such as purchased television and radio air time and direct mail print advertising. In addition, direct marketing cost includes affiliate costs paid to marketers in exchange for referrals of potential customers. All direct marketing costs are expensed as incurred.
Other cost of sales.    Other cost of sales includes data verification costs associated with the underwriting of potential customers, automated clearinghouse (“ACH”) transaction costs associated with customer loan funding and payments, and settlement expense associated with UK affordability claims.
Operating expenses
Operating expenses consist of compensation and benefits, professional services, selling and marketing, occupancy and equipment, depreciation and amortization as well as other miscellaneous expenses.
Compensation and benefits.    Salaries and personnel-related costs, including benefits, bonuses and share-based compensation expense, comprise a majority of our operating expenses and these costs are driven by our number of employees.
Professional services.    These operating expenses include costs associated with legal, accounting and auditing, recruiting and outsourced customer support and collections.
Selling and marketing.    Selling and marketing costs include costs associated with the use of agencies that perform creative services and monitor and measure the performance of the various marketing channels. Selling and marketing costs also include the production costs associated with media advertisements that are expensed as incurred over the licensing or production period. These expenses do not include direct marketing costs incurred to acquire customers, which comprises CAC.
Occupancy and equipment.    Occupancy and equipment includes rent expense on our leased facilities, as well as telephony and web hosting expenses.
Depreciation and amortization.    We capitalize all acquisitions of property and equipment of $500 or greater as well as certain software development costs. Costs incurred in the preliminary stages of software development are expensed. Costs incurred thereafter, including external direct costs of materials and services as well as payroll and payroll-related costs, are capitalized. Post-development costs are expensed. Depreciation is computed using the straight-line method over the estimated useful lives of the depreciable assets.




56



Other income (expense)
Net interest expense.    Net interest expense primarily includes the interest expense associated with the VPC Facility that funds the Rise and Sunny installment loans, and after July 1, 2015, the interest expense associated with the ESPV Facility related to the Elastic lines of credit and related Elastic SPV entity. For the nine months ended September 30, 2018, net interest expense also included amortization of the debt discount for the Convertible Term Notes.
Foreign currency transaction gain (loss).    We incur foreign currency transaction gains and losses related to activities associated with our UK entity, Elevate Credit International, Ltd., primarily with regard to the VPC Facility used to fund Sunny installment loans.
Non-operating gain (loss).    Non-operating gain (loss) primarily includes gains and losses on adjustments to the fair value of derivatives not designated as cash flow hedges.

RESULTS OF OPERATIONS
The following table sets forth our Condensed Consolidated Statements of Operations data for each of the periods indicated:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Condensed Consolidated Statements of Operations data (dollars in thousands)
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
Revenues
 
$
201,480

 
$
172,851

 
$
579,394

 
$
479,689

Cost of sales:
 
 
 
 
 
 
 
 
Provision for loan losses
 
113,896

 
96,203

 
294,636

 
251,293

Direct marketing costs
 
21,280

 
20,242

 
64,155

 
50,322

Other cost of sales
 
7,997

 
5,834

 
20,892

 
14,367

Total cost of sales
 
143,173

 
122,279

 
379,683

 
315,982

Gross profit
 
58,307

 
50,572

 
199,711

 
163,707

Operating expenses:
 
 
 
 
 
 
 
 
Compensation and benefits
 
24,380

 
19,502

 
70,187

 
60,854

Professional services
 
9,789

 
8,618

 
26,475

 
25,045

Selling and marketing
 
2,170

 
2,042

 
7,525

 
6,662

Occupancy and equipment
 
4,553

 
3,227

 
13,302

 
10,003

Depreciation and amortization
 
3,490

 
2,656

 
9,167

 
7,657

Other
 
1,233

 
1,085

 
4,018

 
3,095

Total operating expenses
 
45,615

 
37,130

 
130,674

 
113,316

Operating income
 
12,692

 
13,442

 
69,037

 
50,391

Other income (expense):
 
 
 
 
 
 
 
 
Net interest expense
 
(19,810
)
 
(17,261
)
 
(58,286
)
 
(54,602
)
Foreign currency transaction gain (loss)
 
(325
)
 
536

 
(800
)
 
2,820

Non-operating gain (loss)
 

 
(106
)
 
(38
)
 
2,407

Total other expense
 
(20,135
)
 
(16,831
)
 
(59,124
)
 
(49,375
)
Income (loss) before taxes
 
(7,443
)
 
(3,389
)
 
9,913

 
1,016

Income tax expense (benefit)
 
(3,209
)
 
(3,979
)
 
1,536

 
(4,262
)
Net income (loss)
 
$
(4,234
)
 
$
590

 
$
8,377

 
$
5,278





57



 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
As a percentage of revenues
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
Cost of sales:
 
 
 
 
 
 
 
 
Provision for loan losses
 
57
 %
 
56
 %
 
51
 %
 
52
 %
Direct marketing costs
 
11

 
12

 
11

 
10

Other cost of sales
 
4

 
3

 
4

 
3

Total cost of sales
 
71

 
71

 
66

 
66

Gross profit
 
29

 
29

 
34

 
34

Operating expenses:
 
 
 
 
 
 
 
 
Compensation and benefits
 
12

 
11

 
12

 
13

Professional services
 
5

 
5

 
5

 
5

Selling and marketing
 
1

 
1

 
1

 
1

Occupancy and equipment
 
2

 
2

 
2

 
2

Depreciation and amortization
 
2

 
2

 
2

 
2

Other
 
1

 
1

 
1

 
1

Total operating expenses
 
23

 
21

 
23

 
24

Operating income
 
6

 
8

 
12

 
11

Other income (expense):
 
 
 
 
 
 
 
 
Net interest expense
 
(10
)
 
(10
)
 
(10
)
 
(11
)
Foreign currency transaction gain (loss)
 

 

 

 
1

Non-operating gain (loss)
 

 

 

 
1

Total other expense
 
(10
)
 
(10
)
 
(10
)
 
(10
)
Income (loss) before taxes
 
(4
)
 
(2
)
 
2

 

Income tax expense (benefit)
 
(2
)
 
(2
)
 

 
(1
)
Net income (loss)
 
(2
)%
 
 %
 
1
 %
 
1
 %
Comparison of the three months ended September 30, 2018 and 2017
Revenues
 
 
 
Three Months Ended September 30,
 
 
 
 
2018
 
2017
 
Period-to-period change
(Dollars in thousands)
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage
 
 
 
Finance charges
 
$
200,416

 
99
%
 
$
170,418

 
99
%
 
$
29,998

 
18
 %
Other
 
1,064

 
1

 
2,433

 
1

 
(1,369
)
 
(56
)
Revenues
 
$
201,480

 
100
%
 
$
172,851

 
100
%
 
$
28,629

 
17
 %




58



Revenues increased by $28.6 million, or 17%, from $172.9 million for the three months ended September 30, 2017 to $201.5 million for the three months ended September 30, 2018. This growth in revenues was primarily attributable to increased finance charges driven by growth in our average loan balances as illustrated in the tables below. Over time, we expect our overall effective APR of our loan portfolio to decrease as our loan portfolio continues to grow and mature with more existing and repeat customers who pay lower interest rates over time. The decrease in Other revenues is due primarily to a decrease in marketing and licensing fees related to the Rise CSO programs.
The tables below break out this change in revenue (including CSO fees and cash advance fees) by product:
 
 
 
Three Months Ended September 30, 2018
(Dollars in thousands)
 
Rise(1)
 
Elastic
 
Total
Domestic
 
Sunny
 
Total
 
 
 
Average combined loans receivable – principal(2)
 
$
293,312

 
$
270,701

 
$
564,013

 
$
52,349

 
$
616,362

Effective APR
 
139
%
 
96
%
 
119
%
 
242
%
 
129
%
Finance charges
 
$
102,787

 
$
65,676

 
$
168,463

 
$
31,953

 
$
200,416

Other
 
405

 
600

 
1,005

 
59

 
1,064

Total revenue
 
$
103,192

 
$
66,276

 
$
169,468

 
$
32,012

 
$
201,480

 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2017
(Dollars in thousands)
 
Rise(1)
 
Elastic
 
Total
Domestic
 
Sunny
 
Total
 
 
 
Average combined loans receivable – principal(2)
 
$
265,075

 
$
215,677

 
$
480,752

 
$
42,700

 
$
523,452

Effective APR
 
138
%
 
96
%
 
119
%
 
240
%
 
129
%
Finance charges
 
$
92,331

 
$
52,261

 
$
144,592

 
$
25,826

 
$
170,418

Other
 
1,708

 
604

 
2,312

 
121

 
2,433

Total revenue
 
$
94,039

 
$
52,865

 
$
146,904

 
$
25,947

 
$
172,851


 _________
(1) Includes loans originated by third party lenders through the CSO programs, which are not included in the Company’s condensed consolidated financial statements.
(2) Average combined loans receivable - principal is calculated using daily principal balances. Not a financial measure prepared in accordance with US GAAP. See reconciliation table accompanying this release for a reconciliation of non-GAAP financial measures to the most directly comparable financial measure calculated in accordance with US GAAP.

During the three months ended September 30, 2018, our average combined loans receivable – principal increased $92.9 million compared to the prior year period as we continued to market our Rise, Sunny and Elastic products in the US and UK. As a result of the increased average combined loans receivable – principal, finance charges increased $30.2 million during the three months ended September 30, 2018 compared to the same prior year period, which is the primary driver for the change in revenues, partially offset by change in product mix. We expect the trend of increasing average combined loans receivable - principal and lower average APR to continue.





