ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Components of Our Results of Operations
As a result of the sale of the Legacy U.S. Direct Lending Business on July 8, 2022, the Company no longer guarantees loans originated by third-party lenders through CSO programs. As such, the Company's results of operations discussed below only include the results from the CSO program through July 8, 2022. Refer to Note 14, "Acquisitions and Divestiture" for additional information.
Revenue
The core consumer finance products we offer include Revolving LOC and Installment loans. Interest and fees revenue in our Consolidated Statements of Operations includes interest income, merchant discount revenue (MDR), finance charges and CSO fees. Insurance revenue includes the premiums and commissions we earn on insurance products. Other revenue includes late fees, membership fees and non-sufficient funds fees. Product offerings differ by, and are governed by the laws in each, jurisdiction in which we operate.
Revolving LOC loans are lines of credit without specified maturity dates and include our POS financing products at Flexiti. We record revenue from Revolving LOC loans on a simple-interest basis. Revolving LOC revenues include interest income on outstanding revolving balances and other usage or maintenance fees as permitted by underlying statutes. Accrued interest and fees are included in "Gross loans receivable" in the Consolidated Balance Sheets. Revolving LOC revenues also include MDR, which represents a fee charged to merchant partners to facilitate customer purchases at merchant locations. The fee is recorded as unearned revenue when received and recognized over the expected loan term.
Historically, Installment loans range from unsecured, short-term, small-denomination loans, whereby a customer receives cash in exchange for a post-dated personal check or pre-authorized debit from the customer's bank account, to fixed-term, fully amortizing loans with a fixed payment amount due each period during the term of the loan. With the acquisitions of Heights Finance in December 2021 and First Heritage in July 2022, we now offer long-term large loans to customers. For our short-term, small denomination loans, we recognize revenue on a constant-yield basis ratably over the team of each loan. We defer and recognize unearned fees over the remaining term of the loan at the end of each reporting period. Revenues from these short-term loans represent deferred presentment or other fees as defined by the underlying provincial or national regulations. For our fixed-term, fully amortizing loans, we record revenues on a simple-interest basis. Revenue for fixed-term Installment loans includes interest income from Company-Owned loans, CSO fees and non-sufficient funds or returned-items fees on late or defaulted payments on past-due loans, known as late fees. Late fees comprise approximately 1% of Installment revenues. Accrued interest and fees are included in "Gross loans receivable" in the Consolidated Balance Sheets.
We also offer a number of insurance products, including optional credit protection insurance, life insurance, auto and home insurance, property insurance, check cashing, prepaid cards, demand deposit accounts and money transfer services. We earn miscellaneous fees revenues such as administrative fees, deferral fees, annual membership fees and over limit fees. Heights Finance and First Heritage offer optional insurance products, including credit life, credit accident and health, credit property insurance and credit involuntary unemployment insurance through policies written by unaffiliated third-party insurance companies. Insurance commissions, written in connection with certain loans, are credited to unearned insurance commissions and recognized as income over the life of the related insurance contracts, using a method similar to that used for the recognition of interest income.
Provision for Losses
Credit losses are an inherent part of outstanding loans receivable. We maintain an ALL for gross loans receivable at a level estimated to be adequate to absorb such losses based primarily on our analysis of historical loss rates of products containing similar risk characteristics. The ALL reduces the outstanding gross loans receivables balance in the Consolidated Balance Sheets. The liability for estimated incurred losses related to loans originated by third-party lenders through CSO programs, which we guarantee but do not include in the Consolidated Financial Statements (referred to as "Guaranteed by the Company"), is reported in "Liability for losses on CSO lender-owned consumer loans" in the Consolidated Balance Sheets. Changes in either the allowance or the liability, net of charge-offs and recoveries, are recorded as “Provision for losses” in the Consolidated Statements of Operations.
Operating Expense
Our primary categories of operating expense are as follows:
• Salaries and Benefits —includes salaries and personnel-related costs, including benefits, bonuses and share-based compensation expense.
• Occupancy —includes rent expense on our leased facilities and equipment, utilities, insurance and certain maintenance expenses.
• Advertising —costs are expensed as incurred and include costs associated with attracting, retaining and/or reactivating customers as well as creating brand awareness. We have internal creative, web and print design capabilities and if we outsource these services, it is limited to mass-media production and placement. Advertising expense also includes costs for all marketing activities including paid search, advertising on social networking sites, affiliate programs, direct response television, radio air time and direct mail.
• Direct Operations —includes expenses associated with the direct operations and technology infrastructure related to loan underwriting, collections and processing, and bank service charges and credit scoring charges.
• Depreciation and amortization —includes all store and corporate depreciation and amortization expense.
• Other operating expense —includes expenses such as office expense, security expense, travel and entertainment expenses, certain taxes, legal and professional fees, foreign currency impact to our intercompany balances, gains or losses on foreign currency exchanges, disposals of fixed assets, certain store closure costs and other miscellaneous income and expense amounts.
Other Expense
Our non-operating expenses include the following:
• Interest Expense —includes interest primarily related to our Senior Secured Notes, our SPV facilities and our revolvers, including any unused portion of commitment fees.
• Loss (income) from equity method investment, Gain from equity method investment— includes our share of Katapult's income or loss and a recognized gain from the merger of Katapult and FinServ in 2021. Refer to Item 1, "Business—Company History and Overview " and Note 5 , "Fair Value Measurements " of the Notes to the Consolidated Financial Statements for additional details on our equity method investment.
• Goodwill impairment— includes the impairment losses recorded on the U.S. Direct Lending and Canada POS Lending reporting unit in the fourth quarter of 2022. Refer to Note 4 , " G oodwill and Intangibles " of the Notes to the Consolidated Financial Statements for additional details.
• Loss on extinguishment of debt— includes costs associated with the extinguishment of debt facilities.
• (Gain) loss on change in fair value of contingent consideration— includes change in contingent consideration payable as part of the Flexiti acquisition in March 2021.
Consolidated Revenue by Product and Segment
Beginning in 2022, we report "Interest and fees revenue," "Insurance premiums and commissions" and "Other revenue" in place of our previously reported "Revenue" on our Statements of Operations. Prior period presentations have been revised to conform to the current period presentation.
As a result of the sale of the Legacy U.S. Direct Lending Business on July 8, 2022, the Company no longer guarantees loans originated by third-party lenders through CSO programs. As such, the Company's results of operations discussed below only include the results from the CSO program through July 8, 2022. Refer to Note 14, "Acquisitions and Divestiture" for additional information.
The following table summarizes revenue by product for the period indicated:
For the Year Ended
December 31, 2022
December 31, 2021
(in thousands)
U.S. Direct Lending
Canada Direct Lending
Canada POS Lending
Total
% of Total
U.S. Direct Lending
Canada Direct Lending
Canada POS Lending
Total
% of Total
Revolving LOC
Installment
Total interest and fees revenue
Insurance premiums and commissions
Other revenue
Total revenue
During the year ended December 31, 2022, total revenue increased $208.1 million, or 25.4%, to $1,025.9 million, compared to the prior-year period, primarily driven by growth in U.S. Direct Lending revenue due to our acquisitions of Heights Finance in December 2021 and First Heritage in July 2022, partially offset by the sale of the Legacy U.S. Direct Lending Business in July 2022, organic growth in Canada Direct Lending and increased revenue in Canada POS Lending related to a full year of consolidated results and significant increases in loan balances at Flexiti, which we acquired in March 2021.
Product Revenue for the Year Ended December 31, 2022
• Revolving LOC
◦ Revolving LOC revenue for the year ended December 31, 2022 increased $51.2 million, or 17.4%, compared to the prior-year period, driven by growth and a full year of consolidated results in Canada POS lending of $63.0 million, or 195.2%, and Canada Direct Lending revenue of $37.2 million, or 23.9%, partially offset by the impact of the sale of the Legacy U.S. Direct Lending Business in July 2022.
