ELEVATE CREDIT, INC. 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 our brands (Rise, Elastic and Today Card) 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 USwho are not well-served by traditional bank products andwho 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 2.5 million customers with$8.5 billion in credit. Our current online credit products, Rise, Elastic and Today Card 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." Prior toJune 29, 2020 , we provided services in theUnited Kingdom ("UK") through our wholly-owned subsidiary,Elevate Credit International Limited ("ECIL") under the brand name 'Sunny.' During the year endedDecember 31, 2018 , ECIL began to receive an increased number of customer complaints initiated by claims management companies ("CMCs") related to the affordability assessment of certain loans. The CMCs' campaign against the high cost lending industry increased significantly during the third and fourth quarters of 2018 and continued through 2019 and into the second half of 2020, resulting in a significant increase in affordability claims against all companies in the industry over this period.The Financial Conduct Authority ("FCA"), a regulator in theUK financial services industry, began regulating the CMCs inApril 2019 in order to ensure that the methods used by the CMCs are in the best interests of the consumer and the industry. Separately, theFCA asked all industry participants to review their lending practices to ensure that such companies are using an appropriate affordability and creditworthiness analysis. However, there continued to be a lack of clarity within the regulatory environment in theUK . This lack of clarity, coupled with the ongoing impact of the Coronavirus Disease 2019 ("COVID-19") on theUK market for Sunny, led the ECIL board of directors to place ECIL into administration under theUK Insolvency Act 1986 and appoint insolvency practitioners fromKPMG LLP to take control and management of theUK business. As a result, we have deconsolidated ECIL and are presenting its results as discontinued operations. We earn revenues on the Rise installment loans, on the Rise and Elastic lines of credit and on the Today Card credit card product. Our revenue primarily consists of finance charges and line of credit fees. 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. Line of credit fees are recognized when they are assessed and recorded to revenue over the life of the loan. We present certain key metrics and other information on a "combined" basis to reflect information related to loans originated by us and by our bank partners that license our brands, Republic Bank,FinWise Bank andCapital Community 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." 42 -------------------------------------------------------------------------------- We use our working capital, funds provided by third-party lenders pursuant to CSO programs and our credit facility withVictory Park Management, LLC ("VPC" and the "VPC Facility") to fund the loans we make to our Rise customers 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 approximately$368 million atJune 30, 2020 . See "-Liquidity and Capital Resources-Debt facilities." Beginning in the fourth quarter of 2018, the Company also licenses its Rise installment loan brand to a third-party lender,FinWise Bank , which originates Rise installment loans in 18 states.FinWise Bank initially provides all of the funding and retains a percentage of the balances of all of the loans originated and sells the remaining loan participation in those Rise installment loans to a third-party SPV,EF SPV, Ltd. ("EF SPV"). Prior toAugust 1, 2019 ,FinWise Bank retained 5% of the balances and sold a 95% participation to EF SPV. OnAugust 1, 2019 , EF SPV purchased an additional 1% participation in the outstanding portfolio with the participation percentage revised going forward to 96%. These loan participation purchases are funded through a separate financing facility (the "EF SPV Facility"), effectiveFebruary 1, 2019 , and through cash flows from operations generated by EF SPV. The EF SPV Facility has a maximum total borrowing amount available of$150 million . We do not own EF SPV, but we have a credit default protection agreement with EF SPV whereby we provide credit protection to the investors in EF SPV against Rise loan losses in return for a credit premium. Elevate is required to consolidate EF SPV as a variable interest entity under GAAP and the condensed consolidated financial statements include revenue, losses and loans receivable related to the 96% of the Rise installment loans originated byFinWise Bank and sold to EF SPV. 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. An SPV structure was implemented such that the loan participations are sold by Republic Bank toElastic SPV, Ltd. ("Elastic SPV") and Elastic SPV receives its funding from VPC in a separate financing facility (the "ESPV Facility"), which was finalized onJuly 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 VIE in its consolidated financial results.
The ESPV Facility has also been amended several times and the original
commitment amount of
Our management assesses our financial performance and future strategic goals through key metrics based primarily on the following three themes: • Revenue growth. 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).
• Stable credit quality. Since the time they were managing our legacy
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 improved our credit quality. The credit quality
metrics we monitor include net charge-offs as a percentage of revenues, 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.
• Margin expansion. We expect that our operating margins will continue to
expand over the long term as we lower our direct marketing costs and
efficiently manage our operating expenses while continuing to improve our
credit quality. 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.