59



Cost of sales
 
 
 
Three Months Ended September 30,
 
Period-to-period
change
 
 
2018
 
2017
 
(Dollars in thousands)
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage
 
 
 
Cost of sales:
 
 
 
 
 
 
 
 
 
 
 
 
Provision for loan losses
 
$
113,896

 
57
%
 
$
96,203

 
56
%
 
$
17,693

 
18
%
Direct marketing costs
 
21,280

 
11

 
20,242

 
12

 
1,038

 
5

Other cost of sales
 
7,997

 
4

 
5,834

 
3

 
2,163

 
37

Total cost of sales
 
$
143,173

 
71
%
 
$
122,279

 
71
%
 
$
20,894

 
17
%
Provision for loan losses.    Provision for loan losses increased by $17.7 million, or 18%, from $96.2 million for the three months ended September 30, 2017 to $113.9 million for the three months ended September 30, 2018 primarily due to a $20.1 million increase in net charge-offs resulting from an increase in the overall loan portfolio. This increase was partially offset by a decrease of $2.4 million in the additional provision for loan losses due to a slight decline in the combined loan loss reserve as a percentage of combined loans receivable, which, in turn, was due to stable credit quality and the continued maturation of the loan portfolio.
The tables below break out these changes by loan product:
 
 
Three Months Ended September 30, 2018
(Dollars in thousands)
 
Rise
 
Elastic
 
Total
Domestic
 
Sunny
 
Total
 
 
 
Combined loan loss reserve(1):
 
 
 
 
 
 
 
 
 
 
Beginning balance
 
$
40,796

 
$
29,394

 
$
70,190

 
$
10,341

 
$
80,531

Net charge-offs
 
(53,990
)
 
(33,103
)
 
(87,093
)
 
(13,252
)
 
(100,345
)
Provision for loan losses
 
61,716

 
38,243

 
99,959

 
13,937

 
113,896

Effect of foreign currency
 

 

 

 
(150
)
 
(150
)
Ending balance
 
$
48,522

 
$
34,534

 
$
83,056

 
$
10,876

 
$
93,932

Combined loans receivable(1)(2)
 
$
322,266

 
$
298,564

 
$
620,830

 
$
52,981

 
$
673,811

Combined loan loss reserve as a percentage of ending combined loans receivable
 
15
%
 
12
%
 
13
%
 
21
%
 
14
%
Net charge-offs as a percentage of revenues
 
52
%
 
50
%
 
51
%
 
41
%
 
50
%
Provision for loan losses as a percentage of revenues
 
60
%
 
58
%
 
59
%
 
44
%
 
57
%





60



 
 
Three Months Ended September 30, 2017
(Dollars in thousands)
 
Rise
 
Elastic
 
Total
Domestic
 
Sunny
 
Total
 
 
 
Combined loan loss reserve(1):
 
 
 
 
 
 
 
 
 
 
Beginning balance
 
$
41,029

 
$
20,686

 
$
61,715

 
$
8,125

 
$
69,840

Net charge-offs
 
(46,833
)
 
(24,691
)
 
(71,524
)
 
(8,708
)
 
(80,232
)
Provision for loan losses
 
55,560

 
31,807

 
87,367

 
8,836

 
96,203

Effect of foreign currency
 

 

 

 
258

 
258

Ending balance
 
$
49,756

 
$
27,802

 
$
77,558

 
$
8,511

 
$
86,069

Combined loans receivable(1)(2)
 
$
301,323

 
$
234,853

 
$
536,176

 
$
43,088

 
$
579,264

Combined loan loss reserve as a percentage of ending combined loans receivable
 
17
%
 
12
%
 
14
%
 
20
%
 
15
%
Net charge-offs as a percentage of revenues
 
50
%
 
47
%
 
49
%
 
34
%
 
46
%
Provision for loan losses as a percentage of revenues
 
59
%
 
60
%
 
59
%
 
34
%
 
56
%

 _________

1.
Not a financial measure prepared in accordance with US GAAP. See “—Non-GAAP Financial Measures” for more information and for a reconciliation to the most directly comparable financial measure calculated in accordance with US GAAP.
2.Includes loans originated by third-party lenders through the CSO programs, which are not included in our financial statements.
Net charge-offs increased $20.1 million for the three months ended September 30, 2018 compared to the three months ended September 30, 2017, due to the overall loan growth in the portfolio. Net charge-offs as a percentage of revenues for the three months ended September 30, 2018 was 50%, an increase from 46% for the comparable period in 2017. Loan loss provision for the three months ended September 30, 2018 totaled 57% of revenues, slightly higher than 56% for the three months ended September 30, 2017. The credit quality of the portfolio has remained relatively stable compared to the prior year period.
Direct marketing costs.    Direct marketing costs increased by $1.0 million, or 5%, from $20.2 million for the three months ended September 30, 2017 to $21.3 million for the three months ended September 30, 2018. For the three months ended September 30, 2018, the number of new customers acquired increased to 94,526 compared to 91,081 during the three months ended September 30, 2017. The resulting CAC increased by $3, or 1%, increasing to $225 from $222 in the prior year period. The overall CAC for the three months ended September 30, 2018 continued to be below the lower end of our targeted range of $250 to $300.

Other cost of sales.    Other cost of sales increased by $2.2 million, or 37%, from $5.8 million for the three months ended September 30, 2017 to $8.0 million for the three months ended September 30, 2018 primarily due to increased affordability claim settlement expense of $3.0 million related to the Sunny product.




61



Operating expenses
 
 
 
Three Months Ended September 30,
 
Period-to-period
change
 
 
2018
 
2017
 
(Dollars in thousands)
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
Compensation and benefits
 
$
24,380

 
12
%
 
$
19,502

 
11
%
 
$
4,878

 
25
%
Professional services
 
9,789

 
5

 
8,618

 
5

 
1,171

 
14

Selling and marketing
 
2,170

 
1

 
2,042

 
1

 
128

 
6

Occupancy and equipment
 
4,553

 
2

 
3,227

 
2

 
1,326

 
41

Depreciation and amortization
 
3,490

 
2

 
2,656

 
2

 
834

 
31

Other
 
1,233

 
1

 
1,085

 
1

 
148

 
14

Total operating expenses
 
$
45,615

 
23
%
 
$
37,130

 
21
%
 
$
8,485

 
23
%
Compensation and benefits.    Compensation and benefits increased by $4.9 million, or 25%, from $19.5 million for the three months ended September 30, 2017 to $24.4 million for the three months ended September 30, 2018 primarily due to an increase in the number of employees as we continue to grow our business.
Professional services.     Professional services increased by $1.2 million, or 14%, from $8.6 million for the three months ended September 30, 2017 to $9.8 million for the three months ended September 30, 2018 primarily due to increased legal expenses related to several Company initiatives.
Occupancy and equipment.    Occupancy and equipment increased by $1.3 million, or 41%, from $3.2 million for the three months ended September 30, 2017 to $4.6 million for the three months ended September 30, 2018 primarily due to increased licenses and rent expense needed to support an increased number of employees as we continue to grow our business.
Depreciation and amortization.     Depreciation and amortization increased by $0.8 million, or 31%, from $2.7 million for the three months ended September 30, 2017 to $3.5 million for the three months ended September 30, 2018 primarily due to increased property and equipment.

Net interest expense
 
 
 
Three Months Ended September 30,
 
Period-to-period
change
 
 
2018
 
2017
 
(Dollars in thousands)
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage
 
 
 
Net interest expense
 
$
19,810

 
10
%
 
$
17,261

 
10
%
 
$
2,549

 
15
%
Net interest expense increased $2.5 million, or 15%, during the three months ended September 30, 2018 as compared to the prior year period. At September 30, 2017, we had an average balance of $467.8 million in notes payable outstanding under our debt facilities, which increased to $538.1 million at September 30, 2018, resulting in additional interest expense of approximately $2.6 million, partially offset by the impact of a slightly lower interest rate for the three months ended September 30, 2018 as compared to the prior year period. In January 2018, the Company entered into interest rate caps, which cap 3-month LIBOR at 1.75%, to mitigate the floating interest rate risk on $240 million of the US Term Notes included in the VPC Facility and on $216 million of the ESPV Facility. Our average effective interest rate on our notes payable outstanding has remained consistent at 14.6% for the three months ended September 30, 2018 and 2017.




62



The following table shows the effective cost of funds of each debt facility for the period:
 
 
Three Months Ended September 30,
(Dollars in thousands)
 
2018
 
2017
 
 
 
 
 
VPC Facility
 
 
 
 
Average facility balance during the period
 
$
313,610

 
$
279,915

Net interest expense
 
11,235

 
10,435

Effective cost of funds
 
14.2
%
 
14.8
%
 
 
 
 
 
ESPV Facility
 
 
 
 
Average facility balance during the period
 
$
224,456

 
$
187,859

Net interest expense
 
8,575

 
6,826

Effective cost of funds
 
15.2
%
 
14.4
%
Foreign currency transaction (loss) gain
During the three months ended September 30, 2018, we realized a $0.3 million loss in foreign currency remeasurement primarily related to a portion of the debt facility that our UK entity, Elevate Credit International, Ltd., has with a third party lender, VPC, which is denominated in US dollars. The foreign currency remeasurement gain for the three months ended September 30, 2017 was $0.5 million.
Non-operating loss
During the three months ended September 30, 2017, we recognized non-operating losses related to the change in fair value on the embedded derivative in the Convertible Term Notes as discussed in Note 8Fair Value Measurements in the Condensed Consolidated Financial Statements. No non-operating gains or losses were recognized in the three months ended September 30, 2018.