• Installment
◦ Installment revenue for the year ended December 31, 2022 increased $110.5 million, or 24.6%, compared to the prior-year period, primarily due to an increase of $106.1 million in U.S. Direct Lending installment revenue driven by our acquisitions of Heights Finance and First Heritage.
• Insurance premiums and commissions
◦ Insurance premiums and commissions for the year ended December 31, 2022 increased $39.1 million, or 79.1%, compared to the prior-year period, primarily due to an increase of $31.3 million in U.S. Direct Lending insurance premiums and commission revenue driven by our acquisitions of Heights Finance and First Heritage. Canada Direct Lending grew $5.8 million, or 12.0%, year over year, due to organic growth in the sale of insurance products to Revolving LOC and Installment loan customers in Canada.
• Other revenue
◦ Other revenue for the year ended December 31, 2022 increased $7.3 million, or 29.7%, versus the prior-year period, due to a $6.6 million increase in other revenue for Canada POS Lending as ancillary fees rose in line with overall loan growth.
The following table summarizes revenue by product for the periods indicated:
For the Year Ended
December 31, 2021
December 31, 2020
(in thousands)
U.S. Direct Lending
Canada Direct Lending
Canada POS Lending
Total
% of Total
U.S. Direct Lending
Canada Direct Lending
Canada POS Lending
Total
% of Total
Revolving LOC
Installment
Total interest and fees
Insurance premiums and commissions
Other revenue
Total revenue
For a comparison of our results of operations for the years ended December 31, 2021 and 2020, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Revenue by Product and Segment and Related Loan Portfolio Performance" in Part II Item 7 of our 2021 Form 10-K.
Consolidated Results of Operations
Beginning in 2021, we changed our presentation of operating expenses on our Statements of Operations. We have revised prior period presentations to conform to the current period presentation. Refer to "—Operating Expense" above for a description of expenses included within each operating expense line item.
As a result of the sale of the Legacy U.S. Direct Lending Business on July 8, 2022, the Company no longer guarantees loans originated by third-party lenders through CSO programs. As such, the Company's results of operations discussed below only include the results from the CSO program through July 8, 2022. Refer to Note 14, "Acquisitions and Divestiture" for additional information.
The table below presents our consolidated results of operations. A further discussion of the results of our operating segments is provided under "Segment Analysis" below.
(in thousands)
For the Year Ended December 31,
Revenue
Interest and fees revenue
Insurance premiums and commissions
Other revenue
Total revenue
Provision for losses
Net revenue
Operating Expenses
Salaries and benefits
Occupancy
Advertising
Direct operations
Depreciation and amortization
Other operating expense
Total operating expenses
Other expense (income)
Interest expense
Loss (income) from equity method investment
Gain from equity method investment
Goodwill impairment
Loss on extinguishment of debt
(Gain) loss on change in fair value of contingent consideration
Gain on sale of business
Total other expense (income)
(Loss) income from continuing operations before income taxes
(Benefit) provision for income taxes
Net (loss) income from continuing operations
Net income from discontinued operations, net of tax
Net (loss) income
Comparison of Consolidated Results of Operations for the Years Ended December 31, 2022 and 2021
As a result of the sale of the Legacy U.S. Direct Lending Business on July 8, 2022, the Company no longer guarantees loans originated by third-party lenders through CSO programs. As such, the Company's results of operations discussed below only include the results from the CSO program through July 8, 2022. Refer to Note 14, "Acquisitions and Divestiture" for additional information.
Revenue
For a discussion of revenue, see "—Consolidated Revenue by Product and Segment" above.
Provision for Losses
Provision for losses increased by $154.7 million, or 63.0%, for the year ended December 31, 2022 compared to the prior-year period, primarily driven by:
• Year-over-year loan growth, driven by strong consumer demand, across all loan portfolios compared to the same period in the prior year;
◦ Continued orderly credit normalization associated with loan growth as customers returned to pre-COVID-19 payment behaviors resulting in higher NCO rates and past due rates as compared to the prior year when customers received government stimulus payments;
◦ Full year of provision for losses for our Heights Finance acquisition of $114.6 million;
◦ Full year of provision for loan losses and increased gross loans receivable balance for Canada POS Lending of $45.2 million, an increase of $20.5 million compared to the prior-year period;
◦ Partial year of provision for losses for our First Heritage acquisition of $14.5 million; and
◦ Decrease in provision for losses compared to the prior-year period for our Legacy U.S. Direct Lending Business divestiture of $53.5 million.
Operating Expenses
Operating expenses for the year ended December 31, 2022 increased $69.6 million, or 14.3%, primarily driven by:
Salaries and benefits. Salaries and benefits expense was $281.6 million for the year ended December 31, 2022, an increase of $44.5 million, or 18.8%, compared to the prior-year period. The increase is largely due to the acquisitions of Heights Finance and First Heritage, and a full year of Canada POS Lending business salaries and benefits, partially offset by the July 2022 divestiture of our Legacy U.S. Direct Lending Business and severance benefits as the result of restructuring initiatives implemented in the fourth quarter of 2022.
Occupancy. Occupancy expense was $59.5 million for the year ended December 31, 2022, an increase of $3.9 million, or 7.1%, compared to the prior-year period. The increase was largely due to the acquisitions of Heights Finance and First Heritage, which represent all U.S. Direct Lending stores, as of December 31, 2022, partially offset by the 160 stores transferred as part of the July 2022 divestiture of our Legacy U.S. Direct Lending Business.
Advertising. Advertising expense was $32.1 million for the year ended December 31, 2022, a decrease of $6.6 million, or 17.1%, compared to the prior-year period. The decrease was primarily due to decreases in advertising spending in the U.S. Direct Lending business due to lower advertising at Heights Finance and First Heritage compared to the Legacy U.S. Direct Lending Business.
Direct operations. Direct operations expense was $64.1 million for the year ended December 31, 2022, an increase of $4.1 million, or 6.8%, compared to the prior-year period. The increase is primarily driven by increased expenses incurred while growing the loan portfolio year over year.
Depreciation and amortization. Depreciation and amortization expense for the year ended December 31, 2022, increased $9.4 million, or 34.8%, compared to the prior-year period, primarily due to amortization expense recorded on Canada POS Lending and acquired intangible asserts related to Heights Finance and First Heritage, offset by decreased depreciation expense related to store fixed assets sold as part of the Legacy U.S. Direct Lending Business divestiture.
Other operating expenses. Other operating expenses were $82.8 million for the year ended December 31, 2022, an increase of $14.3 million, or 20.9%, compared to the prior-year period, primarily driven by costs incurred for the sale of the Legacy U.S. Direct Lending Business and the acquisitions of Heights Finance and First Heritage. Refer to the "—Segment Analysis" below for additional details.
Other Expense
Other expenses for the year ended December 31, 2022 were $263.2 million, an increase of $258.5 million compared to the prior-year period, primarily driven by:
I nterest expense. Interest expense for the year ended December 31, 2022, increased $88.3 million, or 90.7%, primarily driven by increased non-recourse ABL borrowing to support organic loan growth and acquired portfolios, Senior Notes issued to fund in part our Heights Finance acquisition and an increase in benchmark rates on variable rate debt.
Equity method investment. During the second quarter of 2021 Katapult became a public company via a SPAC merger, generating a pretax gain of $135.4 million. The Company's share of Katapult earnings and losses was $3.7 million of income for 2021 and $4.0 million of losses for 2022.
Goodwill impairment. We recorded a $107.8 million goodwill impairment in the U.S. Direct Lending reporting unit and a $37.4 million goodwill impairment in the Canada POS Lending reporting unit during the fourth quarter of 2022.
Loss on extinguishment of debt. We recorded a $4.4 million loss on extinguishment of debt for the year ended December 31, 2022 related to the write off of deferred financing costs of debt facilities that we refinanced during 2022. The Loss on extinguishment of debt for the year ended December 31, 2021 of $40.2 million was due to the redemption of the 8.25% Senior Secured Notes.