43-------------------------------------------------------------------------------- Impact of COVID-19 InMarch 2020 , the outbreak of COVID-19 was recognized as a pandemic by theWorld Health Organization . The spread of COVID-19 has created a global public health crisis that has resulted in unprecedented uncertainty, volatility and disruption in financial markets and in governmental, commercial and consumer activity inthe United States and globally, including the markets that we serve. Governmental responses to the pandemic have included orders closing businesses not deemed essential and directing individuals to restrict their movements, observe social distancing and shelter in place. These actions, together with responses to the pandemic by businesses and individuals, have resulted in rapid decreases in commercial and consumer activity, temporary closures of many businesses that have led to a loss of revenues and a rapid increase in unemployment, material decreases in oil and gas prices and in business valuations, disrupted global supply chains, market downturns and volatility, changes in consumer behavior related to pandemic fears, related emergency response legislation and an expectation thatFederal Reserve policy will maintain a low interest rate environment for the foreseeable future. During the second quarter, some restrictions have been lifted, but personal and business activities have not returned to their previous normal levels as the virus continues to impact the population. As COVID-19 has continued to impact our office locations, our employee base continues to operate in a remote working environment. We have sought to ensure our employees feel secure in their jobs and have the flexibility and resources they need to stay safe and healthy. As an 100% online lending solutions provider, our technology and underwriting platform has continued to serve our customers and the bank originators that we support. In response to the COVID-19 pandemic, we, along with the banks we support, have also expanded our payment flexibility programs to provide temporary payment relief to certain customerswho meet the program's qualifications. This program allows for a deferral of payments for an initial period of 30 to 60 days, which we may extend for an additional 30 days, for a maximum of 180 days on a cumulative basis. The customer will return to their normal payment schedule after the end of the deferral period with the extension of their maturity date equivalent to their deferral period not to exceed an additional 180 days. For Rise installment loans, finance charges continue to accrue at a lower effective APR over the expected extended term of the loan considering the deferral periods provided. For Elastic lines of credit, no fees accrue during the payment deferral period. As a result, we expect the average APR of our products to decrease due to the impact of the COVID-19 pandemic and the payment flexibility programs that have been implemented. As ofJune 30, 2020 , 12.5% of customers have been provided relief through a COVID-19 payment deferral program for a total of$50.7 million in loans with deferred payments. Both we and the bank originators are closely monitoring the performance of the payment deferral program and key credit quality indicators such as payment defaults, continued payment deferrals, and line of credit utilization. While we initially anticipated that the COVID-19 pandemic would have a negative impact on our credit quality, instead the large quantity of monetary stimulus provided by the US government to our customer base has generally allowed customers to continue making payments on their loans. Over time, we continue to expect an increase in net charge-offs as compared to prior periods. We believe the Allowance for loan losses is adequate to absorb the losses inherent in the portfolio as ofJune 30, 2020 , including loans that are part of the payment deferral program. Both we, and the bank originators we support, have also implemented underwriting changes to address credit risk associated with loan originations during the economic crisis created by the COVID-19 pandemic and have reduced loan origination applications and loan origination volume since the beginning of the COVID-19 pandemic inMarch 2020 . The portfolio of loan products we and the bank originators provide has experienced decreased demand and application volume for both new and former customers since the COVID-19 pandemic began, including as a result of the effects of underwriting changes implemented in response to COVID-19 risks that limited the volume of new customer loan originations and monetary stimulus provided by the US government reducing demand for our products, resulting in materially lower new customers and loan balances and a corresponding decrease in revenues compared to a year ago. Given the uncertainty surrounding the COVID-19 pandemic we are currently unable to determine if demand for our loan products will increase during the second half of 2020. Until demand increases, our loan balances and revenue will continue to be materially lower than the prior year periods. 44
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Significant uncertainties as to future economic conditions exist, and we have
taken deliberate actions in response, including assessing our minimum cash and
liquidity requirement, monitoring our debt covenant compliance and implementing
measures to ensure that our strong liquidity position is maintained through the
current economic cycle such as our recently implemented operating expense
reduction plan. We continue to monitor the impact of COVID-19 closely, as well
as any effects that may result from the Coronavirus Aid, Relief, and Economic
Security ("CARES") Act and any further economic relief, stimulus payments or
legislation by the federal government; however, the extent to which the COVID-19
pandemic will continue to impact our operations and financial results during the
remainder of 2020 is highly uncertain.