Income tax benefit
 
 
Three Months Ended September 30,
 
Period-to-period
change
 
 
2018
 
2017
 
(Dollars in thousands)
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage
 
 
 
Income tax benefit
 
$
(3,209
)
 
(2
)%
 
$
(3,979
)
 
(2
)%
 
$
(770
)
 
19
%
Our income tax benefit decreased $0.8 million, or 19%, from a $4.0 million benefit for the three months ended September 30, 2017 to $3.2 million benefit for the three months ended September 30, 2018. Our consolidated effective tax rates for the three months ended September 30, 2018 and 2017 were 43% and 117%, respectively. Our effective tax rates are different from the standard corporate federal income tax rate of 21% in the US and 19% in the UK primarily due to our permanent non-deductible and discrete tax items. In addition, in the US, our effective tax rate is impacted by corporate state tax obligations in the states where we have lending activities. The Company's US cash effective tax rate was approximately 1% for the third quarter of 2018. Our UK operations have generated net operating losses which have a full valuation allowance provided due to the lack of sufficient objective evidence regarding the realizability of this asset. Therefore, no UK deferred tax benefit has been recognized in the financial statements for the three months ended September 30, 2018 and 2017.




63



Net income (loss)
 
 
 
Three Months Ended September 30,
 
Period-to-period
change
 
 
2018
 
2017
 
(Dollars in thousands)
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage
 
 
 
Net income (loss)
 
$
(4,234
)
 
(2
)%
 
$
590

 
%
 
$
(4,824
)
 
(818
)%
Our net income (loss) decreased $4.8 million, from net income of $0.6 million for the three months ended September 30, 2017 to a net loss of $4.2 million for the three months ended September 30, 2018 due to increases in gross profit offset by higher operating expenses and interest expense, as mentioned above.
Comparison of the nine months ended September 30, 2018 and 2017
Revenues
 
 
 
Nine Months Ended September 30,
 
Period-to-period
change
 
 
2018
 
2017
 
(Dollars in thousands)
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage
 
 
 
Finance charges
 
$
576,068

 
99
%
 
$
474,803

 
99
%
 
$
101,265

 
21
 %
Other
 
3,326

 
1

 
4,886

 
1

 
(1,560
)
 
(32
)
Revenues
 
$
579,394

 
100
%
 
$
479,689

 
100
%
 
$
99,705

 
21
 %
Revenues increased by $99.7 million, or 21%, from $479.7 million for the nine months ended September 30, 2017 to $579.4 million for the nine months ended September 30, 2018. This growth in revenues was primarily attributable to increased finance charges driven by growth in our average loan balances, partially offset by a decrease in our overall APR, as illustrated in the tables below. Over time, we expect our average customer loan balance to continue to increase and the related overall effective APR of our loan portfolio to decrease as our loan portfolio continues to grow and mature with more existing and repeat customers who pay lower interest rates over time.




64



The tables below break out this change in revenue (including CSO acquisition fees and cash advance fees) by product:
 
 
 
Nine Months Ended September 30, 2018
(Dollars in thousands)
 
Rise(1)
 
Elastic
 
Total
Domestic
 
Sunny
 
Total
 
 
 
Average combined loans receivable – principal(2)
 
$
290,828

 
$
253,648

 
$
544,476

 
$
52,098

 
$
596,574

Effective APR
 
138
%
 
97
%
 
119
%
 
235
%
 
129
%
Finance charges
 
$
300,711

 
$
183,877

 
$
484,588

 
$
91,480

 
$
576,068

Other
 
1,670

 
1,425

 
3,095

 
231

 
3,326

Total revenue
 
$
302,381

 
$
185,302

 
$
487,683

 
$
91,711

 
$
579,394

 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2017
(Dollars in thousands)
 
Rise(1)
 
Elastic
 
Total
Domestic
 
Sunny
 
Total
 
 
 
Average combined loans receivable – principal(2)
 
$
247,339

 
$
191,006

 
$
438,345

 
$
42,915

 
$
481,260

Effective APR
 
141
%
 
96
%
 
122
%
 
235
%
 
132
%
Finance charges
 
$
261,499

 
$
137,841

 
$
399,340

 
$
75,463

 
$
474,803

Other
 
3,265

 
1,385

 
4,650

 
236

 
4,886

Total revenue
 
$
264,764

 
$
139,226

 
$
403,990

 
$
75,699

 
$
479,689

 _________
(1) Includes loans originated by third party lenders through the CSO programs, which are not included in the Company’s condensed consolidated financial statements.
(2) Average combined loans receivable - principal is calculated using daily principal balances. Not a financial measure prepared in accordance with US GAAP. See reconciliation table accompanying this release for a reconciliation of non-GAAP financial measures to the most directly comparable financial measure calculated in accordance with US GAAP.

During the nine months ended September 30, 2018, our average combined loans receivable – principal increased $115.3 million compared to the prior year period as we continued to market our Rise, Sunny and Elastic products in the US and UK. As a result of the increased average combined loans receivable – principal, finance charges increased $111.3 million during the nine months ended September 30, 2018 compared to the same prior year period. We expect this trend of increasing average combined loans receivable – principal year-over-year and lower average APR to continue. This increase was offset by a decrease of $10.8 million due to a reduction in our average APR due to the strong growth in Elastic, which has the lowest APR of the three products and as the Rise and Sunny installment loan portfolios continue to mature and existing customers continue to receive lower rates on subsequent loans. The remaining increase was due to product mix partially offset by changes in the US dollar to British pound exchange rate.





65



Cost of sales
 
 
 
Nine Months Ended September 30,
 
Period-to-period
change
 
 
2018
 
2017
 
(Dollars in thousands)
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage
 
 
 
Cost of sales:
 
 
 
 
 
 
 
 
 
 
 
 
Provision for loan losses
 
$
294,636

 
51
%
 
$
251,293

 
52
%
 
$
43,343

 
17
%
Direct marketing costs
 
64,155

 
11

 
50,322

 
10

 
13,833

 
27

Other cost of sales
 
20,892

 
4

 
14,367

 
3

 
6,525

 
45

Total cost of sales
 
$
379,683

 
66
%
 
$
315,982

 
66
%
 
$
63,701

 
20
%
Provision for loan losses.    Provision for loan losses increased by $43.3 million, or 17%, from $251.3 million for the nine months ended September 30, 2017 to $294.6 million for the nine months ended September 30, 2018 primarily due to a $45.8 million increase in net charge-offs resulting from an increase in the overall loan portfolio.
The tables below break out these changes by loan product:
 
 
Nine Months Ended September 30, 2018
(Dollars in thousands)
 
Rise
 
Elastic
 
Total
Domestic
 
Sunny
 
Total
 
 
 
Combined loan loss reserve(1):
 
 
 
 
 
 
 
 
 
 
Beginning balance
 
$
55,867

 
$
28,870

 
$
84,737

 
$
9,052

 
$
93,789

Net charge-offs
 
(166,931
)
 
(91,278
)
 
(258,209
)
 
(35,934
)
 
(294,143
)
Provision for loan losses
 
159,586

 
96,942

 
256,528

 
38,108

 
294,636

Effect of foreign currency
 

 

 

 
(350
)
 
(350
)
Ending balance
 
$
48,522

 
$
34,534

 
$
83,056

 
$
10,876

 
$
93,932

Combined loans receivable(1)(2)
 
$
322,266

 
$
298,564

 
$
620,830

 
$
52,981

 
$
673,811

Combined loan loss reserve as a percentage of ending combined loans receivable
 
15
%
 
12
%
 
13
%
 
21
%
 
14
%
Net charge-offs as a percentage of revenues
 
55
%
 
49
%
 
53
%
 
39
%
 
51
%
Provision for loan losses as a percentage of revenues
 
53
%
 
52
%
 
53
%
 
42
%
 
51
%





66



 
 
Nine Months Ended September 30, 2017
(Dollars in thousands)
 
Rise
 
Elastic
 
Total
Domestic
 
Sunny
 
Total
 
 
 
Combined loan loss reserve(1):
 
 
 
 
 
 
 
 
 
 
Beginning balance
 
$
53,336

 
$
19,389

 
$
72,725

 
$
9,651

 
$
82,376

Net charge-offs
 
(149,509
)
 
(68,630
)
 
(218,139
)
 
(30,253
)
 
(248,392
)
Provision for loan losses
 
145,929

 
77,043

 
222,972

 
28,321

 
251,293

Effect of foreign currency
 

 

 

 
792

 
792

Ending balance
 
$
49,756

 
$
27,802

 
$
77,558

 
$
8,511

 
$
86,069

Combined loans receivable(1)(2)
 
$
301,323

 
$
234,853

 
$
536,176

 
$
43,088

 
$
579,264

Combined loan loss reserve as a percentage of ending combined loans receivable
 
17
%
 
12
%
 
14
%
 
20
%
 
15
%
Net charge-offs as a percentage of revenues
 
56
%
 
49
%
 
54
%
 
40
%
 
52
%
Provision for loan losses as a percentage of revenues
 
55
%
 
55
%
 
55
%
 
37
%
 
52
%
 _________
1.
Not a financial measure prepared in accordance with GAAP. See “—Non-GAAP Financial Measures” for more information and for a reconciliation to the most directly comparable financial measure calculated in accordance with GAAP.
2.
Includes loans originated by third-party lenders through the CSO programs, which are not included in our financial statements.
Net charge-offs increased $45.8 million for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017, primarily due to loan growth in all three products during 2018. Net charge-offs as a percentage of revenues for the nine months ended September 30, 2018 was 51%, a decrease from 52% for the comparable period in 2017. Total loan loss provision for the nine months ended September 30, 2018 was 51% of revenues as compared to 52% of revenue for the nine months ended September 30, 2017, which was within our targeted range of 45% to 55%.
Direct marketing costs.    Direct marketing costs increased 27% for the nine months ended September 30, 2018 compared to the same period in 2017. This increase was primarily due to an increase in the number of new customers acquired, which increased to 249,807 compared to 210,522 during the nine months ended September 30, 2017. The resulting CAC increased to $257 from $239 in the prior year period. We expect marketing expenses to remain within or below our targeted range of $250 to $300 as we continue to optimize the efficiency of our marketing channels in the last quarter of 2018.