Gain or loss on change in fair value of contingent consideration. We recorded a $7.6 million gain related to the decrease in fair value of the contingent consideration liability related to the Flexiti acquisition during the year ended December 31, 2022 and a $6.2 million loss related to the increase in the fair value of contingent consideration liability during the year ended December 31, 2021.
Gain on sale of business. We recorded a gain on sale of our Legacy U.S. Direct Lending Business of $68.4 million that occurred in July 2022.
Provision for Income Taxes
The effective income tax rate for the year ended December 31, 2022 was 4.5%. The income tax benefit recognized as a result of being in a pre-tax loss position was lower than the blended federal and state/provincial statutory rate of approximately 26%, primarily as a result of lost tax benefits related to the divestiture of the Legacy U.S. Direct Lending Business of $11.1 million, share-based compensation of $0.2 million, officers’ compensation of $1.5 million, non-deductible transaction costs of $0.2 million and non-deductible goodwill impairment of $26.9 million, partially offset by tax benefits related to change in fair value of contingent consideration of $2.1 million. The effective income tax rate of adjusted tax expense included in Adjusted Net Income for the year ended December 31, 2022 was 22.1%.
The effective income tax rate for the year ended December 31, 2021 was 26.3%, consistent with the blended federal and state/provincial statutory rate of approximately 26%. The income tax expense includes nondeductible expense items related to the change in fair value of contingent consideration of $1.6 million and nondeductible transaction costs of $1.2 million, partially offset by proportionally more net income in lower-tax rate jurisdictions, driven by the gain on the Katapult transaction of $146.9 million in the second quarter of 2021 and the loss on extinguishment of debt of $40.2 million in the third quarter of 2021. Additionally, income tax expense includes the release of a valuation allowance of $0.4 million due to our share of Katapult's income, tax benefits related to share-based compensation of $0.8 million, $0.2 million tax expense of additional Texas accrual for 2020 due to the settlement of 2013 to 2019 Texas returns and a tax benefit of $0.9 million for the recognition of research and development tax credit.
Comparison of Consolidated Results of Operations for the Years Ended December 31, 2021 and 2020
For a comparison of our results of operations for the years ended December 31, 2021 and 2020, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Consolidated Results of Operations" in Part II Item 7 of our 2021 Form 10-K.
Segment Analysis
The following is a summary of portfolio performance and results of operations for the segment and period indicated. We report financial results for three reportable segments: U.S.Direct Lending, Canada Direct Lending and Canada POS Lending.
U.S. Direct Lending Portfolio Performance
(in thousands, except percentages, unaudited)
Gross loans receivable
Revolving LOC
Installment loans
Total gross loans receivable (3)
Lending Revenue:
Revolving LOC
Installment loans (4)
Total lending revenue
Lending Provision:
Revolving LOC
Installment loans (5)
Total lending provision
NCOs (6)
Revolving LOC
(in thousands, except percentages, unaudited)
Installment loans (7)
Total NCOs
NCO rate (annualized) (6) (8)
Revolving LOC
Installment loans
Total NCO rate (9)
ALL rate (10)
Revolving LOC
Installment loans
Total ALL rate (11)
31+ days past-due rate (10)
Revolving LOC
Installment loans
Total past-due rate (12)
(1) On December 27, 2021, we acquired Heights Finance, which accounted for approximately $472 million of U.S. Direct Lending Installment loans as of December 31, 2021. As the period between December 27, 2021 and December 31, 2021 did not result in material loan performance, we have excluded Heights Finance from the table for the fourth quarter of 2021.
(2) Includes loan balances and activity classified as Held for Sale.
(3)Total combined gross loans receivable including receivables from installment loans originated by third-party lenders through CSO programs and guaranteed by the Company were $737.4 million,$683.1 million and $236.6 million as of June 30, 2022, March 31, 2022 and December 31, 2021, respectively, including installment loans – guaranteed by the Company of $51.3 million, $44.4 million and $46.3 million as of June 30, 2022, March 31, 2022 and December 31, 2021, respectively. All balances in connection with the CSO programs were disposed of on July 8, 2022 upon closing of the divestiture of the Legacy U.S. Direct Lending business. Total Gross Combined Loans Receivable and installment loans – guaranteed by the Company are non-GAAP measures. For a description of each non-GAAP metric, see "Non-GAAP Financial Measures.”
(4) Includes lending revenue from installment loans originated by third-party lenders through CSO programs and guaranteed by the Company of $3.9 million,$48.3 million, $49.0 million and $47.3 million for the three months ended September 30, 2022, June 30, 2022, March 31, 2022 and December 31, 2021, respectively. All balances in connection with the CSO programs were disposed of on July 8, 2022 upon closing of the divestiture of the Legacy U.S. Direct Lending Business.
(5) Includes provision from installment loans originated by third-party lenders through CSO programs and guaranteed by the Company of $28.3 million, $21.7 million and $26.0 million for the three months ended June 30, 2022, March 31, 2022 and December 31, 2021, respectively. All balances in connection with the CSO programs were disposed of on July 8, 2022 upon closing of the divestiture of the Legacy U.S. Direct Lending Business.
(6) NCOs presented above include $0.0 million, $0.5 million, $10.3 million and $5.0 million, for the three months ended December 31, 2022, September 30, 2022, June 30, 2022 and March 31, 2022, respectively, related to the purchase accounting fair value discount, which are excluded from provision.
(7) Total NCOs included NCOs for installment loans originated by third-party lenders through CSO programs and guaranteed by the Company of $1.6 million, $27.4 million, $21.5 million and $26.07 million for the three months ended September 30, 2022, June 30, 2022, March 31, 2022 and December 31, 2021, respectively. All balances in connection with the CSO programs were disposed of on July 8, 2022 upon closing of the divestiture of the Legacy U.S. Direct Lending Business.
(8) We calculate NCO rate as total quarterly NCOs divided by Average gross loans receivable, then we annualize the rate. The amount and timing of recoveries are impacted by our collection strategies, which are based on customer behavior and risk profile and include direct customer communications and the periodic sale of charged off loans.
(9) Total NCO rate included the NCO rate for installment loans originated by third-party lenders through CSO programs and guaranteed by the Company was 24.8%, 228.8%, 189.6% and 232.4% for the three months ended September 30, 2022, June 30, 2022, March 31, 2022 and December 31, 2021, respectively. All balances in connection with the CSO programs were disposed of on July 8, 2022 upon closing of the divestiture of the Legacy U.S. Direct Lending Business.
(10) We calculate (i) Allowance for loan losses (ALL) rate and (ii) past-due rate as the respective totals divided by gross loans receivable at each respective quarter end.
(11)Total CSO liability for losses for installment loans originated by third-party lenders through CSO programs and guaranteed by the Company was 0%, 15.7%, 16.1% and 14.9% for the three months ended September 30, 2022, June 30, 2022, March 31, 2022 and December 31, 2021, respectively. All balances in connection with the CSO programs were disposed of on July 8, 2022 upon closing of the divestiture of the Legacy U.S. Direct Lending business. Total U.S. Direct Lending ALL and CSO liability for losses rate was 8.9%, 6.6% and 16.0% for the three months ended June 30, 2022, March 31, 2022 and December 31, 2021, respectively.
(12) Total past-due rate included the past-due rate for installment loans originated by third-party lenders through CSO programs and guaranteed by the Company was 2.6%, 4.5% and 3.1% for the three months ended June 30, 2022, March 31, 2022 and December 31, 2021, respectively. All balances in connection with the CSO programs were disposed of on July 8, 2022 upon closing of the divestiture of the Legacy U.S. Direct Lending Business.
Following is a summary of results of operations for the U.S. Direct Lending segment for the periods indicated.