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 endedAs of and for the six months ended
June 30, June 30,
Revenue metrics (dollars in
thousands, except as noted) 2020 2019 2020 2019
Revenues $ 117,991 $ 150,374 $ 280,458 $ 310,440
Period-over-period change in
revenue (22 )% (3 )% (10 )% (2 )%
Ending combined loans
receivable - principal(1) 413,728 553,673 413,728 553,673
Average combined loans
receivable - principal(1)(2) 466,694 530,764 524,932 543,921
Total combined loans
originated - principal 84,502 283,480 321,398 507,277
Average customer loan balance (in
dollars)(3 ) 1,862 1,989 1,862 1,989
Number of new customer loans 2,815 44,003 38,565 66,206
Ending number of combined loans
outstanding 222,244 278,332 222,244 278,332
Customer acquisition costs (in
dollars) 122 252 293 276
Effective APR of combined loan
portfolio 101 % 113 % 107 % 115 %
_________(1) Combined loans receivable is defined as loans owned by the Company and
consolidated VIEs 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 Combined loans receivable - principal balances.
(3) Average customer loan balance is an 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 customerswho obtain a loan through the CSO program for the credit services, including the loan guaranty, we provide), and revenues earned on the Rise and Elastic lines of credit. Finance charge and fee revenues from the Today Card credit card product were immaterial. See "-Components of our Results of Operations-Revenues." 45 -------------------------------------------------------------------------------- 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) and the 96% participation inFinWise Bank originated Rise installment loans, but include the full loan balances on CSO loans, which are not presented on our Condensed Consolidated 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 customers usually receive tax refunds during this period and, thus, have less of a need for loans from us. Further, many 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). 46 -------------------------------------------------------------------------------- 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 six months endedJune 30, 2020 and 2019. Three Months Ended
Rise Elastic (1) Total
Beginning number of combined loans
outstanding 142,633 138,853 281,486
New customer loans originated 627 2,188 2,815
Former customer loans originated 7,593 9 7,602
Attrition (43,728 ) (25,931 ) (69,659 )
Ending number of combined loans
outstanding 107,125 115,119 222,244
Customer acquisition cost $ 306 $ 69 $ 122
Average customer loan balance $ 2,249 $ 1,501 $ 1,862
Three Months Ended June 30, 2019
Rise Elastic (1) Total
Beginning number of combined loans
outstanding 125,021 145,760 270,781
New customer loans originated 30,177 13,826 44,003
Former customer loans originated 18,850 18 18,868
Attrition (38,277 ) (17,043 ) (55,320 )
Ending number of combined loans
outstanding 135,771 142,561 278,332
Customer acquisition cost $ 243 $ 271 $ 252
Average customer loan balance $ 2,253 $ 1,738 $ 1,989
Six Months Ended June 30, 2020
Rise Elastic (1) Total
Beginning number of combined loans
outstanding 152,435 149,524 301,959
New customer loans originated 25,040 13,525 38,565
Former customer loans originated 24,149 140 24,289
Attrition (94,499 ) (48,070 ) (142,569 )
Ending number of combined loans
outstanding 107,125 115,119 222,244
Customer acquisition cost $ 309 $ 265 $ 293
Six Months Ended June 30, 2019
Rise Elastic (1) Total
Beginning number of combined loans
outstanding 142,758 166,397 309,155
New customer loans originated 47,542 18,664 66,206
Former customer loans originated 36,641 27 36,668
Attrition (91,170 ) (42,527 ) (133,697 )
Ending number of combined loans
outstanding 135,771 142,561 278,332
Customer acquisition cost $ 276 $ 277 $ 276
(1) Includes immaterial balances related to the Today Card.
47
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Recent trends. Our revenues for the three months ended June 30, 2020 totaled
$118.0 million , a decrease of 22% versus the three months ended June 30, 2019 .
Additionally, a similar trend occurred for the six months ended June 30, 2020 as
revenues totaled $280.5 million , down 10% versus the prior year. Both the Rise
and Elastic products experienced a year-over-year decline in revenues
attributable to reductions in loan origination volume and lower effective APRs
for the loan portfolio due to the economic crisis created by the COVID-19
pandemic beginning in March 2020 .