Other cost of sales.    Other cost of sales increased by $6.5 million, or 45%, from $14.4 million for the nine months ended September 30, 2017 to $20.9 million for the nine months ended September 30, 2018 due to increased data verification costs incurred from the higher new loan volume for all products and increased affordability claim settlement expenses primarily related to the Sunny product.




67



Operating expenses
 
 
 
Nine Months Ended September 30,
 
Period-to-period
change
 
 
2018
 
2017
 
(Dollars in thousands)
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage
 
 
 
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
Compensation and benefits
 
$
70,187

 
12
%
 
$
60,854

 
13
%
 
$
9,333

 
15
%
Professional services
 
26,475

 
5

 
25,045

 
5

 
1,430

 
6

Selling and marketing
 
7,525

 
1

 
6,662

 
1

 
863

 
13

Occupancy and equipment
 
13,302

 
2

 
10,003

 
2

 
3,299

 
33

Depreciation and amortization
 
9,167

 
2

 
7,657

 
2

 
1,510

 
20

Other
 
4,018

 
1

 
3,095

 
1
%
 
923

 
30

Total operating expenses
 
$
130,674

 
23
%
 
$
113,316

 
24
%
 
$
17,358

 
15
%
Compensation and benefits.    Compensation and benefits increased by $9.3 million, or 15%, from $60.9 million for the nine months ended September 30, 2017 to $70.2 million for the nine months ended September 30, 2018 primarily due to increased share-based compensation expenses and an increase in the number of employees as we continue to grow our business.
Professional services.     Professional services increased by $1.4 million, or 6%, from $25.0 million for the nine months ended September 30, 2017 to $26.5 million for the nine months ended September 30, 2018 due to increased legal costs related to several Company initiatives.
Selling and marketing.    Selling and marketing increased by $0.9 million, or 13%, from $6.7 million for the nine months ended September 30, 2017 to $7.5 million for the nine months ended September 30, 2018 primarily due to increased agency spend associated with television campaigns.
Occupancy and equipment.    Occupancy and equipment increased by $3.3 million, or 33%, from $10.0 million for the nine months ended September 30, 2017 to $13.3 million for the nine months ended September 30, 2018 primarily due to increased licenses and rent expense needed to support an increased number of employees as we continue to grow our business.
Depreciation and amortization.     Depreciation and amortization increased by $1.5 million, or 20%, from $7.7 million for the nine months ended September 30, 2017 to $9.2 million for the nine months ended September 30, 2018 primarily due to increased property and equipment.
Other expenses.    Other expenses increased by $0.9 million, or 30%, from $3.1 million for the nine months ended September 30, 2017 to $4.0 million for the nine months ended September 30, 2018 due to costs associated with growing our business.
 




68



 Net interest expense
 
 
 
Nine Months Ended September 30,
 
Period-to-period
change
 
 
2018
 
2017
 
(Dollars in thousands)
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage
 
 
 
Net interest expense
 
$
58,286

 
10
%
 
$
54,602

 
11
%
 
$
3,684

 
7
%
Net interest expense increased $3.7 million, or 7%, during the nine months ended September 30, 2018 versus the nine months ended September 30, 2017 as we borrowed more debt from our third party lender, VPC, to continue to fund Rise, Elastic and Sunny loan growth, as well as working capital for general corporate purposes. At September 30, 2017, we had $478.1 million in notes payable outstanding under these debt facilities, which increased to $549.5 million at September 30, 2018 primarily related to growth in our loan portfolio. In January 2018, the Company entered into interest rate caps, which cap 3-month LIBOR at 1.75%, to mitigate the floating interest rate risk on $240 million of the US Term Notes included in the VPC Facility and on $216 million of the ESPV Facility. In April 2017, substantially all of the net proceeds from the IPO were used to repay a portion of the outstanding amount of debt under the VPC Facility, thus reducing future net interest expense. In addition, $2.7 million of interest expense related to the amortization of the debt discount associated with the Convertible Term Notes was recognized for the nine months ended September 30, 2017. Of this amount, $2.0 million related to the $14.9 million repayment on the Convertible Term Notes.
The following table shows the effective cost of funds of each debt facility for the period:
 
 
Nine Months Ended September 30,
(Dollars in thousands)
 
2018
 
2017
 
 
 
 
 
VPC Facility
 
 
 
 
Average facility balance during the period
 
$
309,199

 
$
312,125

Net interest expense
 
33,553

 
36,881

Less: acceleration of debt discount associated with the repayment of the Convertible Term Note
 

 
(1,974
)
Net interest expense, as adjusted
 
$
33,553

 
$
34,907

Effective cost of funds
 
14.5
%
 
15.8
%
Effective cost of funds, as adjusted
 
14.5
%
 
15.0
%
 
 
 
 
 
ESPV Facility
 
 
 
 
Average facility balance during the period
 
$
218,557

 
$
165,585

Net interest expense
 
24,733

 
17,721

Effective cost of funds
 
15.1
%
 
14.3
%
Foreign currency transaction (loss) gain
During the nine months ended September 30, 2018, we realized a $0.8 million loss on foreign currency remeasurement primarily related to the debt facility that our UK entity, Elevate Credit International, Ltd., has with a third party lender, VPC, which is denominated in US dollars. The foreign currency remeasurement gain for the nine months ended September 30, 2017 was $2.8 million.




69



Non-operating gain (loss)
During the nine months ended September 30, 2018, we recognized non-operating losses related to the change in fair value on the embedded derivative in the Convertible Term Notes as discussed in Note 8—Fair Value Measurements in the Condensed Consolidated Financial Statements. During the nine months ended September 30, 2017, we recognized $2.7 million in non-operating income related to the change in fair value on the embedded derivative in the Convertible Term Notes, primarily related to the reduction of the derivative liability associated with the $14.9 million repayment on the Convertible Term Notes. In addition, we recognized $0.3 million losses related to mark-to-market adjustments.

Income tax expense (benefit)
 
 
Nine Months Ended September 30,
 
Period-to-period
change
 
 
2018
 
2017
 
(Dollars in thousands)
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage
 
 
 
Income tax expense (benefit)
 
$
1,536

 
%
 
$
(4,262
)
 
(1
)%
 
$
(5,798
)
 
136
%
Our income tax expense increased $5.8 million, from a benefit of $4.3 million for the nine months ended September 30, 2017 to an expense of $1.5 million for the nine months ended September 30, 2018. Our consolidated effective tax rates for the nine months ended September 30, 2018 and 2017 was 15% and negative 419%, respectively. Our consolidated effective tax rates are different from the 2018 and 2017 standard corporate federal income tax rates of 21% and 35%, respectively, in the US and 19% in the UK primarily due to our permanent non-deductible and discrete tax items. In addition, in the US, our effective tax rate is impacted by corporate state tax obligations in the states where we have lending activities. The Company's US cash effective tax rate was approximately 1% for the first nine months of 2018. Our UK operations have generated net operating losses which have a full valuation allowance provided due to the lack of sufficient objective evidence regarding the realizability of this asset. Therefore, no UK deferred tax benefit has been recognized in the financial statements for the nine months ended September 30, 2018 and 2017.
Net income
 
 
 
Nine Months Ended September 30,
 
Period-to-period
change
 
 
2018
 
2017
 
(Dollars in thousands)
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage of
revenues
 
Amount
 
Percentage
 
 
 
Net income
 
$
8,377

 
1
%
 
$
5,278

 
1
%
 
$
3,099

 
59
%
Our net income increased $3.1 million, from $5.3 million for the nine months ended September 30, 2017 to $8.4 million for the nine months ended September 30, 2018. This increase was due to an increase in revenue that resulted from an increase in our overall loan portfolio in addition to improved efficiencies as we continue to grow our business.







70



LIQUIDITY AND CAPITAL RESOURCES
We principally rely on our working capital, funds from third party lenders under the CSO programs, and our credit facility with VPC to fund the loans we make to our customers.

Debt Facilities

VPC Facility
On January 30, 2014, we entered into the VPC Facility in order to fund our Rise and Sunny products and provide working capital. Since originally entering into the VPC Facility, it has been amended several times to increase the maximum total borrowing amount available and other terms of the VPC Facility.
The VPC Facility provided the following term notes as of September 30, 2018:
US Term Note with a maximum borrowing amount of $350 million at a base rate (defined as the 3-month LIBOR with a 1% floor) plus 11% for the outstanding balance used to fund the Rise loan portfolio. The Company entered into an interest rate cap on January 11, 2018 to mitigate the floating rate interest risk on the $240 million outstanding as of September 30, 2018. In addition to VPC, which has committed $290 million to this facility, there are currently three other lenders that have committed $20 million each to this facility.
UK Term Note with a maximum borrowing amount of approximately $48 million at a base rate (defined as the 3-month LIBOR rate) plus 14% used to fund the Sunny loan portfolio.
4th Tranche Term Note with a maximum borrowing amount of $35 million bearing interest at a base rate (defined as the 3-month LIBOR, with a 1% floor) plus 13% used to fund working capital.
There are no principal payments due or scheduled under the VPC Facility until the maturity date of the US Term Note, the UK Term Note and the 4th Tranche Term Note on February 1, 2021.
All of our assets are pledged as collateral to secure the VPC Facility. The agreement contains customary financial covenants, including a maximum loan to value ratio of between 0.75 and 0.85, depending on the actual charge-off rate as of the relevant measurement date, a maximum principal charge-off rate of not greater than 20%, determined by the product of the ratio of principal balances charged-off or past due to principal balances due for the current, 1-30 and 31-60 delinquency status periods determined as of the month of charge-off and the preceding two month period, and a maximum first payment default rate of not greater than 20% for any month and not greater than 17.5% for any two months during any three month period. Additionally, our corporate cash balance must exceed $5 million at all times, and the book value of the equity must exceed $5 million as of the last day of any calendar month. We were in compliance with all covenants as of September 30, 2018.
ESPV Facility

Elastic funding
The Elastic line of credit product is originated by a third-party lender, Republic Bank, which initially provides all of the funding for that product. Republic Bank retains 10% of the balances of all loans originated and sells a 90% loan participation in the Elastic lines of credit.