For the Year Ended December 31,
(dollars in thousands, unaudited)
Revenue
Interest and fees revenue
Insurance premiums and commissions
Other revenue
Total revenue
Provision for losses
Net revenue
Operating Expenses
Salaries and benefits
Occupancy
Advertising
Direct operations
Depreciation and amortization
Other operating expenses
Total operating expenses
Other expense (income)
Interest expense
Loss (income) from equity method investment
Gain from equity method investment
Goodwill impairment
Loss on extinguishment of debt
Gain on disposal of business
Total other expense (income)
Segment (loss) income before income taxes
U.S. Direct Lending Segment Results - For the Years Ended December 31, 2022 and 2021
Total Revenue. Total revenue increased $89.8 million, or 17.1%, compared to the prior-year period for the year ended December 31, 2022, primarily as a result of the acquisitions of Heights Finance in December 2021 and First Heritage in July 2022 and increases in revenue earned in 2022 by the Legacy U.S. Direct Lending Business prior to its divestiture in July 2022. Installment loan balances as of December 31, 2022 increased $635.6 million, or 461.3%, as a result of our acquisitions and divestiture. Following the sale of the Legacy U.S. Direct Lending Business, we no longer offer Revolving LOC loan products in the U.S. or guarantee loans originated by third party lenders through CSO programs.
Provision for Losses. The provision for losses increased $74.5 million, or 44.9%, for the year ended December 31, 2022, compared to the prior-year period, primarily as a result of the increase in U.S. Installment loan balances. Heights Finance and First Heritage offer higher balance, lower yield products that have lower charge off rates and delinquency rates compared to the Legacy U.S. Direct Lending Business. Total NCO rates (annualized) decreased 7,920 bps, or 81.1%, year over year and increased 280 bps, or 17.9%, sequentially due to the change in the composition of the U.S. Direct Lending business following the acquisitions and divestiture.
Operating Expenses. Operating expenses for the year ended December 31, 2022 were $383.4 million, an increase of $44.7 million, or 13.2%, compared to $338.7 million for the year ended December 31, 2021, primarily driven by the Salaries and benefits expense associated with a full year of consolidated Heights Finance results and partial year of First Heritage, partially offset by the divestiture of the Legacy U.S. Direct lending Business in July 2022. The Company experienced an increase in Depreciation and amortization expense of $6.1 million related to the amortization of intangible assets capitalized as part of the acquisitions of Heights Finance and First Heritage. Other operating expense increased by $8.6 million primarily due to costs incurred in the divestiture of the Legacy U.S. Direct Lending Business and the acquisition of First Heritage during 2022. These increases are partially offset by the $6.2 million decrease in Advertising expense which was primarily due to recurring advertising spending being higher on the Legacy U.S. Direct Lending Business as compared to the Heights Finance and First Heritage businesses.
Interest expense . Interest expense for the year ended December 31, 2022 increased $47.4 million, or 65.4%, compared to the prior-year period, primarily driven by (i) increased non-recourse ABL borrowing to support organic loan growth and acquired loans, including the new $225 million non-recourse revolving warehouse facility to finance future loans originated by First Heritage and the new $425 million non-recourse revolving warehouse facility to replace our incumbent lender and finance future loans originated by Heights Finance, (ii) Senior Notes issued to fund in part our Heights Finance acquisition and (iii) an increase in benchmark rates on variable rate debt.
Equity method investment. We recorded a loss of $4.0 million for the year ended December 31, 2022 for our share of Katapult's loss. As of December 31, 2022, we own 19.5% of Katapult on a fully diluted basis (assuming full pay-out of earn-out shares), or 18.2% (excluding pay-out of earn-out shares). During the second quarter of 2021, Katapult became a public company via a SPAC merger, generating a pretax gain of $135.4 million in the year ended December 31, 2021.
Goodwill impairment. On October 1, 2022, management determined the estimated fair value of the U.S. Direct lending reporting unit did not exceed its carrying value. A two step analysis was performed to determine the amount of impairment for the U.S. Direct Lending reporting unit. The goodwill impairment charge unit was driven by rising interest rates, macroeconomic conditions and performance of recent acquisitions. As such, we recorded a pre-tax goodwill impairment charge of $107.8 million for the U.S. Direct Lending Reporting Unit.
Loss on extinguishment of debt. We recorded a $3.7 million loss on extinguishment of debt for the year ended December 31, 2022 related to the write off of deferred financing costs of debt facilities that we refinanced during 2022, as discussed in "—Interest expense" above. The Loss on extinguishment of debt for the year ended December 31, 2021 of $40.2 million was due to the redemption of the 8.25% Senior Secured Notes.
Gain on sale of business. We recorded a gain on sale of our Legacy U.S. Direct Lending Business of $68.4 million that occurred in July 2022.
Comparison of U.S. Direct Lending Segment Results of Operations for the Years Ended December 31, 2021 and 2020
For a comparison of our U.S. Direct Lending segment results of operations for the years ended December 31, 2021 and 2020, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Segment Analysis" in Part II Item 7 of our 2021 Form 10-K.
Canada Direct Lending Portfolio Performance
(in thousands, except percentages, unaudited)
Gross loans receivable:
Revolving LOC
Installment loans
Total gross loans receivable
Lending Revenue:
Revolving LOC
Installment loans
Total lending revenue
Lending Provision:
Revolving LOC
Installment loans
Total lending provision
NCOs
Revolving LOC
Installment loans
Total NCOs
NCO rate (annualized) (1)
Revolving LOC
Installment loans
Total NCO rate
ALL rate (2)
Revolving LOC
Installment loans
Total ALL rate
31+ days past-due rate (2)
Revolving LOC
Installment loans
Total past-due rate
(1) We calculate NCO rate as total quarterly NCOs divided by Average gross loans receivable; then we annualize the rate. The amount and timing of recoveries are impacted by our collection strategies, which are based on customer behavior and risk profile and include direct customer communications and the periodic sale of charged off loans.
(2) We calculate ALL rate and past-due rate as the respective totals divided by gross loans receivable at each respective quarter end.
Canada Direct Lending Results of Operations
For the Year Ended December 31,
(dollars in thousands, unaudited)
Revenue
Interest and Fees Revenue
Insurance Premiums and Commissions
Other Revenue
Total Revenue
Provision for Losses
Net Revenue
Operating expenses
Salaries and Benefits
Occupancy
Advertising Expense
Direct Operations
Amortization and Depreciation
Other operating expenses
Total operating expenses
Other expense (income)
Interest Expense
Other Expense/Income
Segment income before income taxes
Canada Direct Lending Segment Results - For the Year Ended December 31, 2022 and 2021
Total Revenue. Canada Direct Lending total revenue increased $46.7 million, or 18.2%, ($58.6 million, or 22.8%, on a constant currency basis) compared to the prior-year period for the year ended December 31, 2022, primarily due to the organic growth of Revolving LOC and Installment loans in Canada. Gross loans receivable increased $53.8 million, or 12.6%, ($85.3 million, or 20.0%, on a constant currency basis) year over year.
Provision for Losses. The provision for losses increased $59.6 million, or 108.3%, ( $64.5 million, or 117.2%, on a constant currency basis) for the year ended December 31, 2022, compared to the prior-year period. The increase in provision for losses was primarily driven by (i) normalized provisioning on strong year-over-year loan growth as customer behavior returned to pre-COVID-19 levels, (ii) orderly credit normalization to higher NCO and past-due rates as COVID-19 impacts lessened compared to the same period in the prior year, and (iii) continued shift in online originations which have inherently more credit risk versus in-store originations. Fourth quarter NCO rates (annualized) increased 800 bps, or 45.5%, year over year and increased 200 bps, 8.5%, sequentially. Total past-due rates increased 90 bps year over year and decreased 87 bps sequentially.
Operating Expenses. Operating expenses were $113.0 million for the year ended December 31, 2022, an increase of $9.4 million, or 9.1%, ($13.9 million, or 13.5%, on a constant currency basis), compared to the prior-year period. The increase is primarily due to a $6.0 million ($6.9 million on a constant currency basis) increase in other operating expenses related to higher variable costs, largely collection and financial service fees, on higher volume.