In response to the COVID-19 pandemic, we expanded our payment flexibility
program to provide temporary payment relief to certain customers who meet the
program's qualifications. This program allows for a deferral of payments for an
initial period of 30 to 60 days, for a maximum of 180 days on a cumulative
basis. The customer will return to their normal payment schedule after the end
of the deferral period with the extension of their maturity date equivalent to
their deferral period not to exceed an additional 180 days. For Rise installment
loans, finance charges continue to accrue at a lower effective APR over the
expected extended term of the loan considering the deferral periods provided.
For Elastic lines of credit, no fees accrue during the payment deferral period.
As a result, the average APR of our products has decreased due to the impact of
the COVID pandemic and the payment flexibility program that has been
implemented.
Additionally, all products were impacted by the COVID-19 pandemic as we
experienced reduced demand and application volume in the first half of 2020 for
both new and former customers in addition to implementing underwriting changes
that limited the volume of new customer loan originations from the beginning of
the pandemic in March 2020 through the second quarter of 2020.
While we initially anticipated that the COVID-19 pandemic would have a negative
impact on our credit quality, instead the large quantity of monetary stimulus
provided by the US government to our customer base has generally allowed
customers to continue making payments on their loans. However, this has also
caused weaker customer demand for additional loans resulting in lower overall
loan balances and revenues. As a result of the COVID-19 pandemic, Rise and
Elastic principal loan balances at June 30, 2020 totaled $240.9 million and
$164.7 million , respectively, down roughly $65.0 million and $79.3 million ,
respectively, from a year ago.
Credit quality
As of and for the three months ended As of and for the six months ended
June 30, June 30,
Credit quality metrics (dollars
in thousands) 2020 2019 2020 2019
Net charge-offs(1) $ 58,643 $ 68,101 $ 141,450 $ 162,412
Additional provision for loan
losses(1) (17,166 ) 181 (21,398 ) (18,775 )
Provision for loan losses $ 41,477 $ 68,282 $ 120,052 $ 143,637
Past due combined loans
receivable - principal as a
percentage of combined loans
receivable - principal(2) 5 % 9 % 5 % 9 %
Net charge-offs as a percentage
of revenues(1) 50 % 45 % 50 % 52 %
Total provision for loan losses
as a percentage of revenues 35 % 45 % 43 % 46 %
Combined loan loss reserve(3) $ 60,594 $ 67,872 $ 60,594 $ 67,872
Combined loan loss reserve as a
percentage of combined loans
receivable(3)(4) 14 % 12 % 14 % 12 %
_________(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.
48--------------------------------------------------------------------------------
(2) Combined loans receivable is defined as loans owned by the Company and
consolidated VIEs 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.
(3) 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.
(4) Combined loan loss reserve as a percentage of combined loans receivable is
determined using period-end balances.
Net principal charge-offs as a percentage of average combined loans receivable - First Second Third Fourth principal (1) (2) (3) Quarter Quarter Quarter Quarter 2020 11% 9% N/A N/A 2019 13% 10% 11% 13% 2018 13% 12% 13% 15% _________
(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 and
consolidated VIEs 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 income statement 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.
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 total 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.
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.
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.
49
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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
Loan loss reserve methodology. Our loan loss reserve methodology is calculated
separately for each product and, in the case of Rise loans originated under the
state lending model (including 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, during the past three years we have seen our combined
loan loss reserve as a percentage of combined loans receivable fluctuate between
approximately 12% and 17% depending on the overall mix of new, former and past
due customer loans.