71



Elastic SPV structure
As of July 1, 2015, loan participations are sold by Republic Bank to Elastic SPV. We do not own Elastic SPV, but effective July 1, 2015 we entered into a credit default protection agreement with Elastic SPV whereby we agreed to provide credit protection to the investors in Elastic SPV against Elastic loan losses in return for a credit premium. Per the terms of the agreement, under US GAAP, the Company qualifies as the primary beneficiary of Elastic SPV and we are required to consolidate the financial results of Elastic SPV as a variable interest entity in our consolidated financial results. Accordingly, the presentation of this structure does not differ from the presentation of the previous structure reflected in our financial statements, as we continue to earn revenues and incur losses on 90% of the Elastic lines of credit originated by Republic Bank that are sold to Elastic SPV.
Elastic SPV receives its funding from VPC in the ESPV Facility, which was finalized on July 13, 2015. The ESPV Facility provides for a maximum borrowing amount of $50 million at a base rate (defined as the greater of the 3-month LIBOR rate or 1% per annum) plus 13% for the outstanding balance up to $50 million. To continue to fund Elastic growth, as of October 21, 2015, the maximum borrowing amount was expanded to $100 million at a base rate plus 12% for any outstanding balance greater than $50 million. On July 14, 2016, the ESPV Facility was further amended, providing a credit facility with a maximum borrowing amount of $150 million. Interest is charged at a base rate (defined as the greater of the 3-month LIBOR rate or 1% per annum) plus 13% for the outstanding balance up to $50 million, 12% for the outstanding balance greater than $50 million, and 13.5% for the outstanding balance greater than $100 million.
On April 27, 2017, the ESPV Facility was further amended to increase the borrowing base to $250 million, decrease each of the interest rates by 1.0% effective July 1, 2019 and add a base rate (defined as the greater of the 3-month LIBOR or 1% per annum) plus 12.75% for borrowing amounts greater than $150 million, which will decrease to the base rate plus 11.75% effective July 1, 2019. The amendment also extended the maturity date for the ESPV Facility, to July 1, 2021. The Company entered into an interest rate cap on January 11, 2018 to mitigate the floating rate interest risk on the $216 million of the $235 million outstanding as of September 30, 2018. As of September 30, 2018, the base rate of the ESPV Facility was 1.75% per annum for the outstanding balance. There are no principal payments due or scheduled until the credit facility maturity date of July 1, 2021.
All of our assets are pledged as collateral to secure the ESPV Facility. The agreement contains customary financial covenants, including a maximum loan to value ratio of between 0.75 and 0.85, depending on the actual charge off rate as of the relevant measurement date, a maximum principal charge-off rate of not greater than 20%, determined by the product of the ratio of principal balances charged-off or past due to principal balances due for the current, 1-30 and 31-60 delinquency status periods determined as of the month of charge-off and the preceding two month period, and a maximum first payment default rate of not greater than 15% for any one calendar month and for two months during any three month period. We were in compliance with all covenants as of September 30, 2018.
Outstanding Notes Payable
The outstanding balance of notes payable as of September 30, 2018 is as follows:
(Dollars in thousands)
 
September 30, 2018
US Term Note bearing interest at 3-month LIBOR + 11%
 
$
240,000

UK Term Note bearing interest at 3-month LIBOR + 14%
 
39,481

4th Tranche Term Note bearing interest at 3-month LIBOR + 13%
 
35,050

ESPV Term Note bearing interest at 3-month LIBOR + 12-13.5%
 
235,000

Total
 
549,531





72



The following table presents the future debt maturities as of September 30, 2018:
Year (dollars in thousands)
September 30, 2018
Remainder of 2018
$

2019

2020

2021
549,531

2022

Total
$
549,531


Cash and cash equivalents, restricted cash, loans (net of allowance for loan losses), and cash flows
The following table summarizes our cash and cash equivalents, restricted cash, loans receivable, net and cash flows for the periods indicated:
 
 
 
As of and for the nine months ended September 30,
(Dollars in thousands)
 
2018
 
2017
 
 
 
Cash and cash equivalents
 
$
54,794

 
$
53,473

Restricted cash
 
1,593

 
1,640

Loans receivable, net
 
542,976

 
458,584

Cash provided by (used in):
 
 
 
 
Operating activities
 
257,150

 
209,628

Investing activities
 
(277,091
)
 
(277,770
)
Financing activities
 
33,719

 
67,143

Our cash and cash equivalents at September 30, 2018 were held primarily for working capital purposes and to fund our lending activities. We do not enter into investments for trading or speculative purposes. Our policy is to invest any cash in excess of our immediate working capital requirements in investments designed to preserve the principal balance and provide liquidity. Accordingly, our excess cash is invested primarily in demand deposit accounts that are currently providing only a minimal return.
Net cash provided by operating activities
We generated $257.2 million in cash from our operating activities for the nine months ended September 30, 2018, primarily from revenues derived from our loan portfolio. This was up $47.5 million from the $209.6 million of cash provided by operating activities during the nine months ended September 30, 2017. This increase was the result of the growth in our loan portfolio in 2018, which contributed to the $99.7 million increase in our revenues for the nine months ended September 30, 2018 compared to the same prior year period.
 




73



Net cash used in investing activities
For the nine months ended September 30, 2018 and 2017, cash used in investing activities was $277.1 million and $277.8 million, respectively. The decrease of $10 million in net cash used in net loans issued to customers was primarily due to the increase in payments from customers offsetting the increase in loan originations to customers. This decrease was offset by an $8.9 million increase in purchases of property and equipment. The following table summarizes cash used in investing activities for the periods indicated:
 
 
 
 
For the nine months ended September 30,
(Dollars in thousands)
 
 
2018
 
2017
 
 
 
 
Cash used in investing activities
 
 
 
 
 
Net loans issued to consumers, less repayments
 
 
$
(250,914
)
 
$
(261,040
)
Participation premium paid
 
 
(4,740
)
 
(4,227
)
Purchases of property and equipment
 
 
(21,437
)
 
(12,503
)
 
 
 
$
(277,091
)
 
$
(277,770
)
Net cash provided by financing activities
Cash flows from financing activities primarily include cash flows associated with our debt facilities, the issuance of stock related to our IPO and activity related to stock awards. For the nine months ended September 30, 2018 and 2017, cash provided by financing activities was $33.7 million and $67.1 million, respectively. The following table summarizes cash provided by (used in) financing activities for the periods indicated:
 
 
 
For the nine months ended September 30,
(Dollars in thousands)
 
2018
 
2017
 
 
 
Cash provided by (used in) financing activities
 
 
 
 
Proceeds of Notes payable, net
 
$
35,907

 
$
66,635

Payments on Notes payable
 

 
(84,950
)
Cash paid for interest rate caps
 
(1,367
)
 

Settlement of derivative liability
 
(2,010
)
 

Proceeds from issuance of stock, net
 
781

 
85,479

Other activities
 
408

 
(21
)
 
 
$
33,719

 
$
67,143

The decrease in cash provided by financing activities for the nine months ended September 30, 2018 versus the comparable period of 2017 was primarily due to fewer borrowings as we funded more of our growth using operating cash flows. Cash flows from the prior year period included proceeds received in our IPO, which were primarily used as payments on notes payable resulting in a net source of cash provided by financing activities of $1.8 million excluding equity issuance costs.
Free Cash Flow
In addition to the above, we also review FCF when analyzing our cash flows from operations. We calculate free cash flow as cash flows from operating activities, adjusted for the principal loan net charge-offs and capital expenditures incurred during the period. While this is a non-GAAP measure, we believe it provides a useful presentation of cash flows derived from our core operating activities.
 




74



 
 
For the nine months ended September 30,
(Dollars in thousands)
 
2018
 
2017
 
 
 
Net cash provided by operating activities
 
$
257,150

 
$
209,628

Adjustments:
 
 
 
 
Net charge-offs – combined principal loans
 
(229,487
)
 
(197,388
)
Capital expenditures
 
(21,437
)
 
(12,503
)
FCF
 
$
6,226

 
$
(263
)
Our FCF was $6.2 million for the first nine months of 2018 compared to negative $0.3 million for the comparable prior year period. The increase in our FCF was the result of the increase in cash provided by operations, which was partially offset by increased net charge-offs - combined principal loans during the first nine months of 2018 and increased capital expenditures.
Operating and capital expenditure requirements
We believe that our existing cash balances, together with the available borrowing capacity under our VPC Facility and ESPV Facility, will be sufficient to meet our anticipated cash operating expense and capital expenditure requirements through at least the next 12 months. If our loan growth exceeds our expectations, our available cash balances may be insufficient to satisfy our liquidity requirements, and we may seek additional equity or debt financing. This additional capital may not be available on reasonable terms, or at all.
 