Interest expense . Interest expense for the year ended December 31, 2022 was $25.1 million, compared to $9.8 million for the year ended December 31, 2021, due to increased non-recourse asset-backed lending borrowing from the Canada SPV facility to support organic loan growth and an increase in benchmark rates on variable rate debt.
Comparison of Canada Direct Lending Segment Results of Operations for the Years Ended December 31, 2021 and 2020
For a comparison of our Canada Direct Lending segment results of operations for the years ended December 31, 2021 and 2020, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Segment Analysis" in Part II Item 7 of our 2021 Form 10-K.
Canada POS Lending Portfolio Performance
(in thousands, except percentages, unaudited)
Revolving LOC
Total gross loans receivable
Total lending revenue
Total lending provision
NCOs (1)
NCO rate (annualized) (1)(2)
ALL rate (3)
31 + days past-due rate (3)
(1) NCOs presented above include $0.8 million for the three months ended December 31, 2021 of NCOs related to the purchase accounting fair value discount, which are excluded from provision.
(2) We calculate NCO rate as total quarterly NCOs divided by Average gross loans receivable then we annualized the rate. The amount and timing of recoveries are impacted by our collection strategies, which are based on customer behavior and risk profile and include direct customer communications and the periodic sale of charged off loans.
(3) We calculate ALL rate and past-due rate as the respective totals divided by gross loans receivable at each respective quarter end.
Canada POS Lending Results of Operations
For the Year Ended December 31,
(dollars in thousands, unaudited)
Revenue
Interest and fees revenue
Insurance premiums and commissions
Other revenue
Total revenue
Provision for losses
Net revenue
Operating expenses
Salaries and benefits
Occupancy
Advertising
Direct operations
Depreciation and amortization
Other operating expense
Total operating expenses
Other expense
Goodwill Impairment
Loss on Extinguishment of Debt
Interest expense
Total other expense
Segment loss before income taxes
(1) The totals reported for the year ended December 31, 2021 include results from the date of the Flexiti acquisition, March 10, 2021, through December 31, 2021.
Canada POS Lending Segment Results - For the Years Ended December 31, 2022 and 2021
Total Revenue. Total revenue increased year over year by $71.6 million, or 205.5% ($76.3 million, or 219.1%, on a constant currency basis) driven by year over year significant organic loan growth of $374.3 million, or 81.5% ($0.4 million, or 93.4%, on a constant currency basis). The increase in gross loans receivable was driven by growth associated with both existing and new merchant partners.
Provision for losses . The provision for losses increased $20.5 million, or 83.4% ($22.7 million, or 92.3%, on a constant currency basis) for the year ended December 31, 2022, compared to the prior-year period. The increase in provision for losses was primarily driven by organic loan growth, orderly credit normalization to higher NCO and past-due rates as COVID-19 impacts decreased comparatively and strategic loosening of certain credit approval metrics to include select near-prime customers. Total NCO rates for the fourth quarter of 2022 (annualized) increased to 4.4% from 2.0% year over year. Total past-due rates increased 144 bps year over year and decreased 61 bps sequentially.
Operating expenses . Operating expenses for the year ended December 31, 2022 were $60.1 million, an increase of $15.4 million, or 34.5% ($17.6 million, or 39.4%, on a constant currency basis) compared to $44.7 million for the year ended December 31, 2021. The increase was primarily driven by a $10.9 million increase in Salaries and benefits expense due to increased headcount to support higher loan volume year over year. Depreciation and amortization expense increased $3.5 million due to a full year of amortization of intangible assets capitalized upon the March 2021 acquisition of Flexiti.
Interest expense. Interest expense for the year ended December 31, 2022 increased $25.6 million, or 171.1%, compared to the prior-year period, primarily driven by increased non-recourse asset-backed lending borrowing to support significant loan growth and increased benchmark rates on variable debt prior to entering into interest rate swap agreements.
Goodwill impairment. On October 1, 2022, management determined the estimated fair value of the Canada POS Lending reporting unit did not exceed its carrying value. A two step analysis was performed to determine the amount of impairment for the Canada POS Lending reporting unit. The goodwill impairment charge unit was driven by rising interest rates, macroeconomic conditions and performance of recent acquisitions. As such, we recorded a pre-tax goodwill impairment charge of $37.4 million for the Canada POS Lending reporting unit.
Loss on extinguishment of debt. We incurred $0.7 million of debt extinguishment costs for the year ended December 31, 2022 related to the write off of deferred finance costs upon the September 2022 refinance of the Flexiti SPV.
Gain or loss on change in fair value of contingent consideration. We r ecorded a $7.6 million gain following a decrease in fair value of the Flexiti contingent consideration liability during the year ended December 31, 2022 compared to a $6.2 million loss following an increase in the fair value of Flexiti contingent consideration liability during the year ended December 31, 2021.
Results of Canada POS Lending Segment Results of Operations for the Year Ended December 31, 2021
For the results of our Canada POS Lending segment results of operations for the year ended December 31, 2021, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Segment Analysis" in Part II Item 7 of our 2021 Form 10-K. The company acquired Flexiti on March 10, 2021.
Supplemental Non-GAAP Financial Information
Non-GAAP Financial Measures
In addition to the financial information prepared in conformity with U.S. GAAP, we provide certain “non-GAAP financial measures,” including:
• Adjusted Net Income ("ANI") and Adjusted Diluted Earnings Per Share (net income plus or minus certain legal and other costs, income or loss from equity method investment, goodwill and intangible asset impairments, transaction-related costs, restructuring costs, loss on extinguishment of debt, adjustments related to acquisition accounting, share-based compensation, intangible asset amortization, gain on sale of business, changes in fair value of contingent consideration, certain tax adjustments and cumulative tax effect of applicable adjustments, on a total and per share basis); and
• Gross Combined Loans Receivable (includes loans originated by third-party lenders through CSO programs which are not included in the Consolidated Financial Statements). As a result of the sale of the Legacy U.S. Direct Lending Business, we no longer guarantee loans originated by third-party lenders through CSO programs.
We believe that the presentation of non-GAAP financial information is meaningful and useful in understanding the activities and business metrics of our operations. We believe that these non-GAAP financial measures reflect an additional way of viewing aspects of the business that, when viewed with our U.S. GAAP results, provide a more complete understanding of factors and trends affecting the business.
We believe that investors regularly rely on non-GAAP financial measures to assess operating performance and that such measures may highlight trends in the business that may not otherwise be apparent when relying on financial measures calculated in accordance with U.S. GAAP. In addition, we believe that the adjustments shown below are useful to investors to allow them to compare our financial results during the periods shown without the effect of each of these income or expense items. In addition, we believe that these financial measures are frequently used by securities analysts, investors and other interested parties in the evaluation of public companies in our industry, many of which present similar financial measures when reporting their results.
In addition to reporting loans receivable information in accordance with U.S. GAAP, we provide Gross Combined Loans Receivable consisting of owned loans receivable plus loans originated by third-party lenders through the CSO programs, which we historically guaranteed but did not include in the Consolidated Financial Statements. We believe this analysis provides investors with important information needed to evaluate overall lending performance. All balances in connection with the CSO programs were disposed of on July 8, 2022 with the completion of the divestiture of the Legacy U.S. Direct Lending Business.
We provide non-GAAP financial information for informational purposes and to enhance understanding of the U.S. GAAP Consolidated Financial Statements. These financial measures should not be considered as alternatives to income, segment operating income, or any other performance measure derived in accordance with U.S. GAAP, or as an alternative to cash flows from operating activities or any other liquidity measure derived in accordance with U.S. GAAP. Readers should consider the information in addition to, but not instead of or superior to, the financial statements prepared in accordance with U.S. GAAP. This non-GAAP financial information may be determined or calculated differently by other companies, limiting the usefulness of those measures for comparative purposes.