50-------------------------------------------------------------------------------- Recent trends. Total loan loss provision for the three and six months endedJune 30, 2020 was 35% and 43% of revenues, respectively, which was below our targeted range of 45% to 55%, and below the 45% and 46% for the three and six months endedJune 30, 2019 , respectively. For both the three and six months endedJune 30, 2020 , net charge-offs as a percentage of revenues totaled 50%, compared to 45% and 52% in the respective prior year periods. In the near-term we expect that net charge-offs as a percentage of revenues will continue to be approximately 45% to 55% of revenue, within our targeted range. While we initially anticipated that the COVID-19 pandemic would have a negative impact on our credit quality, instead the large quantity of monetary stimulus provided by the US government to our customer base has generally allowed customers to continue making payments on their loans. However, this has also caused weaker customer demand for additional loans resulting in lower overall loan balances and revenues. We continue to monitor the portfolio during this economic crisis resulting from COVID-19 and continue to adjust our underwriting and credit policies to mitigate any potential negative impacts. In the long-term (post-COVID-19), we expect to continue to manage our total loan loss provision as a percentage of revenues to continue to remain within our targeted range. The combined loan loss reserve as a percentage of combined loans receivable totaled 14% and 12% as ofJune 30, 2020 andJune 30, 2019 , respectively. This percentage increase in the loan loss reserve is due to an increase in loans outstanding with a payment deferral under the payment flexibility program offered in response to the COVID-19 pandemic. While we have seen positive payment performance once loans complete their payment deferral status, the loans in this population have a higher inherent risk of loss which is reflected in our loan loss reserve calculations. Past due loan balances atJune 30, 2020 were 5% of total combined loans receivable - principal, down significantly from 9% from a year ago, also attributable to the COVID-19 loan payment deferral program. 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 throughJune 30, 2020 for each annual vintage since the 2013 vintage are generally under 30% and continue to trend at or slightly below our 25% to 30% long-term targeted range. In the beginning of 2019, we implemented new fraud tools that have helped lower fraud losses for the 2019 vintage. In addition, we rolled out our next generation of credit models during the second quarter of 2019 and continued refining the models during the third and fourth quarters of 2019. The preliminary data on the 2019 vintage is that it is performing better than both 2017 and 2018 vintages. However, it is possible that the cumulative loss rates on all vintages will increase and may exceed our recent historical cumulative loss experience due to the impact of a prolonged economic crisis resulting from the COVID-19 pandemic. 51
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[[Image Removed: cumulativecreditlossa062020.jpg]]
1) The 2019 and 2020 vintages are not yet fully mature from a loss perspective.
2)
52
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Margins
Three Months Ended Six Months Ended
June 30, June 30,
Margin metrics (dollars in
thousands) 2020 2019 2020 2019
Revenues $ 117,991 $ 150,374 $ 280,458 $ 310,440
Net charge-offs(1) (58,643 ) (68,101 ) (141,450 ) (162,412 )
Additional provision for loan
losses(1) 17,166 (181 ) 21,398 18,775
Direct marketing costs (344 ) (11,074 ) (11,313 ) (18,271 )
Other cost of sales (1,607 ) (2,508 ) (4,277 ) (4,786 )
Gross profit 74,563 68,510 144,816 143,746
Operating expenses (36,498 ) (40,557 ) (78,855 ) (80,823 )
Operating income $ 38,065 $ 27,953 $ 65,961 $ 62,923
As a percentage of revenues:
Net charge-offs 50 % 45 % 51 % 52 %
Additional provision for loan
losses (15 ) - (8 ) (6 )
Direct marketing costs - 7 4 6
Other cost of sales 1 2 2 2
Gross margin 63 46 52 46
Operating expenses 31 27 28 26
Operating margin 32 % 19 % 24 % 20 %
_________(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. Due to the negative impact of COVID-19 on our loan balances and revenue, we are monitoring our profit margins closely. Long-term, we intend to continue to manage the business to a targeted 20% operating margin. Recent operating margin trends. For the three months endedJune 30, 2020 , our operating margin was 32%, which was an increase from 19% in the prior year period. For the six months endedJune 30, 2020 , our operating margin was 24%, which was also an increase from 20% in the prior year period. These margin increases were primarily driven by the reductions in both additional provisions for loan losses and direct marketing costs due to reduced loan originations and lower loan balances resulting from the COVID-19 pandemic. While gross margins are currently above our targeted 40%, operating expenses as a percentage of revenue continue to increase due to the negative impact of the COVID-19 pandemic on loan balances and revenue. As a result, the Company recently implemented an operating expense reduction plan. The Company has completed the following actions under its operating expense reduction plan:
• Reduction of its
• Suspension of its 2020 short-term incentive plan (bonus pool) effective as
of June 30, 2020 ;
• Reduction of executive salaries and board compensation beginning July
2020 ; and
• Elimination of discretionary operating expense items and renegotiated
terms with key vendors.
Implementing these operating expense reductions will help keep operating expenses between 20% and 30% of revenues until growth of the loan portfolio and related revenue resumes.
53-------------------------------------------------------------------------------- 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 Earnings Adjusted earnings represents our net income from continuing operations, adjusted to exclude: • Contingent loss related to a legal matter
• Cumulative tax effect of adjustments
Adjusted diluted earnings per share is Adjusted earnings divided by Diluted
weighted average shares outstanding.
