NICHOLAS FINANCIAL INC - Quarter Report: 2005 September (Form 10-Q)
Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR
THE TRANSITION PERIOD FROM ______ TO ______.
Commission file number: 0-26680
NICHOLAS FINANCIAL, INC.
(Exact Name of Registrant as Specified in its Charter)
British Columbia, Canada | 8736-3354 | |
(State or Other Jurisdiction of Incorporation or Organization) |
(I.R.S. Employer Identification No.) |
|
2454 McMullen Booth Road, Building C Clearwater, Florida (Address of Principal Executive Offices) |
33759 (Zip Code) |
(727) 726-0763
(Registrants telephone number, including area code)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 and 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter periods that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act) Yes o No þ
Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act) Yes o No þ
As of October 31, 2005, the registrant had 9,872,031 shares of common stock outstanding.
NICHOLAS FINANCIAL, INC.
FORM 10-Q
TABLE OF CONTENTS
FORM 10-Q
TABLE OF CONTENTS
1
Table of Contents
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Nicholas Financial, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
September 30, | March 31, | |||||||
2005 | 2005 | |||||||
(Unaudited) | ||||||||
Assets |
||||||||
Cash |
$ | 1,242,427 | $ | 853,494 | ||||
Finance receivables, net |
126,141,483 | 113,708,122 | ||||||
Accounts receivable |
8,502 | 12,849 | ||||||
Assets held for resale |
836,690 | 530,230 | ||||||
Prepaid expenses and other assets |
896,604 | 507,952 | ||||||
Property and equipment, net |
828,964 | 763,247 | ||||||
Derivatives |
830,711 | 740,223 | ||||||
Deferred income taxes |
3,839,133 | 3,699,324 | ||||||
Total assets |
$ | 134,624,514 | $ | 120,815,441 | ||||
Liabilities |
||||||||
Line of credit |
$ | 74,153,967 | $ | 65,330,897 | ||||
Drafts payable |
1,033,047 | 973,268 | ||||||
Notes payable related party |
600,000 | 1,000,000 | ||||||
Accounts payable and accrued expenses |
5,452,250 | 4,852,787 | ||||||
Income taxes payable |
| 540,899 | ||||||
Deferred revenues |
1,508,600 | 1,359,696 | ||||||
Total liabilities |
82,747,864 | 74,057,547 | ||||||
Shareholders equity |
||||||||
Preferred stock, no par: 5,000,000 shares authorized;
none issued and outstanding |
||||||||
Common stock, no par: 50,000,000 shares authorized;
9,872,031 and 9,840,531 shares issued and
outstanding, respectively |
15,287,582 | 15,127,922 | ||||||
Accumulated other comprehensive income |
515,041 | 458,949 | ||||||
Retained earnings |
36,074,027 | 31,171,023 | ||||||
Total shareholders equity |
51,876,650 | 46,757,894 | ||||||
Total liabilities and shareholders equity |
$ | 134,624,514 | $ | 120,815,441 | ||||
See accompanying notes.
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Table of Contents
Nicholas Financial, Inc. and Subsidiaries
Condensed Consolidated Statements of Income
(Unaudited)
(Unaudited)
Three months ended | Six months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Revenue: |
||||||||||||||||
Interest income on finance receivables |
$ | 10,197,903 | $ | 7,796,997 | $ | 19,307,604 | $ | 15,011,255 | ||||||||
Sales |
40,817 | 36,668 | 91,507 | 99,065 | ||||||||||||
10,238,720 | 7,833,665 | 19,399,111 | 15,110,320 | |||||||||||||
Expenses: |
||||||||||||||||
Cost of sales |
9,913 | 14,050 | 22,284 | 28,861 | ||||||||||||
Marketing |
293,594 | 219,062 | 544,849 | 415,688 | ||||||||||||
Salaries and employee benefits |
2,678,672 | 2,139,580 | 5,312,970 | 4,233,648 | ||||||||||||
Administrative |
1,229,562 | 841,609 | 2,154,471 | 1,642,249 | ||||||||||||
Provision for credit losses |
832,009 | 659,599 | 1,260,034 | 1,240,445 | ||||||||||||
Depreciation |
82,595 | 55,287 | 156,259 | 104,825 | ||||||||||||
Interest expense |
1,058,479 | 894,764 | 2,039,032 | 1,810,084 | ||||||||||||
6,184,824 | 4,823,951 | 11,489,899 | 9,475,800 | |||||||||||||
Operating income before income taxes |
4,053,896 | 3,009,714 | 7,909,212 | 5,634,520 | ||||||||||||
Income tax expense: |
||||||||||||||||
Current |
1,535,649 | 1,481,512 | 3,180,413 | 2,892,499 | ||||||||||||
Deferred |
9,071 | (337,470 | ) | (174,205 | ) | (756,043 | ) | |||||||||
1,544,720 | 1,144,042 | 3,006,208 | 2,136,456 | |||||||||||||
Net Income |
$ | 2,509,176 | $ | 1,865,672 | $ | 4,903,004 | $ | 3,498,064 | ||||||||
Earnings per share: |
||||||||||||||||
Basic |
$ | 0.25 | $ | 0.19 | $ | 0.50 | $ | 0.38 | ||||||||
Diluted |
$ | 0.24 | $ | 0.18 | $ | 0.47 | $ | 0.36 | ||||||||
Dividends declared per share |
| $ | 0.07 | | $ | 0.07 | ||||||||||
See accompanying notes.