Description and Reconciliations of Non-GAAP Financial Measures
Adjusted Net Income and Adjusted Diluted Earnings per Share Measures have limitations as analytical tools, and you should not consider these measures in isolation or as a substitute for analysis of our income or cash flows as reported under U.S. GAAP. Some of these limitations are:
• they do not include cash expenditures or future requirements for capital expenditures or contractual commitments;
• they do not include changes in, or cash requirements for, working capital needs;
• they do not include the interest expense, or the cash requirements necessary to service interest or principal payments on debt;
• depreciation and amortization are non-cash expense items reported in the statements of cash flows; and
• other companies in our industry may calculate these measures differently, limiting their usefulness as comparative measures.
We calculate Adjusted Diluted Earnings per Share utilizing diluted shares outstanding at year-end. If the Company records a loss under U.S. GAAP, shares outstanding utilized to calculate Diluted Earnings per Share are equivalent to basic shares outstanding. Shares outstanding utilized to calculate Adjusted Diluted Earnings per Share reflect the number of diluted shares the Company would have reported if reporting net income under U.S. GAAP.
As noted above, Gross Combined Loans Receivable includes loans originated by third-party lenders through CSO programs which are not included in the consolidated financial statements but from which we earn revenue and for which we provide a guarantee to the lender. All balances in connection with the CSO programs were disposed of on July 8, 2022 with the completion of the divestiture of the Legacy U.S. Direct Lending Business. Management believes this analysis provides investors with important information needed to evaluate overall lending performance.
We believe Adjusted Net Income and Adjusted Diluted Earnings per Share are used by investors to analyze operating performance and to evaluate our ability to incur and service debt and the capacity for making capital expenditures.
Reconciliation of Net Income and Diluted Earnings per Share to Adjusted Net Income and Adjusted Diluted Earnings per Share, non-GAAP measures (in thousands, except per share data)
For the Year Ended
December 31,
Net (loss) income from continuing operations
Adjustments:
Restructuring costs (1)
Legal and other costs (2)
Loss (income) from equity method investment (3)
Gain from equity method investment (4)
Transaction costs (5)
Acquisition-related adjustments (6)
Change in fair value of contingent consideration (7)
Loss on extinguishment of debt (8)
Share-based compensation (9)
Intangible asset amortization (10)
Gain on sale of business (11)
Goodwill impairment (12)
Cumulative tax effect of adjustments (13)
Canada GST adjustment (14)
Income tax valuations (15)
Impact of tax law changes (16)
Adjusted net (loss) income
Net (loss) income
Diluted weighted average shares outstanding
Adjusted diluted weighted average shares outstanding
Diluted (loss) earnings per share
Per share impact of adjustments to net income (loss)
Adjusted diluted (loss) earnings per share
Note: Footnotes follow Reconciliation of Net income table on the next page
Restructuring costs primarily related to U.S. and Canada store closures and other cost saving initiatives.
Legal and other costs primarily related to settlement costs related to certain legal matters.
Share of Katapult's U.S. GAAP net income or loss, recognized on a one quarter lag.
Gain on investment in Katapult recorded as a result of the completion of its reverse merger with FinServ.
Transaction costs primarily related to the sale of the Legacy U.S. Direct Lending Business in July 2022, the acquisition of First Heritage in July 2022 and the acquisition of Heights Finance in December 2021.
During 2022, acquisition-related adjustments related to the Heights Finance and First Heritage acquisitions.
During 2022 and 2021, acquisition-related adjustments related to the Flexiti acquisition.
Adjustments related to the fair value of the contingent consideration related to the acquisition of Flexiti.
On July 30, 2021, we entered into new 7.50% Senior Secured Notes due 2028, which were used on August 12, 2021 to extinguish the 8.25% Senior Secured Notes due 2025. During the three and nine months ended December 30, 2021, $40.2 million from the loss on the extinguishment of debt was due to the early redemption of the 8.25% Senior Secured Notes due 2025. An additional $2.1 million of interest was incurred for the year ended December 30, 2021, which represents interest on the 8.25% Senior Secured Notes due 2025 for the period between July 30, 2021 and August 12, 2021, the period during which the 8.25% Senior Secured Notes and 7.50% Senior Secured Notes were outstanding.
During the year ended December 31, 2022,, $3.1 million of the loss on extinguishment of debt was due to the early extinguishment of the U.S. SPV on July 8, 2022 upon the completion of the divestiture of our Legacy U.S.Direct Lending business to Community Choice Financial, $0.6 million was due to the extinguishment of the Heights Finance SPV on July 15, 2022 and $0.7 million of the loss on extinguishment of debt was due to the Flexiti SPF loan settlement.
Estimated fair value of share-based awards was recognized as non-cash compensation expense on a straight-line basis over the vesting period.
Intangible asset amortization primarily included amortization of identifiable intangible assets established in connection with the acquisitions of Flexiti in March 2021, Heights Finance in December 2021 and First Heritage in July 2022.
Gain on the divestiture of its Legacy U.S. Direct Lending Business to Community Choice Financial in July 2022.
Goodwill impairment charge of $107.8 million recorded on the U.S. Direct Lending reporting unit and $37.4 million recorded on the Canada POS Lending reporting unit during the fourth quarter of 2022.
Cumulative tax effect of adjustments included in Reconciliation of Net (loss) income to Adjusted net (loss) income table is calculated using the estimated incremental tax rate by country.
We received a Notice of Adjustment from Canadian tax authority auditors in the second quarter 2020 related to the treatment of certain expenses in prior years
for purposes of calculating the Goods and Services Tax ("GST") due.
During the year ended December 31, 2020, a Texas court ruling related to the apportionment of income to the state for an unrelated company resulted in a
change in estimate regarding the realization of a tax benefit previously taken. Accordingly, we recorded a $1.1 million liability for our estimated exposure related
to this position, which was settled in April 2021. Also in the year ended December 31, 2020, we released a $4.6 million valuation allowance related to Net
Operating Losses ("NOLs") for certain entities in Canada.
On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act ("CARES Act") was enacted by the U.S. Federal government in response to the
COVID-19 pandemic. The CARES Act, among other things, allows NOLs incurred in 2018, 2019 and 2020 to be carried back to each of the five preceding
taxable years to generate a refund of previously paid income taxes. For the year ended December 31, 2020, we recorded an income tax benefit of $11.3 million
related to the carryback of NOL from tax years 2018 and 2019.
Currency Information
We operate in the U.S. and Canada and our consolidated results are reported in U.S. dollars.
Changes in our reported revenues and net (loss) income include the effect of changes in currency exchange rates. We translate the Consolidated Balance Sheet into U.S. dollars at the currency exchange rate in effect at the end of each period. We translate the Consolidated Statement of Operations at the average rates of exchange for the period. We record currency translation adjustments as a component of Accumulated other comprehensive loss in Stockholders’ Equity.
Constant Currency Analysis
We have operations in the U.S. and Canada. For the year ended December 31, 2022 and 2021, 40.0% and 35.7%, respectively, of our revenues were originated in Canadian Dollars. As a result, changes in our reported results include the impacts of changes in foreign currency exchange rates for the Canadian Dollar.
Income Statement
For the Year Ended December 31,
For the Year Ended December 31,
% Change
% Change
Average Exchange Rates for the Canadian Dollar
Balance Sheet - Exchange Rate as of December 31, 2022 and December 31, 2021
December 31,
December 31,
Change
Exchange Rate for the Canadian Dollar
The following constant currency analysis removes the impact of the fluctuation in foreign exchange rates and utilizes constant currency results in our analysis of the Canada Direct Lending and Canada POS Lending segment performance. Our constant currency assessment assumes foreign exchange rates in the current fiscal periods remained the same as in the prior fiscal periods. All conversion rates below are based on the U.S. Dollar equivalent to the Canadian Dollar. We believe that the constant currency assessment below is a useful measure in assessing the comparable growth and profitability of our operations.