The following table presents a reconciliation of net income from continuing
operations and diluted earnings per share to Adjusted earnings and Adjusted
diluted earnings per share, which excludes the impact of the contingent loss for
each of the periods indicated:
Three Months Ended June 30, Six Months Ended June 30,
(Dollars in thousands except per
share amounts) 2020 2019 2020 2019
Net income from continuing
operations $ 16,093 $ 8,383 $ 24,015 $ 19,338
Impact of contingent loss related
to a legal matter 1,422 - 5,685 -
Cumulative tax effect of
adjustments (395 ) - (1,580 ) -
Adjusted earnings $ 17,120 $ 8,383 $ 28,120 $ 19,338
Diluted earnings per share $ 0.38 $ 0.19 $ 0.56 $ 0.44
Impact of contingent loss related
to a legal matter 0.03 - 0.13 -
Cumulative tax effect of
adjustments (0.01 ) - (0.04 ) -
Adjusted diluted earnings per
share $ 0.40 $ 0.19 $ 0.65 $ 0.44 54
-------------------------------------------------------------------------------- Adjusted EBITDA and Adjusted EBITDA Margin Adjusted EBITDA represents our net income from continuing operations, adjusted to exclude: • Net interest expense, primarily associated with notes payable under the VPC
Facility, EF SPV Facility and ESPV Facility used to fund the loan portfolios;
• Share-based compensation;
• Depreciation and amortization expense on fixed assets and intangible assets;
• Gains and losses from fair value adjustments, dispositions or contingent
losses related to legal matters 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 from continuing operations 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 the loan portfolios, for other corporate purposes or tax payments
that may represent a reduction in cash available to us.
The following table presents a reconciliation of net income from continuing operations to Adjusted EBITDA and Adjusted EBITDA margin for each of the periods indicated:
Three Months Ended June 30, Six Months Ended June 30,
(Dollars in thousands) 2020 2019 2020 2019
Net income from continuing
operations $ 16,093 $ 8,383 $ 24,015 $ 19,338
Adjustments:
Net interest expense 12,177 16,936 25,833 34,936
Share-based compensation 2,599 2,510 5,347 4,922
Depreciation and
amortization 4,529 3,955 8,825 7,811
Non-operating loss 1,422 - 5,685 -
Income tax expense 8,373 2,634 10,428 8,649
Adjusted EBITDA $ 45,193 $ 34,418 $ 80,133 $ 75,656
Adjusted EBITDA margin 38 % 23 % 29 % 24 %
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.
55--------------------------------------------------------------------------------
The following table presents a reconciliation of net cash provided by operating activities to FCF for each of the periods indicated:
Six Months Ended June 30,
(Dollars in thousands) 2020 2019
Net cash provided by continuing operating
activities(1) $ 131,244 $ 152,478
Adjustments:
Net charge-offs - combined principal loans (108,532 ) (127,570 ) Capital expenditures (9,508 ) (9,750 ) FCF $ 13,204 $ 15,158 _________
(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 total amount of gross
charge-offs.
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 June 30, Six Months Ended June 30,
(Dollars in thousands) 2020 2019 2020 2019
Net charge-offs $ 58,643 $ 68,101 $ 141,450 $ 162,412
Additional provision for
loan losses (17,166 ) 181 (21,398 ) (18,775 )
Provision for loan losses $ 41,477 $ 68,282 $ 120,052 $ 143,637
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
VIE under US GAAP and the condensed 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.
56
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Beginning in the fourth quarter of 2018, the Company also licenses its Rise
installment loan brand to a third-party lender, FinWise Bank , which originates
Rise installment loans in 18 states. Prior to August 1, 2019 , FinWise Bank
retained 5% of the balances of all originated loans and sold a 95% loan
participation in those Rise installment loans to a third-party SPV, EF SPV. On
August 1, 2019 , EF SPV purchased an additional 1% participation in the
outstanding portfolio with the participation percentage revised going forward to
96%. We do not own EF SPV, but we are required to consolidate EF SPV as a VIE
under US GAAP and the condensed consolidated financial statements include
revenue, losses and loans receivable related to the 96% of Rise installment
loans originated by FinWise Bank and sold to EF 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. See "-Basis of
Presentation and Critical Accounting Policies-Allowance and liability for
estimated losses on consumer loans" and "-Basis of Presentation and Critical
Accounting Policies-Liability for estimated losses on credit service
organization loans."