3
Table of Contents
Nicholas Financial, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(Unaudited)
Six months ended | ||||||||
September 30, | ||||||||
2005 | 2004 | |||||||
Cash flows from operating activities |
||||||||
Net income |
$ | 4,903,004 | $ | 3,498,064 | ||||
Adjustments to reconcile net income to net cash provided
by operating activities: |
||||||||
Depreciation |
156,259 | 104,825 | ||||||
Gain on sale of property and equipment |
(14,366 | ) | | |||||
Provision for credit losses |
1,260,034 | 1,240,445 | ||||||
Deferred income taxes |
(174,205 | ) | (756,043 | ) | ||||
Changes in operating assets and liabilities: |
||||||||
Accounts receivable |
4,347 | 2,248 | ||||||
Prepaid expenses, other assets and assets held for resale |
(695,112 | ) | (527,816 | ) | ||||
Accounts payable and accrued expenses |
599,463 | 419,528 | ||||||
Income taxes payable |
(540,899 | ) | (125,618 | ) | ||||
Deferred revenues |
148,904 | 212,194 | ||||||
Net cash provided by operating activities |
5,647,429 | 4,067,827 | ||||||
Cash flows from investing activities |
||||||||
Purchase and origination of finance contracts |
(63,284,350 | ) | (40,182,092 | ) | ||||
Principal payments received |
49,590,955 | 31,032,299 | ||||||
Purchase of property and equipment |
(221,976 | ) | (135,920 | ) | ||||
Proceeds from sale of property and equipment |
14,366 | | ||||||
Net cash used in investing activities |
(13,901,005 | ) | (9,285,713 | ) | ||||
Cash flows from financing activities |
||||||||
(Repayment)
issuance of notes payable related party |
(400,000 | ) | 319,000 | |||||
Net proceeds from (repayment of) line of credit |
8,823,070 | (3,969,924 | ) | |||||
Payment of dividend |
| (324,913 | ) | |||||
Increase (decrease) in drafts payable |
59,779 | (155,342 | ) | |||||
Proceeds from exercise of stock options and income tax benefit
related thereto |
159,660 | 45,007 | ||||||
Proceeds from the issuance of common stock |
| 10,416,000 | ||||||
Payment of offering costs |
(384,470 | ) | ||||||
Net cash provided by financing activities |
8,642,509 | 5,945,358 | ||||||
Net increase in cash |
388,933 | 727,472 | ||||||
Cash, beginning of period |
853,494 | 957,684 | ||||||
Cash, end of period |
$ | 1,242,427 | $ | 1,685,156 | ||||
See accompanying notes.