We calculated the revenues and gross margin below for our Canadian segments during the year ended December 31, 2022 using the actual average exchange rate during the year ended December 31, 2021 (in thousands).
For the Year Ended December 31,
$ Change
% Change
Canada Direct Lending – constant currency basis:
Revenues
Net revenue
Segment income before income taxes
Canada POS Lending – constant currency basis (1) :
Revenues
Net revenue
Segment loss before income taxes
(1) The totals reported for the year ended December 31, 2021 include results from the date of acquisition, March 10, 2021, through December 31, 2021.
We calculated gross loans receivable for our Canada segments below as of December 31, 2022 using the actual exchange rate as of December 31, 2021 (in thousands).
December 31,
December 31,
Change
Canada Direct Lending – constant currency basis:
Gross loans receivable
Canada POS Lending – constant currency basis:
Gross loans receivable
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of liquidity to fund the loans we make to our customers are (i) cash provided by operations and (ii) our revolving credit facilities and our non-recourse funding facilities, as further described in Note 6 , "Debt " of the Notes to the Consolidated Financial Statements. Historically, we also used funds from third-party lenders under our CSO programs. As a result of the sale of the Legacy U.S. Direct Lending Business on July 8, 2022, we no longer guarantee loans originated by third-party lenders through CSO programs.
We anticipate that our primary use of cash will be to fund growth in our working capital, finance capital expenditures to further our business strategy in both the U.S. and Canada and meet our debt obligations. We may also use cash for potential strategic investments in and acquisitions of other companies that help us extend our reach and product portfolio. Additionally, we may use cash to fund a return on capital for our stockholders through share repurchase programs or in the form of dividends. Our Board of Directors authorized a $25.0 million share repurchase program in February 2022, under which no shares have been repurchased to date. Refer to Note 23 , "Share Repurchase Program " of the Notes to the Consolidated Financial Statements for further details of the program. The Board of Directors suspended the quarterly dividend payment in October 2022.
Our level of cash flow provided by operating activities typically experiences seasonal fluctuations related to our levels of net income and changes in working capital levels, particularly loans receivable. Unexpected changes in our financial condition or other unforeseen factors may result in our inability to obtain third-party financing or could increase our borrowing costs in the future. We have the ability to adjust our volume of lending to consumers to the extent we experience any short-term or long-term funding shortfalls, such as tightening our credit approval practices (as we did during the COVID-19 pandemic), which has the effect of reducing cash outflow requirements while increasing cash inflows through loan repayments.
We may also sell or securitize our assets, draw on our available revolving credit facilities or lines of credit, enter into additional refinancing agreements or reduce our capital spending to generate additional liquidity. The impacts to cash as described in "—Cash Flows" below and other factors resulted in our available unrestricted cash on hand of $73.9 million as of December 31, 2022. We believe our cash on hand and available borrowings provide us with sufficient liquidity for at least the next 12 months.
Our recent acquisitions of First Heritage and Heights Finance have increased our product offerings to include additional customers in the near-prime and prime space. The acquisition of First Heritage and Heights Finance completed our strategic transition in the U.S. toward longer term, higher balance and lower rate credit products and provides us with access to a larger addressable market while mitigating regulatory risk. These initiatives to expand our product offerings and grow the U.S. and Canadian businesses could materially impact our future cash flows. For further information regarding the acquisitions, refer to Note 1, "Summary of Significant Accounting Policies and Nature of Operations," and Note 14,"Acquisitions and Divestiture" of the Notes to the Consolidated Financial Statements.
As of December 31, 2022, we were in compliance with or have received waivers of all financial ratios, covenants and other requirements in our debt agreements. These waivers are temporary and management expects to extend the waivers and renegotiate related covenants. If we do not reach an agreement, we will be in default under certain debt agreements.
We have no additional material commitments or demands that are likely to affect our liquidity.
Debt Capitalization Summary
(in thousands, except capacity, net of deferred financing costs)
Capacity
Interest Rate
Maturity
Balance as of December 31, 2022 (in USD)
7.50% Senior Secured Notes (due 2028) (2)
$1.0 billion
August 1, 2028
Heights SPV
$425.0 million
1-Mo SOFR + 4.25%
July 15, 2025
First Heritage SPV
$225.0 million
1-Mo SOFR + 4.25%
July 13, 2025
Flexiti SPV (1)
C$535.0 million
Weighted average interest rate (3)(5) 8.33%
September 29, 2025
Flexiti Securitization (1)
C$526.5 million
1-Mo CDOR + 3.59% )(5)
December 9, 2025
Canada SPV (1)
C$400.0 million
3-Mo CDOR + 6.00%
August 2, 2026
Curo Canada Revolving Credit Facility (1)(4)
C$5.0 million
Canada Prime Rate + 1.95%
January 6, 2023
Senior Revolver
$40.0 million
1-Mo SOFR + 5.00%
August 31, 2023
(1) Capacity amounts are denominated in Canadian dollars, while outstanding balances as of December 31, 2022 are denominated in U.S. dollars.
(2) On July 30, 2021, we closed our $750 million aggregate principal amount of new 7.50% Senior Secured Notes, which was used to redeem our $690.0 million 8.25% Senior Secured Notes due 2025. On December 27, 2021, we issued an additional $250.0 million of our 7.50% Senior Secured Notes for a total capacity of $1.0 billion.
(3) The weighted average interest rate does not include the impact of the amortization of deferred loan origination costs or debt discounts.
(4) On December 21, 2022 the maximum amount of the CURO Canada Revolving Credit Facility was reduced from C$10.0million to C$5.0 million, and the facility was cancelled in its entirety on January 6, 2023.
(5) Swapped to fixed rate via interest rate swap hedging arrangement that terminates on September 29, 2025 for Flexiti SPV and December 9, 2025 for Flexiti Securitization.
Refer to Note 6 , "Debt," for details on each of our credit facilities and resources.
Cash Flows
The following highlights our cash flow activity and the sources and uses of funding during the periods indicated (in thousands):
For the Year Ended December 31,
Net cash provided by continuing operating activities
Net cash used in investing activities
Net cash provided by financing activities
Years Ended December 31, 2022 and 2021
Operating Activities
Net cash provided by operating activities for the year ended December 31, 2022 was $284.6 million, which is primarily attributable to the effect of non-cash reconciling items of $505.7 million offset by net loss of $185.5 million, and changes in our operating assets and liabilities of $35.6 million. Our non-cash reconciling items of $505.7 million primarily included $400.3 million of provision for losses, $145.2 million of goodwill impairment expense recorded on the U.S. Direct Lending and Canada POS Lending segments, and $36.3 million of depreciation and amortization, offset by the gain on the disposal of our Legacy U.S. Direct Lending Business of $68.4 million and deferred income tax benefit of $38.3 million. Our changes in operating assets and liabilities of $35.6 million were primarily related to $46.6 million of lower accounts payable and accrued liabilities as a result of timing on the settlement of certain accruals and $37.3 million of lower accrued interest on our gross loans receivable offset primarily by an increase in deferred revenue of $17.8 million and $17.9 million of lower Income taxes receivable.
Investing Activities
Net cash used in investing activities for the year ended December 31, 2022 was $777.9 million, primarily due to net origination of loans of $890.1 million. In addition, we used cash to purchase $45.8 million of property, equipment and software, an increase from the prior year due to the acquisitions of Flexiti and Heights Finance in 2021 and First Heritage in 2022. We also utilized $131.0 million of cash to acquire First Heritage and received $289.0 million of cash for the sale of the Legacy U.S. Direct Lending Business, net of cash.
Financing Activities
Net cash provided by financing activities for the year ended December 31, 2022 was $501.1 million primarily due to $549.6 million of net proceeds from our non-recourse debt facilities partially offset by (i) $12.5 million of share repurchases in the first quarter of 2022 and (ii) $13.7 million of cash dividends.