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).
57--------------------------------------------------------------------------------
2019 2020
(Dollars in thousands) June 30 September 30 December 31Company Owned Loans: Loans receivable - principal, current, company owned$ 484,131 $ 507,551 $ 530,463 $ 486,396 $ 387,939 Loans receivable - principal, past due, company owned 47,846 59,240 58,489 53,923 18,917 Loans receivable - principal, total, company owned 531,977 566,791 588,952 540,319 406,856 Loans receivable - finance charges, company owned 27,472 31,698 33,033 31,621 25,606 Loans receivable - company owned 559,449 598,489 621,985 571,940 432,462 Allowance for loan losses on loans receivable, company owned (65,889 ) (80,537 ) (79,912 ) (76,188 ) (59,438 ) Loans receivable, net, company owned$ 493,560 $ 517,952 $ 542,073 $ 495,752 $ 373,024 Third Party Loans Guaranteed by the Company: Loans receivable - principal, current, guaranteed by company$ 21,099 $ 18,633 $ 17,474 $ 12,606 $ 6,755 Loans receivable - principal, past due, guaranteed by company 596 697 723 564 117 Loans receivable - principal, total, guaranteed by company(1) 21,695 19,330 18,197 13,170 6,872 Loans receivable - finance charges, guaranteed by company(2) 1,676 1,553 1,395 1,150 550 Loans receivable - guaranteed by company 23,371 20,883 19,592 14,320 7,422 Liability for losses on loans receivable, guaranteed by company (1,983 ) (1,972 ) (2,080 ) (1,571 ) (1,156 ) Loans receivable, net, guaranteed by company(2)$ 21,388 $ 18,911 $ 17,512 $ 12,749 $ 6,266 Combined Loans Receivable(3): Combined loans receivable - principal, current$ 505,230 $ 526,184 $ 547,937 $ 499,002 $ 394,694 Combined loans receivable - principal, past due 48,442 59,937 59,212 54,487 19,034 Combined loans receivable - principal 553,672 586,121 607,149 553,489 413,728 Combined loans receivable - finance charges 29,148 33,251 34,428 32,771 26,156 Combined loans receivable$ 582,820 $ 619,372 $ 641,577 $ 586,260 $ 439,884 Combined Loan Loss Reserve(3): Allowance for loan losses on loans receivable, company owned$ (65,889 ) $ (80,537 ) $ (79,912 ) $ (76,188 ) $ (59,438 ) Liability for losses on loans receivable, guaranteed by company (1,983 ) (1,972 ) (2,080 ) (1,571 ) (1,156 ) Combined loan loss reserve$ (67,872 ) $ (82,509 ) $ (81,992 ) $ (77,759 ) $ (60,594 ) Combined loans receivable - principal, past due(3)$ 48,442 $ 59,937 $ 59,212 $ 54,487 $ 19,034 Combined loans receivable - principal(3)$ 553,672 $ 586,121 $ 607,149 $ 553,489 $ 413,728 Percentage past due(1) 9 % 10 % 10 % 10 % 5 % Combined loan loss reserve as a percentage of combined loans receivable(3)(4) 12 % 13 % 13 % 13 % 14 % Allowance for loan losses as a percentage of loans receivable - company owned 12 % 13 % 13 % 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.
58-------------------------------------------------------------------------------- COMPONENTS OF OUR RESULTS OF OPERATIONS Revenues Our revenues are composed of Rise finance charges and CSO fees (inclusive of finance charges attributable to the participation in Rise installment loans originated byFinWise Bank ), 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, Rise CSO and Elastic products. See "-Overview" above for further information on the structure of Elastic. Finance charge and fee revenues related to the Today Card credit card product were immaterial. 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 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 and automated clearing house ("ACH") transaction costs associated with customer loan funding and payments. 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 include 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. 59
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Other expense Net interest expense. Net interest expense primarily includes the interest expense associated with the VPC Facility that funds the Rise installment loans, the EF SPV Facility that funds Rise installment loans originated byFinWise Bank and the interest expense associated with the ESPV Facility related to the Elastic lines of credit and related Elastic SPV entity. For the six months endedJune 30, 2019 , amortization of the costs of and realized gains from the interest rate caps on the VPC and ESPV Facility are included within Net interest expense. Non-operating loss. Non-operating loss for the three and six months endedJune 30, 2020 included a contingent loss related to a legal matter.
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