CONTRACTUAL OBLIGATIONS
Our principal commitments consist of obligations under our debt facilities and operating lease obligations. There have been no material changes to our contractual obligations since December 31, 2017, with the exception of the automatic extensions of our debt facilities discussed previously. See “—Liquidity and Capital Resources.”
OFF-BALANCE SHEET ARRANGEMENTS
We provide services in connection with installment loans originated by independent third-party lenders (“CSO lenders”) whereby we act as a credit service organization/credit access business on behalf of consumers in accordance with applicable state laws through our “CSO program.” The CSO program includes arranging loans with CSO lenders, assisting in the loan application, documentation and servicing processes. Under the CSO program, we guarantee the repayment of a customer’s loan to the CSO lenders as part of the credit services we provide to the customer. A customer who obtains a loan through the CSO program pays us a fee for the credit services, including the guaranty, and enters into a contract with the CSO lenders governing the credit services arrangement. We estimate a liability for losses associated with the guaranty provided to the CSO lenders using assumptions and methodologies similar to the allowance for loan losses, which we recognize for our consumer loans.
RECENT REGULATORY DEVELOPMENTS
On July 30, 2018, the Ohio Governor signed legislation which places limits on short-term loans and extensions of credit. The legislation sets specific limits for fees, charges and interest that can be assessed on small loans with a maximum loan amount of $1,000. The new law applies to credit extended on or after April 26, 2019.  Management does not anticipate that the legislation will have a material adverse effect on the Company. We cannot currently assess the likelihood of any other future unfavorable federal, state, local or international legislation or regulations being proposed or enacted that could affect our products and services.




75



During the three months ended September 30, 2018, the Company's UK business began to receive an increased number of customer complaints initiated by claims management companies ("CMCs") related to the affordability assessment of certain loans. If the Company's evidence supports the affordability assessment and the Company rejects the claim, the customer has the right to take the complaint to the Financial Ombudsman Service for further adjudication. The CMCs' campaign against the high cost lending industry increased significantly during the third quarter of 2018 resulting in a significant increase in affordability claims against all companies in the industry during this period. The Company believes that many of the increased claims against it are without merit and reflect the use of abusive and deceptive tactics by the CMCs. The Financial Conduct Authority, a regulator in the UK financial services industry, expects to begin regulating the CMCs in April 2019 in order to ensure that the methods used by the CMCs are in the best interests of the consumer and the industry.
As of September 30, 2018, the Company accrued approximately $947 thousand for the claims received that were determined to be probable and reasonably estimable based on the Company's historical loss rates related to these claims. The outcomes of the adjudication of these claims may differ from the Company's estimates, and as a result, the Company's estimates may change in the near term and the effect of any such change could be material to the financial statements. The Company continues to monitor the matters for further developments that could affect amount of the accrued liability recognized.
BASIS OF PRESENTATION AND CRITICAL ACCOUNTING POLICIES
Revenue recognition
We realize revenues in connection with the consumer loans we offer for each of our products, including finance charges, lines of credit fees and fees for services provided through CSO programs (“CSO fees”). Generally, all of our revenues consist of finance charges on Rise and Sunny installment loans, cash advance fees associated with the Elastic line of credit product, and fees for services provided through CSO programs associated with Rise installment loans in Texas and Ohio. The Company also recorded revenues related to the sale of customer applications to unrelated third parties. These applications are sold with the customer’s consent in the event that the Company or its CSO lenders are unable to offer the customer a loan. Revenue is recognized at the time of the sale. Other revenues also include marketing and licensing fees received from the originating lender related to the Elastic product and CSO programs. Revenue related to these fees is recognized when service is performed.
We recognize finance charges on installment loans on a constant yield basis over their terms. We realize fees such as CSO fees and lines of credit fees as they are earned over the term of the loan. We do not recognize finance charges or other fees on installment loans or lines of credit more than 60 days past due based on management’s historical experience that such past due loans and lines of credit are unlikely to be repaid, and thus, the loans are charged off. Installment loans and lines of credit are considered past due if a grace period has not been requested and a scheduled payment is not paid on its due date. Payments received on past due loans are applied against the loan and accrued interest balance to bring the loan current. When payments are received, they are first applied to accrued charges and fees, then interest, and then to the principal loan balance.
Allowance and liability for estimated losses on consumer loans
Credit losses are an inherent part of outstanding loans receivable. We maintain an allowance for loan losses for loans and interest receivable at a level estimated to be adequate to absorb such losses based primarily on our analysis of historical loss rates by product, stratified by delinquency ranges. We also consider recent collection and delinquency trends, as well as macro-economic conditions that we believe may affect portfolio losses. Additionally, due to the uncertainty of economic conditions and cash flow resources of our customers, we adjust our estimates as needed, with the result that the allowance for loan losses is subject to change in the near-term, which could significantly impact our consolidated financial statements. If a loan is deemed to be uncollectible before it is fully reserved based on information we become aware of (e.g., receipt of customer bankruptcy notice), we charge off such loan at that time. In addition, allowance for loan losses is impacted by the impairment of certain loans considered to be troubled debt restructurings ("TDR").




76



We classify our loans as either current or past due. A customer in good standing may request a 16 day grace period when or before a payment becomes due, and if granted, the loan is considered current during the grace period. Installment loans and lines of credit are considered past due if a grace period has not been requested and a scheduled payment is not paid on its due date. As noted above, we believe that loans and lines of credit more than 60 days past due have a low probability of being repaid. We charge off such overdue loans and reduce the allowance accordingly. Any recoveries on loans previously charged to the allowance are credited to the allowance when collected.
Liability for estimated losses on credit service organization loans
Under the CSO program, we guarantee the repayment of a customer’s loan to the CSO lenders as part of the credit services we provide to the customer. A customer who obtains a loan through the CSO program pays us a fee for the credit services, including the guaranty, and enters into a contract with the CSO lenders governing the credit services arrangement. We estimate a liability for losses associated with the guaranty provided to the CSO lenders using assumptions and methodologies similar to the allowance for loan losses, which we recognize for our consumer loans.

Goodwill
Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in each business combination. We perform an impairment review of goodwill and intangible assets with an indefinite life annually at October 31 and between annual tests if we determine that an event has occurred or circumstances changed in a way that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Such a determination may be based on our consideration of macro-economic and other factors and trends, such as current and projected financial performance, interest rates and access to capital.
Our impairment evaluation of goodwill is based on comparing the fair value of the respective reporting unit to its carrying value. The fair value of the reporting unit is determined based on a weighted average of the income and market approaches. The income approach establishes fair value based on estimated future cash flows of the reporting unit, discounted by an estimated weighted-average cost of capital developed using the capital asset pricing model, which reflects the overall level of inherent risk of the reporting unit. The income approach uses our projections of financial performance for a six- to nine-year period and includes assumptions about future revenue growth rates, operating margins and terminal values. The market approach establishes fair value by applying cash flow multiples to the respective reporting unit’s operating performance. The multiples are derived from other publicly traded companies that are similar but not identical from an operational and economic standpoint.
We completed our 2017 annual test and determined that there was no evidence of impairment of goodwill for the two reporting units that have goodwill. Although no goodwill impairment was noted, there can be no assurances that future goodwill impairments will not occur.
Internal-use software development costs
We capitalize certain costs related to software developed for internal-use, primarily associated with the ongoing development and enhancement of our technology platform. Costs incurred in the preliminary development and post-development stages are expensed. These costs are amortized on a straight-line basis over the estimated useful life of the related asset, generally three years.




77



Income taxes
Our income tax expense (benefit) and deferred income tax balances in the consolidated financial statements have been calculated on a separate tax return basis. As part of the process of preparing our consolidated financial statements, we are required to estimate income taxes in each of the jurisdictions in which we operate. This process involves estimating the actual current tax expense (benefit) based on various factors and assumptions, together with assessing temporary differences in recognition of income for tax and accounting purposes. These differences result in net deferred tax assets and are included within the Condensed Consolidated Balance Sheets. We then must assess the likelihood that the deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not likely, we must establish a valuation allowance. An expense or benefit is included within the tax provision in the Consolidated Statements of Operations for any increase or decrease in the valuation allowance for a given period.

We perform an evaluation of the recoverability of our deferred tax assets on a quarterly basis. We establish a valuation allowance if it is more likely than not (greater than 50 percent) that all or some portion of the deferred tax asset will not be realized. We analyze several factors, including the nature and frequency of operating losses, our carryforward period for any losses, the reversal of future taxable temporary differences, the expected occurrence of future income or loss and the feasibility of available tax planning strategies to protect against the loss of deferred tax assets. We have established a full valuation allowance for our UK deferred tax assets due to the lack of sufficient objective evidence supporting the realization of these assets in the foreseeable future.
We account for uncertainty in income taxes in accordance with applicable guidance, which requires that a more-likely-than-not threshold be met before the benefit of a tax position may be recognized in the consolidated financial statements and prescribes how such benefit should be measured. We must evaluate tax positions taken on our tax returns for all periods that are open to examination by taxing authorities and make a judgment as to whether and to what extent such positions are more likely than not to be sustained based on merit.
Our judgment is required in determining the provision for income taxes, the deferred tax assets and liabilities and any valuation allowance recorded against deferred tax assets. Our judgment is also required in evaluating whether tax benefits meet the more-likely-than-not threshold for recognition.
Share-Based Compensation
In accordance with applicable accounting standards, all share-based compensation, consisting of stock options and restricted stock units (“RSUs") issued to employees is measured based on the grant-date fair value of the awards and recognized as compensation expense on a straight-line basis over the period during which the recipient is required to perform services in exchange for the award (the requisite service period). Starting July 2017, we also have an employee stock purchase plan (“ESPP”). The determination of fair value of share-based payment awards and ESPP purchase rights on the date of grant using option-pricing models is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the expected stock price volatility over the term of the awards, actual and projected employee stock option exercise activity, risk-free interest rate, expected dividends and expected term. We use the Black-Scholes-Merton Option Pricing Model to estimate the grant-date fair value of stock options. We also use an equity valuation model to estimate the grant-date fair value of RSUs. Additionally, the recognition of share-based compensation expense requires an estimation of the number of awards that will ultimately vest and the number of awards that will ultimately be forfeited.
Derivative Financial Instruments
Our derivative financial instruments include bifurcated embedded derivatives that were identified within the Convertible Term Notes and interest rate caps on our US Term Notes and our ESPV Facility, which are cash flow hedges. The derivatives are recorded as assets or liabilities at fair value. Changes in the bifurcated embedded derivatives' fair value are immediately included in earnings. Changes in the interest rate caps fair value are included in Accumulated other comprehensive income and subsequently reclassified to interest expense when the hedged expenses are recorded.