4
Table of Contents
Nicholas Financial, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
(Unaudited)
1. Basis of Presentation
The accompanying condensed consolidated balance sheet as of March 31, 2005, which has been derived
from audited financial statements and the accompanying unaudited interim condensed consolidated
financial statements of Nicholas Financial, Inc. (including its subsidiaries, the Company) have
been prepared in accordance with accounting principles generally accepted in the United States for
interim financial information and with the instructions to Form 10-Q pursuant to the Securities and
Exchange Act of 1934, as amended in Article 10 of Regulation S-X. Accordingly, they do not include
all of the information and footnotes required by accounting principles generally accepted in the
United States for complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair presentation have been
included. Operating results for interim periods are not necessarily indicative of the results that
may be expected for the year ending March 31, 2006. For further information, refer to the
consolidated financial statements and accompanying notes thereto included in the Companys Annual
Report on Form 10-KSB for the year ended March 31, 2005 as filed with the Securities and Exchange
Commission on June 29, 2005.
On May 12, 2005, the Board of Directors declared a three-for-two stock split, payable in the form
of a 50% stock dividend on June 17, 2005 to shareholders of record on June 3, 2005. All references
in the condensed consolidated financial statements and accompanying notes to the number of shares
outstanding, and per share amounts of the Companys common shares have been restated to reflect the
effect of the stock split for all periods presented.
The preparation of consolidated financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates and assumptions that
affect the amounts reported in the consolidated financial statements and accompanying notes. Actual
results could differ from those estimates.
2. Revenue Recognition
The Company is principally a specialized consumer finance company engaged primarily in acquiring
and servicing retail installment sales Contracts (Contracts) for purchases of new and used
automobiles and light trucks. To a lesser extent, the Company also makes direct loans and sells
consumer-finance related products.
Interest income on finance receivables is recognized using the interest method. Accrual of interest
income on finance receivables is suspended when a loan is contractually delinquent for 60 days or
more or the collateral is repossessed, whichever is earlier.
A dealer discount represents the difference between the finance receivable, net of unearned
interest, of a Contract and the amount of money the Company actually pays for the Contract. The
entire amount of discount is related to credit quality and is considered to be part of the credit
loss reserve. The Company receives a commission for selling add-on services to consumer borrowers
and amortizes the commission, net of the related costs, over the term of the loan using the
interest method. The Companys net fees charged for processing a loan are recognized as an
adjustment to the yield and are amortized over the life of the loan using the interest method.
The amount of future unearned income is computed as the product of the Contract rate, the Contract
term, and the Contract amount. The Company aggregates the Contracts purchased during a three-month
period for each of its branch locations. After the analysis of purchase date accounting is
complete, any uncollectable amounts would be contemplated in the allowance for credit losses.
5
Table of Contents
Nicholas Financial, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
3. Earnings Per Share
Basic earnings per share is calculated by dividing the reported net income for the period by the
weighted average number of shares of common stock outstanding. Diluted earnings per share includes
the effect of dilutive options. Basic and diluted earnings per share have been computed as follows:
Three months ended | Six months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Numerator
for earnings per share net income |
$ | 2,509,176 | $ | 1,865,672 | $ | 4,903,004 | $ | 3,498,064 | ||||||||
Denominator: |
||||||||||||||||
Denominator
for basic earnings per share
weighted average shares |
9,871,183 | 9,736,714 | 9,861,474 | 9,123,888 | ||||||||||||
Effect of dilutive securities: |
||||||||||||||||
Stock options |
595,428 | 578,394 | 612,941 | 585,198 | ||||||||||||
Denominator for diluted earnings per share |
10,466,611 | 10,315,108 | 10,474,415 | 9,709,086 | ||||||||||||
Earnings per
share basic |
$ | 0.25 | $ | 0.19 | $ | 0.50 | $ | 0.38 | ||||||||
Earnings per
share diluted |
$ | 0.24 | $ | 0.18 | $ | 0.47 | $ | 0.36 | ||||||||
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Nicholas Financial, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
4. | Finance Receivables |
Finance receivables consist of automobile finance installment Contracts and direct consumer loans and are detailed as follows: |
September 30, | March 31, | |||||||
2005 | 2005 | |||||||
Finance receivables, gross Contract |
$ | 201,566,731 | $ | 182,386,735 | ||||
Unearned interest |
(51,928,343 | ) | (43,432,023 | ) | ||||
Finance receivables, net of unearned interest |
149,638,388 | 138,954,712 | ||||||
Dealer discounts |
(16,355,319 | ) | (18,598,147 | ) | ||||
Allowance for credit losses |
(7,141,586 | ) | (6,648,443 | ) | ||||
Finance receivables, net |
$ | 126,141,483 | $ | 113,708,122 | ||||
The terms of the receivables range from 12 to 72 months and bear a weighted average interest rate
of 24% for the three and six months ended September 30, 2005.