Years Ended December 31, 2021 and 2020
For a comparison of our cash flows for the years ended December 31, 2021 and 2020, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Cash Flows" in Part II Item 7 of our 2021 Form 10-K.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ significantly from those estimates. We consider the following accounting policies to be critical in understanding our historical and future performance and require management's most subjective and complex judgments.
Allowance for Loan Losses
Credit losses are an inherent part of outstanding loans receivable. We maintain an ALL for loans and interest receivable at a level we estimate to be adequate to absorb incurred losses based primarily on our analysis of historical loss or charge-off rates by products containing similar risk characteristics. The ALL on our gross loans receivables reduces the outstanding gross loans receivables balance in the Consolidated Balance Sheets. We record increases in the allowance, net of charge-offs and recoveries, as “Provision for losses” in the Consolidated Statements of Operations. We adopted CECL as of January 1, 2023, which requires a broader range of reasonable and supportable information to inform credit loss estimates. See "Recently Issued Accounting Pronouncements Not Yet Adopted" in Note 1, " Summary of Significant Policies and Nature of Operations for more information."
We also consider delinquency trends as well as macro-economic conditions we believe may affect portfolio losses. 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 or death), we charge off such loan at that time. Qualitative factors such as the impact of new loan products, changes to underwriting criteria or lending policies, new store development or entrance into new markets, changes in jurisdictional regulations or laws, recent credit trends and general economic conditions impact management’s judgment on the overall adequacy of the allowance for loan losses. Any recoveries on loans previously charged to the allowance are credited to the allowance when collected.
Business Combinations and Contingent Consideration
We include the results of operations of acquired businesses from the date of acquisition. We determine the fair value of the assets acquired and liabilities assumed based on their estimated fair value as of the date of acquisition. The excess purchase price over the fair values of identifiable assets and liabilities is recorded as goodwill.
Determining the fair value of assets acquired and liabilities assumed requires management to use significant judgment and estimates including the selection of valuation methodologies, estimates of future revenue and cash flows, discount rates and selection of comparable companies. Our estimates of fair value are based on assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates.
During the measurement period, not to exceed one year from the date of acquisition, we may record adjustments to the assets acquired and liabilities assumed, with a corresponding offset to goodwill. After the conclusion of the measurement period, any subsequent adjustments are reflected in the consolidated statements of operations. When we grant equity to employees of the selling stockholders in connection with an acquisition, we evaluate whether the awards are compensatory. This evaluation includes whether stock award vesting is contingent on the continued employment beyond the acquisition date. If continued employment is required for stock awards to vest, the award is treated as compensation for post-acquisition services and is recognized as compensation expense.
Transaction costs associated with business combinations are expensed as incurred and are included in Other operating expense in our Consolidated Statements of Operations.
On July 13, 2022, we completed the acquisition of First Heritage. The fair value of total consideration paid as part of the acquisition was comprised of $140.0 million in cash. Net assets acquired were $89.0 million, resulting in goodwill of $75.4 million.
On December 27, 2021, we acquired 100% of the outstanding stock of Heights Finance. The fair value of total consideration paid as part of the acquisition was comprised of $335.0 million in cash and $25.0 million of our common stock. Net assets acquired were $162.4 million, resulting in goodwill of $265.7 million. As of December 31, 2021, we completed the determination of the fair values of the acquired identifiable assets and liabilities. During the year ended December 31, 2022,we recorded measurement period adjustments that increased goodwill by $11.8 million$11.8 million. The measurement period adjustment related to the fair value of the loan portfolio and would have resulted in $7.7 million of incremental interest and fee revenue during the three months ended March 31, 2022 and no impact on the year ended December 31, 2022. We recorded a measurement period adjustment in the
fourth quarter of 2022 that decreased goodwill by $3.5 million related to the final true-up of deferred tax balances after the pre-acquisition income tax returns were filed in October 2022. We made these measurement period adjustments to reflect the correct deferred tax balances which existed as of the acquisition date rather than events subsequent to such date. As of December 31, 2022, we completed the determination of the fair values of the acquired identifiable assets and liabilities.
On March 10, 2021, we acquired 100% of the outstanding stock of Flexiti. The fair value of total consideration paid as part of the acquisition was comprised of $86.5 million in cash, $6.3 million in debt costs and $20.6 million in contingent cash consideration subject to future operating metrics, including revenue less NCOs and loan originations. Net assets acquired were $68.5 million, resulting in goodwill of $44.9 million. During the year ended December 31, 2021, we recorded a cumulative net measurement period adjustment that decreased goodwill by $4.5 million. The measurement period adjustment would have resulted in an insignificant increase in amortization expense related to the merchant relationships intangible asset during the first quarter of 2021 when we acquired Flexiti. We made these measurement period adjustments to reflect facts and circumstances that existed as of the acquisition date rather than from intervening events subsequent to such date. As of December 31, 2021, we completed the determination of the fair values of the acquired identifiable assets and liabilities. For the year ended December 31, 2022, we recorded a $7.6 million gain related to the decrease in fair value of contingent consideration.
Goodwill
We exercise judgment in evaluating assets for impairment. Goodwill is tested for impairment annually, or when circumstances arise which could more likely than not reduce the fair value of a reporting unit below its carrying value. These tests require comparing carrying values to estimated fair values of the reporting unit under review.
Our reporting units consist of the U.S. Direct Lending, Canada Direct Lending and Canada POS Lending segments, as defined by FASB’s ASC 280, Segment Reporting, for which we assess goodwill for impairment. Considering the uncertain macroeconomic environment, for the annual goodwill impairment analysis at October 1, 2022, management elected to forgo the qualitative assessment, and performed a Step 1 analysis for all three reporting units. Management calculated the fair value of each reporting unit using a weighted combination of the income approach and the market approach. An impairment would occur if the carrying amount of a reporting unit exceeds the fair value of that reporting unit. We describe our approach to calculating fair value of the goodwill in Note 1, " Summary of Significant Policies and Nature of Operations ." As a result of the goodwill impairment test at October 1, 2022, management determined the estimated fair value of the U.S. Direct Lending and Canada POS Lending reporting units did not exceed their respective carrying value. A two step analysis was performed to determine the amount of impairment for the U.S. Direct Lending reporting unit. The Canada Direct Lending reporting unit estimated fair values exceeded its carrying value. As such, we recorded a pre-tax goodwill impairment charge of $107.8 million for the U.S. Direct Lending reporting unit and $37.4 million for the Canada POS Lending reporting unit. No charge was required for the Canada Direct Lending reporting units. Events or circumstances that could indicate an include a significant change in the business climate, a change in strategic direction, legal factors, operating performance indicators, a change in the competitive environment, the sale or of a significant portion of a reporting unit or economic outlook. These and other macroeconomic factors were considered when performing the annual test as of October 1, 2022 and the quarterly triggering event analyses.
For the three months ended December 31, 2022, we reviewed U.S. Direct Lending, Canada Direct Lending and Canada POS Lending goodwill for triggering events that would indicate a need for an interim quantitative or qualitative assessment of goodwill impairment. As a result of the review, no additional assessment was deemed necessary, and thus there was no additional goodwill impairment recorded.
There continues to be uncertainty surrounding macroeconomic factors that could impact our reporting units. Changes in the expected length of the current economic downturn, timing of recovery or long-term revenue growth or profitability for these reporting units could increase the likelihood of a future goodwill impairment. Additionally, changes in market participant assumptions such as an increased discount rate or further share price reductions could increase the likelihood of a future impairment.
The following table summarizes the segment allocation of recorded goodwill on our Consolidated Balance Sheets as of December 31, 2022:
(in thousands)
December 31, 2022
Percent of Total
December 31, 2021
Percent of Total
U.S. Direct Lending (1)
Canada Direct Lending
Canada POS Lending
Total Goodwill
(1) Changes in Goodwill between December 31, 2021 and September 30, 2022 are primarily due to the acquisition of First Heritage, offset by the sale of the Legacy U.S. Direct Lending Business, refer to FN 14 "Acquisitions and Divestitures".