78



RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS AND JOBS ACT ELECTION
Under the Jumpstart Our Business Startups Act (the “JOBS Act”), we meet the definition of an emerging growth company. We have irrevocably elected to opt out of the extended transition period for complying with new or revised accounting standards pursuant to Section 107(b) of the JOBS Act.

Recently Adopted Accounting Standards
In March 2018, the FASB issued Accounting Standards Update ("ASU") No. 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 ("ASU 2018-05"). The purpose of ASU 2018-05 is to incorporate the guidance pronounced through Staff Accounting Bulletin No. 118 ("SAB 118"). The Company has adopted all of the amendments of ASU 2018-05 on a prospective basis as of January 1, 2018. The adoption of ASU 2018-05 did not have a material impact on the Company's condensed consolidated financial statements.
In February 2018, the FASB issued ASU No. 2018-02, Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income ("ASU 2018-02"). The purpose of ASU 2018-02 is to allow an entity to elect to reclassify the stranded tax effects related to the Tax Cuts and Jobs Act from Accumulated other comprehensive income into Retained earnings. The amendments in ASU 2018-02 are effective for all entities for fiscal years beginning after December 15, 2018, and for interim periods within those fiscal years. Early adoption is permitted. The Company adopted all amendments of ASU 2018-02 on a prospective basis as of January 1, 2018 and elected to reclassify the stranded tax effects resulting from the Tax Cuts and Jobs Act from Accumulated other comprehensive income to Accumulated deficit. The amount of the reclassification for the three and nine months ended September 30, 2018 was $0 and $920 thousand, respectively.
In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815)—Targeted Improvements to Accounting for Hedging Activities ("ASU 2017-12"). The purpose of ASU 2017-12 is to improve the financial reporting of hedging relationships to better portray the economic results of an entity's risk management activities in its financial statements. In addition, ASU 2017-12 makes certain targeted improvements to simplify the application of the hedge accounting guidance. This guidance is effective for public companies for fiscal years beginning after December 15, 2018, and for interim periods within those fiscal years. Early adoption is permitted. The Company has adopted all of the amendments of ASU 2017-12 on a prospective basis as of January 1, 2018. Since the Company did not have derivatives accounted for as hedges prior to December 31, 2017, there was no cumulative-effect adjustment needed to Accumulated other comprehensive income and Accumulated deficit. The adoption of ASU 2017-12 did not have a material impact on the Company's condensed consolidated financial statements.
In May 2017, the FASB issued ASU No. 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting ("ASU 2017-09"). The purpose of ASU 2017-09 is to provide clarity and reduce both the diversity in practice and the cost and complexity when applying the guidance to a change to the terms or conditions of a share-based payment award. Under this new guidance, an entity should account for the effects of a modification unless all of the following are met: (1) The fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the modified award is the same as the fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the original award immediately before the original award is modified. If the modification does not affect any of the inputs to the valuation technique that the entity uses to value the award, the entity is not required to estimate the value immediately before and after the modification. (2) The vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified. (3) The classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified. The guidance is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. The Company adopted all amendments of ASU 2017-09 on a prospective basis as of January 1, 2018. The adoption of ASU 2017-09 did not have a material impact on the Company's financial condition, results of operations or cash flows.




79



In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash a consensus of the FASB Emerging Issues Task Force ("ASU 2016-18"). The purpose of ASU 2016-18 is to reduce diversity in practice related to the classification and presentation of changes in restricted cash on the statement of cash flows. Under this new guidance, the statement of cash flows during the reporting period must explain the change in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. ASU 2016-18 is effective for public entities for fiscal years beginning after December 15, 2017 and for interim periods within those fiscal years. The Company adopted all amendments of ASU 2016-18 on a retrospective basis as of January 1, 2018. Upon adoption, the Company included any restricted cash balances as part of cash and cash equivalents in its Condensed Consolidated Statements of Cash Flows and did not present the change in restricted cash balances as a separate line item under investing activities. The amount of the reclassification for the nine months ended September 30, 2018 and 2017 was immaterial for both periods.
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments ("ASU 2016-15"). ASU 2016-15 is intended to reduce diversity in practice for certain cash receipts and cash payments that are presented and classified in the statement of cash flows. For public entities, ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company adopted all amendments of ASU 2016-15 on a prospective basis as of January 1, 2018. The adoption of ASU 2016-15 did not have a material impact on the Company's condensed consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). ASU 2014-09 is a comprehensive new revenue recognition model that requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. ASU 2014-09 also requires 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. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of Effective Date ("ASU 2015-14"), which defers the effective date of this guidance by one year, to the annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. A reporting entity may choose to early adopt the guidance as of the original effective date. In April 2016, the FASB issued ASU 2016-10, Revenues from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing ("ASU 2016-10"), which clarifies the guidance related to identifying performance obligations and licensing implementation. The Company adopted all amendments of ASU 2016-10 using the alternative transition method, which requires the application of the guidance only to contracts that are uncompleted on the date of initial application. As a result of the scope exception for financial contracts, the Company's management has determined that there are no material changes to the nature, extent or timing of revenues and expenses; additionally, the adoption of ASU 2014-09 did not have a significant impact to pretax income upon adoption as of September 30, 2018.
Accounting Standards to be Adopted in Future Periods
In August 2018, the FASB issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract ("ASU 2018-15"). The purpose of ASU 2018-15 is to provide additional guidance on the accounting for costs of implementation activities performed in a cloud computing arrangement that is a service contract. This guidance is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The Company is still assessing the potential impact of ASU 2018-15 on the Company's condensed consolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement ("ASU 2018-13"). The purpose of ASU 2018-13 is to modify the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement. This guidance is effective for public companies for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years and requires both a prospective and retrospective approach to adoption based on amendment specifications. Early adoption of any removed or modified disclosures is permitted. Additional disclosures may be delayed until their effective date. The Company does not expect ASU 2018-13 to have a material impact on the Company's condensed consolidated financial statements.




80



In July 2018, the FASB issued ASU No. 2018-09, Codification Improvements ("ASU 2018-09"). The purpose of ASU 2018-09 is to clarify, correct errors in, or make minor improvements to the Codification. Among other revisions, the amendments clarify that an entity should recognize excess tax benefits or tax deficiencies for share compensation expense that is taken on an entity’s tax return in the period in which the amount of the deduction is determined. This portion of the guidance is effective for public companies for fiscal years beginning after December 15, 2018 and requires a modified retrospective approach to adoption. The Company does not expect ASU 2018-09 to have a material impact on the Company's condensed consolidated financial statements.
In January 2017, the FASB issued ASU No. 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment ("ASU 2017-04"). The purpose of ASU 2017-04 is to simplify the subsequent measurement of goodwill. The amendments modify the concept of impairment from the condition that exists when the carrying amount of goodwill exceeds its implied fair value to the condition that exists when the carrying amount of a reporting unit exceeds its fair value. An entity no longer will determine goodwill impairment by calculating the implied fair value of goodwill by assigning the fair value of a reporting unit to all of its assets and liabilities as if that reporting unit had been acquired in a business combination. This guidance is effective for public companies for goodwill impairment tests in fiscal years beginning after December 15, 2019. The Company is still assessing the potential impact of ASU 2017-04 on the Company's condensed consolidated financial statements.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"). ASU 2016-13 is intended to replace the incurred loss impairment methodology in current US GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates to improve the quality of information available to financial statement users about expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. For public entities, ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is still assessing the potential impact of ASU 2016-13 on the Company's condensed consolidated financial statements. The internal financial controls processes in place for the Company's loan loss reserve process are expected to be impacted. The Company expects to complete its analysis of the impact in 2018.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) ("ASU 2016-02"). ASU 2016-02 is intended to improve the reporting of leasing transactions to provide users of financial statements with more decision-useful information. ASU 2016-02 will require organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. In July 2018, the FASB issued ASU No. 2018-10, Codification Improvements to Topic 842, Leases (“ASU 2018-10”), which clarifies certain matters in the codification with the intention to correct unintended application of the guidance. Also in July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements (“ASU 2018-11”), which provides entities with an additional (and optional) transition method whereby the entity applies the new lease standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Additionally, under the new transition method, an entity’s reporting for the comparative periods presented in the financial statements in which it adopts the new lease standard will continue to be in accordance with current US GAAP (Topic 840, Leases). ASU 2016-02, as amended, is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Company expects to adopt the transition method in ASU 2018-11 by applying the practical expedient prospectively and by using the retrospective approach at the beginning of the period of adoption through cumulative-effect adjustment. The Company is still assessing the potential impact of ASU 2016-02 on the Company's condensed consolidated financial statements. The Company is progressing as planned for implementation on January 1, 2019. The Company expects adoption of the standard to result in the recognition of significant additional right of use assets and liabilities for operating leases, but to not have a material impact on the Condensed Consolidated Statements of Operations.