5. Line of Credit
The Company has an $85.0 million line of credit facility (the Line) expiring on November 30, 2008.
On September 15, 2005 the Company executed Amendment No. 6 to its credit facility extending the
maturity date until November 30, 2008 and reducing the interest rate charged under LIBOR pricing
options from 212.5 basis points to 175.0 basis points. The Company may borrow the lesser of $85.0
million or amounts based upon formulas principally related to a percentage of eligible finance
receivables, as defined. For the three months ended September 30, 2005, $65.0 million of borrowings
under the Line used LIBOR plus 212.5 basis points pricing options. The remainder of the borrowings
under the Line used the prime rate plus 37.5 basis points pricing option. The prime rate based
borrowings are generally less than $5.0 million. The Companys cost of borrowed funds based upon
the interest rates charged under the Line, related party debt and the effect of the swaps (see note
7) amounted to 5.90% and 5.84% for the three and six months ended September 30, 2005, respectively,
as compared to 5.67% and 5.71% for the three and six month period ended September 30, 2004,
respectively. Pledged as collateral for this credit facility are all of the assets of the Companys
subsidiary, Nicholas Financial, Inc. As of September 30, 2005, the amount outstanding under the
Line was approximately $74.2 million and the amount available under the Line was approximately
$10.8 million. The facility requires compliance with certain financial ratios and covenants and
satisfaction of specified financial tests, including maintenance of asset quality and performance
tests. Dividends require consent in writing by the agent and majority lenders under the facility.
As of September 30, 2005, the Company was in full compliance with all debt covenants.
6. Notes Payable Related Party
The Company has unsecured notes payable to the President and Chief Executive Officer totaling
$600,000 and $1,000,000 at September 30, 2005 and March 31, 2005, respectively. For the three and
six months ended September 30, 2005 and for fiscal year 2005, the notes bore a variable interest
rate equal to the average cost of borrowed funds for the Company plus 25 basis points (6.11% at
September 30, 2005 and 5.94% at March 31, 2005). The interest rate is recalculated every three
months. The notes are due upon thirty-day demand. The Company incurred interest expense on the
above notes of approximately $9,300 and $16,200 for the three months ended September 30, 2005 and
2004, respectively. The Company incurred interest expense on the above notes of approximately
$20,400 and $28,700 for the six months ended September 30, 2005 and 2004, respectively.
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Nicholas Financial, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
7. Derivatives and Hedging
The Company is party to interest rate swap agreements which are derivative instruments. For
derivative instruments that are designated and qualify as a cash flow hedge (i.e., hedging the
exposure to variability in expected future cash flows that is attributable to a particular risk,
such as interest rate risk), the effective portion of the gain or loss on the derivative instrument
is reported as a component of comprehensive income and reclassified into earnings in the same
period or periods during which the hedged transaction affects earnings. The remaining gain or loss
on the derivative instrument in excess of the cumulative change in the present value of the future
cash flows of the hedged item, if any, is recognized in current earnings during the period of
change.
The Company has entered into interest rate swap agreements that effectively convert a portion of
its floating-rate debt to a fixed-rate basis, thus reducing the impact of interest rate changes on
future interest expense. At September 30, 2005, $60.0 million of the Companys borrowings were
designated as hedged items to interest rate swap agreements. Under the swap agreements, the Company
received an average variable rate of 3.53% and 1.51% for the three months ended September 30, 2005
and 2004, respectively. During the same period the Company paid an average fixed rate of 3.73% and
3.63%, respectively. Under the swap agreements, the Company received an average variable rate of
3.28% and 1.31% for the six months ended September 30, 2005 and 2004, respectively. During the same
period the Company paid an average fixed rate of 3.66% and 3.77%, respectively. A gain of $830,711
related to the fair value of the swaps at September 30, 2005 has been recorded in the caption
derivatives on the balance sheet. Accumulated other comprehensive income at September 30, 2005, in
the amount of $515,041 represents the after-tax effect of the derivative income. Amounts of net
income or losses on derivative instruments expected to be reclassified from comprehensive income to
earnings in the next 12 months are not expected to be material. The following table summarizes the
interest rate swap agreements.