81



Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk is the risk of loss to future earnings, values or future cash flows that may result from changes in the price of a financial instrument. The value of a financial instrument may change as a result of changes in interest rates, exchange rates, commodity prices, equity prices and other market changes. We are exposed to market risk related to changes in interest rates and foreign currency exchange rates. We do not use derivative financial instruments for speculative or trading purposes, although in the future we may continue to enter into interest rate hedging or enter into exchange rate hedging arrangements to manage the risks described below.
Interest rate sensitivity
Our cash and cash equivalents as of September 30, 2018 consisted of demand deposit accounts. Our primary exposure to market risk for our cash and cash equivalents is interest income sensitivity, which is affected by changes in the general level of US interest rates. Given the currently low US interest rates, we generate only a de minimis amount of interest income from these deposits.
All of our customer loan portfolios are fixed APR loans and not variable in nature. Additionally, given the high APR’s associated with these loans, we do not believe there is any interest rate sensitivity associated with our customer loan portfolio.
Our VPC Facility and ESPV Facility are variable rate in nature and tied to the 3-month LIBOR rate. In January 2018, the Company entered into interest rate caps, which cap 3-month LIBOR at 1.75%, to mitigate the floating interest rate risk on $240 million of the US Term Notes included in the VPC Facility and on $216 million of the ESPV Facility. Any increase in the 3-month LIBOR rate on borrowings not subject to an interest rate cap will result in an increase in our net interest expense. The outstanding balance of our VPC Facility at September 30, 2018 was $314.5 million and the balance at December 31, 2017 was $306.3 million. The outstanding balance of our ESPV Facility was $235 million and $208.0 million at September 30, 2018 and December 31, 2017, respectively. Based on the average outstanding indebtedness through the nine months ended September 30, 2018, a 1% (100 basis points) increase in interest rates would have increased our interest expense by approximately $0.9 million for the period.
Foreign currency exchange risk
We provide installment loans to customers in the UK. Interest income from our Sunny UK installment loans is earned in GBP. Fluctuations in exchange rate of the USD against the GBP and cash held in such foreign currency can result, and have resulted, in fluctuations in our operating income and foreign currency transaction gains and losses. We had foreign currency transaction gains (losses) of approximately $(0.8) million and $2.8 million during the nine months ended September 30, 2018 and 2017, respectively. We currently do not engage in any foreign exchange hedging activity but may do so in the future.
At September 30, 2018, our GBP-denominated net assets were approximately $58.4 million (which excludes the $26.8 million then drawn under the USD-denominated UK term note under the VPC Facility). A hypothetical 10% strengthening or weakening in the value of the USD compared to the GBP at this date would have resulted in a decrease/increase in net assets of approximately $5.8 million. During the nine months ended September 30, 2018, the GBP-denominated pre-tax loss was approximately $4.8 million. A hypothetical 10% strengthening or weakening in the value of the USD compared to the GBP during this period would have resulted in a decrease/increase in the pre-tax income of approximately $0.5 million.





82



Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a- 15(e) and 15d- 15(e) under the Exchange Act), as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of such date, our disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting

The Securities and Exchange Commission has adopted rules that generally require every company that files reports with the Commission to evaluate its effectiveness of internal controls over financial reporting. Our management, with the participation of our principal executive and principal financial officers, will not be required to evaluate the effectiveness of our internal controls over financial reporting until the filing of our Annual Report on Form 10-K for the annual period ending December 31, 2018, due to a transition period established by Commission rules applicable to new public companies.

There were no changes in our internal control over financial reporting identified in management’s evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the period covered by this Quarterly Report on Form 10-Q that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.





83



PART II - OTHER INFORMATION
Item 1. Legal Proceedings
In addition to the matters discussed below, in the ordinary course of business, from time to time, we have been and may be named as a defendant in various legal proceedings arising in connection with our business activities, including affordability claims related to the Sunny product. We may also be involved, from time to time, in reviews, investigations and proceedings (both formal and informal) by governmental agencies regarding our business (collectively, “regulatory matters”). We contest liability and/or the amount of damages as appropriate in each such pending matter. We do not anticipate that the ultimate liability, if any, arising out of any such pending matter will have a material effect on our financial condition, results of operations or cash flows.

Civil Investigative Demand
In June 2012, prior to the spin-off from Think Finance, Inc. ("TFI"), and in February 2016, after the spin-off, TFI received Civil Investigative Demands from the CFPB. The purpose of the Civil Investigative Demands was to determine whether small-dollar online lenders or other unnamed persons engaged in unlawful acts or practices relating to the advertising, marketing, provision, or collection of small-dollar loan products, in violation of Section 1036 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Electronic Funds Transfer Act, the Gramm-Leach-Bliley Act, or any other federal consumer financial law and to determine whether CFPB action to obtain legal or equitable relief would be in the public interest. Further, on November 15, 2017 the CFPB sued TFI alleging it deceived consumers into paying debts that were not valid and that it collected loan payments that consumers did not owe. While TFI’s business is distinct from our business, we cannot predict the final outcome of the Civil Investigative Demands or to what extent any obligations arising out of such final outcome will be applicable to our company or business, if at all.





84



Item 1A. Risk Factors

There have been no material changes from the Risk Factors described in Item 1A. “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2017, except as set forth in Item 1A. “Risk Factors” of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2018 and as set forth below.

RISKS RELATED TO OUR BUSINESS AND INDUSTRY

Customer complaints or negative public perception of our business could result in a decline in our customer growth and our business could suffer.
Our reputation is very important to attracting new customers to our platform as well as securing repeat lending to existing customers. While we believe that we have a good reputation and that we provide customers with a superior experience, there can be no assurance that we will continue to maintain a good relationship with customers or avoid negative publicity.
In recent years, consumer advocacy groups and some media reports have advocated governmental action to prohibit or place severe restrictions on non-bank consumer loans. Such consumer advocacy groups and media reports generally focus on the annual percentage rate for this type of consumer loan, which is compared unfavorably to the interest typically charged by banks to consumers with top-tier credit histories. The finance charges assessed by us, the originating lenders and others in the industry can attract media publicity about the industry and be perceived as controversial. If the negative characterization of the types of loans we offer, including those originated through third-party lenders, becomes increasingly accepted by consumers, demand for any or all of our consumer loan products could significantly decrease, which could materially affect our business, prospects, results of operations, financial condition or cash flows. Additionally, if the negative characterization of these types of loans is accepted by legislators and regulators, we could become subject to more restrictive laws and regulations applicable to consumer loan products that could have a material adverse effect on our business, prospects, results of operations, financial condition or cash flows.
Third parties may also seek to take advantage of unique regulations applicable to consumer loan products to drive up complaints and the cost of doing business in our industry. During the three months ended September 30, 2018, the Company's UK business began to receive an increased number of customer complaints initiated by claims management companies ("CMCs") related to the affordability assessment of certain loans. If the Company's evidence supports the affordability assessment and the Company rejects the claim, the customer has the right to take the complaint to the Financial Ombudsman Service (“FOS”) for further adjudication. We have incurred significant costs in the form of FOS administrative fees associated with each individual complaint submitted to FOS, operational costs necessary to manage the large volume of complaints, and payments we are required to make to customers to resolve these complaints. We believe that many of the increased claims against it are without merit and reflect the use of abusive and deceptive tactics by the CMCs. If we continue to experience an increased volume of complaints due to the activities of the CMCs and we are required to continue incurring significant costs to resolve such complaints, such costs could continue to have a material adverse effect on our business, results of operations, financial condition and cash flows.
In addition, our ability to attract and retain customers is highly dependent upon the external perceptions of our level of service, trustworthiness, business practices, financial condition and other subjective qualities. Negative perceptions or publicity regarding these matters-even if related to seemingly isolated incidents, or even if related to practices not specific to short-term loans, such as debt collection-could erode trust and confidence and damage our reputation among existing and potential customers, which would make it difficult to attract new customers and retain existing customers, significantly decrease the demand for our products, result in increased regulatory scrutiny, and have a material adverse effect on our business, prospects, results of operations, financial condition or cash flows.






85



Item 6. Exhibits
Exhibit
number
Description
10.1
10.2
10.3
10.4
10.5
31.1
31.2
32.1&
32.2&
101.INS*
XBRL Instance Document.
101.SCH*
XBRL Taxonomy Extension Schema Document.
101.CAL*
XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF*
XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB*
XBRL Taxonomy Extension Labels Linkbase Document.
101.PRE*
XBRL Taxonomy Extension Presentation Linkbase Document.
 
Confidential treatment has been requested as to certain portions of this exhibit, which portions have been omitted and submitted separately to the Securities and Exchange Commission.
&
 
This certification is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended (Exchange Act), or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act or the Exchange Act.
*
 
Pursuant to applicable securities laws and regulations, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act, are deemed not filed for purposes of section 18 of the Exchange Act and otherwise are not subject to liability under these sections.

 







86



SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
Elevate Credit, Inc.
 
 
 
 
Date:
November 9, 2018
By:
/s/ Kenneth E. Rees
 
 
 
Kenneth E. Rees
 
 
 
Chief Executive Officer and Chairman
(Principal Executive Officer)
 
 
 
 
Date:
November 9, 2018
By:
/s/ Christopher Lutes
 
 
 
Christopher Lutes
 
 
 
Chief Financial Officer
(Principal Financial Officer)
 
 
 
 





87