Fixed Rate | ||||||||||||
Date Entered | Effective Date | Notional Amount | Of Interest | Maturity Date | ||||||||
January 6, 2003
|
April 2, 2003 | 10,000,000 | 3.350 | % | April 2, 2007 | |||||||
January 31, 2003
|
August 1, 2003 | 10,000,000 | 3.200 | % | August 2, 2006 | |||||||
February 26, 2003
|
May 17, 2004 | 10,000,000 | 3.910 | % | May 19, 2008 | |||||||
March 11, 2004
|
October 5, 2004 | 10,000,000 | 3.640 | % | October 5, 2009 | |||||||
January 18, 2005
|
July 2, 2005 | 10,000,000 | 4.380 | % | July 2, 2010 | |||||||
September 9, 2005
|
September 13, 2005 | 10,000,000 | 4.458 | % | September 2, 2010 |
The Company utilizes the above noted interest rate swaps to manage its interest rate exposure. The
swaps effectively convert a portion of the Companys floating rate debt to a fixed rate, more
closely matching the interest rate characteristics of the Companys finance receivables. There has
historically been no ineffectiveness associated with the Companys hedges.
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Nicholas Financial, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
7. Derivatives and Hedging (continued)
The following table reconciles net income with comprehensive income.
Three months ended | Six months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Net Income |
$ | 2,509,176 | $ | 1,865,672 | $ | 4,903,004 | $ | 3,498,064 | ||||||||
Mark to market interest rate swaps
(net of tax) |
421,933 | (304,808 | ) | 56,092 | 762,929 | |||||||||||
Comprehensive income |
$ | 2,931,109 | $ | 1,560,864 | $ | 4,959,096 | $ | 4,260,993 | ||||||||
8. Stock Options
The Company has an employee stock incentive plans (the SIP) for officers, directors and key
employees. The Company is authorized to grant options for up to 1,410,000 common shares under the
SIP, of which 271,700 shares were remaining available for future grants as of September 30, 2005.
Of the 271,700 shares remaining available for future grants 260,000 shares are available for
directors and 11,700 shares are available for employees. Options currently granted by the Company
generally vest over a five-year period.
As permitted under Statement of Financial Accounting Standards (SFAS) No. 148, Accounting for
Stock-Based Compensation Transaction and Disclosure, which amended SFAS No. 123, Accounting for
Stock-Based Compensation, the Company has elected to continue to follow the intrinsic value method
in accounting for its stock-based employee compensation arrangements as defined by Accounting
Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees, and related
interpretations including FASB Interpretation No. 44, Accounting for Certain Transactions
Involving Stock Compensation, an interpretation of APB No. 25. No stock-based employee
compensation cost is reflected in operations, as all options granted under those plans have an
exercise price equal to or above the market value of the underlying common stock on the date of
grant.
The fair value method uses the Black-Scholes option-pricing model to determine compensation expense
associated with the Companys options. The following table illustrates the effect on net income and
net income per share if the Company had applied the fair value recognition provisions of SFAS
No.123 to stock-based employee compensation:
Three months ended | Six months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Reported net income |
$ | 2,509,176 | $ | 1,865,672 | $ | 4,903,004 | $ | 3,498,064 | ||||||||
Stock based employee compensation cost
under the fair value method, net of tax |
13,183 | 11,353 | 27,186 | 23,390 | ||||||||||||
Pro forma net income |
$ | 2,495,993 | $ | 1,854,319 | $ | 4,875,818 | $ | 3,474,674 | ||||||||
Reported basic earnings per share |
$ | 0.25 | $ | 0.19 | $ | 0.50 | $ | 0.38 | ||||||||
Pro forma basic earnings per share |
$ | 0.25 | $ | 0.19 | $ | 0.50 | $ | 0.38 | ||||||||
Reported diluted earnings per share |
$ | 0.24 | $ | 0.18 | $ | 0.47 | $ | 0.36 | ||||||||
Pro forma diluted earnings per share |
$ | 0.24 | $ | 0.18 | $ | 0.47 | $ | 0.36 | ||||||||
9
Table of Contents
ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Information
This report on Form 10-Q contains various statements, other than those concerning historical
information, that are based on managements beliefs and assumptions, as well as information
currently available to management, and should be considered forward-looking statements. This
notice is intended to take advantage of the safe harbor provided by the Private Securities
Litigation Reform Act of 1995 with respect to such forward-looking statements. When used in this
document, the words anticipate, estimate, expect, and similar expressions are intended to
identify forward-looking statements. Although the Company believes that the expectations reflected
in such forward-looking statements are reasonable, it can give no assurance that such expectations
will prove to be correct. Such statements are subject to certain risks, uncertainties and
assumptions. Should one or more of these risks or uncertainties materialize, or should underlying
assumptions prove incorrect, actual results may vary materially from those anticipated, estimated
or expected. Among the key factors that may have a direct bearing on the Companys operating
results are fluctuations in the economy, the degree and nature of competition, demand for consumer
financing in the markets served by the Company, the Companys products and services, increases in
the default rates experienced on Contracts, adverse regulatory changes in the Companys existing
and future markets, the Companys ability to expand its business, including its ability to complete
acquisitions and integrate the operations of acquired businesses, to recruit and retain qualified
employees, to expand into new markets and to maintain profit margins in the face of increased
pricing competition. All forward looking statements included in this report are based on
information available to the Company on the date hereof, and the Company assumes no obligations to
update any such forward looking statement. You should also consult factors described from time to
time in the Companys filings made with the Securities and Exchange Commission, including its
reports on Form 10-K, 10-KSB, 10-Q, 8-K and annual reports to shareholders.
Critical Accounting Policy
The Companys critical accounting policy relates to the allowance for losses on loans. It is
based on managements opinion of an amount that is adequate to absorb losses in the existing
portfolio. The allowance for credit losses is established through allocations of dealer discount
and a provision for loss based on managements evaluation of the risk inherent in the loan
portfolio, the composition of the portfolio, specific impaired loans and current economic
conditions. Such evaluation, which includes a review of all loans on which full collectibility may
not be reasonably assured, considers among other matters, the estimated net realizable value or the
fair value of the underlying collateral, economic conditions, historical loan loss experience,
managements estimate of probable credit losses and other factors that warrant recognition in
providing for an adequate credit loss allowance.
Introduction
Consolidated net income increased to $2.5 million for the three-month period ended September
30, 2005 as compared to $1.9 million for the three-month period ended September 30, 2004.
Consolidated net income increased to $4.9 million for the six-month period ended September 30, 2005
as compared to $3.5 million for the six-month period ended September 30, 2004. Earnings were
favorably impacted by an increase in the outstanding loan portfolio and a reduction in the
charge-off rate. The Companys software subsidiary, Nicholas Data Services (NDS), did not
contribute significantly to consolidated operations in the three or six-month periods ended
September 30, 2005 or 2004.
10
Table of Contents
Three months ended | Six months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
Portfolio Summary | 2005 | 2004 | 2005 | 2004 | ||||||||||||
Average finance receivables, net of
unearned interest (1) |
$ | 146,973,291 | $ | 128,266,971 | $ | 144,471,462 | $ | 125,646,208 | ||||||||
Average indebtedness (2) |
$ | 71,747,445 | $ | 63,070,954 | $ | 69,843,069 | $ | 63,392,887 | ||||||||
Finance revenue (3) |
$ | 10,197,903 | $ | 7,796,997 | $ | 19,307,604 | $ | 15,011,255 | ||||||||
Interest expense |
1,058,479 | 894,764 | 2,039,032 | 1,810,084 | ||||||||||||
Net finance revenue |
$ | 9,139,424 | $ | 6,902,233 | $ | 17,268,572 | $ | 13,201,171 | ||||||||
Weighted average contractual rate (4) |
23.92 | % | 24.06 | % | 24.02 | % | 24.17 | % | ||||||||
Average cost of borrowed funds (2) |
5.90 | % | 5.67 | % | 5.84 | % | 5.71 | % | ||||||||
Gross portfolio yield (5) |
27.75 | % | 24.31 | % | 26.73 | % | 23.89 | % | ||||||||
Interest expense as a percentage of
average finance receivables, net of
unearned interest |
2.88 | % | 2.79 | % | 2.82 | % | 2.88 | % | ||||||||
Provision for credit losses as a
percentage of average finance
receivables, net of unearned interest |
2.26 | % | 2.06 | % | 1.74 | % | 1.97 | % | ||||||||
Net portfolio yield (5) |
22.61 | % | 19.46 | % | 22.17 | % | 19.04 | % | ||||||||
Operating expenses as a percentage
of average finance receivables, net of
unearned interest (6) |
11.46 | % | 9.96 | % | 11.10 | % | 10.00 | % | ||||||||
Pre-tax yield as a percentage of
average finance receivables, net of
unearned interest (7) |
11.15 | % | 9.50 | % | 11.07 | % | 9.04 | % | ||||||||
Write-off to liquidation (8) |
6.48 | % | 7.99 | % | 5.77 | % | 6.75 | % | ||||||||
Net charge-off percentage (9) |
5.83 | % | 6.85 | % | 5.13 | % | 5.77 | % |
Note: | All three and six month key performance indicators expressed as percentages have been annualized. | |
(1) | Average finance receivables, net of unearned interest, represents the average of gross finance receivables, less unearned interest throughout the period. | |
(2) | Average indebtedness represents the average outstanding borrowings under the Line and notes payable-related party. Average cost of borrowed funds represents interest expense as a percentage of average indebtedness. | |
(3) | Finance revenue does not include revenue generated by NDS. See pages 12 and 13 for details on NDS revenue during the period. | |
(4) | Weighted average contractual rate represents the weighted average annual percentage rate (APR) of all Contracts purchased and direct loans originated during the period. | |
(5) | Gross portfolio yield represents finance revenues as a percentage of average finance receivables, net of unearned interest. Net portfolio yield represents finance revenue minus (a) interest expense and (b) the provision for credit losses as a percentage of average finance receivables, net of unearned interest. | |
(6) | Operating expenses represent total expenses, less interest expense, the provision for credit losses and operating costs associated with NDS. See pages 12 and 13 for details on NDS operating expenses during the period. | |
(7) | Pre-tax yield represents net portfolio yield minus operating expenses as a percentage of average finance receivables, net of unearned interest. | |
(8) | Write-off to liquidation percentage is defined as net charge-offs divided by liquidation. Liquidation is defined as beginning receivable balance plus current period purchases minus voids and refinances minus ending receivable balance. | |
(9) | Net charge-off percentage represents net charge-offs divided by average finance receivables, net of unearned interest, outstanding during the period. |
11
Table of Contents
Three months ended September 30, 2005 compared to three months ended September 30, 2004
Interest Income and Loan Portfolio
Interest income on finance receivables, predominately finance charge income, increased 31% to
$10.2 million for the three-month period ended September 30, 2005, from $7.8 million for the
corresponding period ended September 30, 2004. Average finance receivables, net of unearned
interest equaled $147.0 million for the three-month period ended September 30, 2005, an increase of
15% from $128.3 million for the corresponding period ended September 30, 2004. The primary reason
average finance receivables, net of unearned interest increased was the increase in the receivable
base of several existing branches and the opening of additional branch locations. The gross finance
receivable balance increased 19% to $201.6 million at September 30, 2005 from $169.4 million at
September 30, 2004. The primary reason interest income increased was the increase in the
outstanding loan portfolio and accretion of reserves. The gross portfolio yield increased from
24.31% for the three-month period ended September 30, 2004 to 27.75% for the three-month period
ended September 30, 2005. The net portfolio yield increased from 19.46% for the three-month period
ended September 30, 2004 to 22.61% for the corresponding period ended September 30, 2005. The
primary reason for the increase in the net portfolio yield was a decrease in charge-offs for the
period ended September 30, 2005. Reserves accreted into income for the three months ended September
30, 2005 were approximately $1,927,000 as compared to $1,056,000 for the three months ended
September 30, 2004. There were no provisions reversed for the three months ended September 30, 2005
or September 30, 2004. The primary reasons for the increase in reserves accreted during the three
months ended September 30, 2005 as compared to the three months ended September 30, 2004 was a
decrease in the net charge-off percentage from 6.85% to 5.83% and an increase in the size of the
portfolio.
Computer Software Business
Sales for the three-month period ended September 30, 2005 were approximately $41,000 as
compared to $37,000 for the corresponding period ended September 30, 2004, an increase of 11%. This
increase was primarily due to higher revenue from the existing customer base during the period
ended September 30, 2005. Cost of sales and operating expenses increased from approximately $75,000
for the three-month period ended September 30, 2004 to $84,000 for the corresponding period ended
September 30, 2005. The primary reason for the increase was the hiring of additional software
engineers.
Operating Expenses
Operating expenses, excluding provision for credit losses and interest expense and costs
associated with NDS, increased to $4.2 million for the three-month period ended September 30, 2005
from $3.2 million for the corresponding period ended September 30, 2004. This increase of 31% was
primarily attributable to the additional staffing of several existing branches, increased general
operating expenses and the opening of additional branch offices. Operating expenses as a percentage
of finance receivables, net of unearned interest increased from 9.96% for the three-month period
ended September 30, 2004 to 11.46% for the corresponding period ended September 30, 2005.
Interest Expense
Interest expense increased from $894,764 for the three-month period ended September 30, 2004
to $1,058,479 for the corresponding period ended September 30, 2005. The average indebtedness for
the three-month period ended September 30, 2005 increased to $71.7 million as compared to $63.1
million for the corresponding period ended September 30, 2004. The Companys average cost of
borrowed funds increased to 5.90% for the three months ended September 30, 2005 as compared to
5.67% for the corresponding period ended September 30, 2004.
12
Table of Contents
Six months ended September 30, 2005 compared to six months ended September 30, 2004
Interest Income and Loan Portfolio
Interest income on finance receivables, predominately finance charge income, increased 29% to
$19.3 million for the six-month period ended September 30, 2005, from $15.0 million for the
corresponding period ended September 30, 2004. Average finance receivables, net of unearned
interest equaled $144.5 million for the six-month period ended September 30, 2005, an increase of
15% from $125.6 million for the corresponding period ended September 30, 2004. The primary reason
average finance receivables, net of unearned interest increased was the increase in the receivable
base of several existing branches and the opening of additional branch locations. The gross finance
receivable balance increased 19% to $201.6 million at September 30, 2005 from $169.4 million at
September 30, 2004. The primary reason interest income increased was the increase in the
outstanding loan portfolio and accretion of reserves. The gross portfolio yield increased from
23.89% for the six-month period ended September 30, 2004 to 26.73% for the six-month period ended
September 30, 2005. The net portfolio yield increased from 19.04% for the six-month period ended
September 30, 2004 to 22.17% for the corresponding period ended September 30, 2005. The primary
reason for the increase in the net portfolio yield was a decrease in charge-offs for the period
ended September 30, 2005. Reserves accreted into income for the six months ended September 30, 2005
were approximately $3,559,000 as compared to $1,941,000 for the six months ended September 30,
2004. There were no provisions reversed for the six months ended September 30, 2005 or September
30, 2004. The primary reasons for the increase in reserves accreted during the six months ended
September 30, 2005 as compared to the six months ended September 30, 2004 was a decrease in the net
charge-off percentage from 5.77% to 5.13% and an increase in the size of the portfolio.
Computer Software Business
Sales for the six-month period ended September 30, 2005 were approximately $92,000 as compared
to $99,000 for the corresponding period ended September 30, 2004, a decrease of 8%. This decrease
was primarily due to lower revenue from the existing customer base during the six-months ended
September 30, 2005. Cost of sales and operating expenses increased from approximately $144,100 for
the six-month period ended September 30, 2004 to $170,200 for the corresponding period ended
September 30, 2005. The primary reason for the increase was the hiring of additional software
engineers.
Operating Expenses
Operating expenses, excluding provision for credit losses and interest expense and costs
associated with NDS, increased to $8.0 million for the six-month period ended September 30, 2005
from $6.3 million for the corresponding period ended September 30, 2004. This increase of 27% was
primarily attributable to the additional staffing of several existing branches, increased general
operating expenses and the opening of additional branch offices. Operating expenses as a percentage
of finance receivables, net of unearned interest increased from 10.00% for the six-month period
ended September 30, 2004 to 11.10% for the corresponding period ended September 30, 2005.
Interest Expense
Interest expense increased from $1,810,084 for the six-month period ended September 30, 2004
to $2,039,032 for the corresponding period ended September 30, 2005. The average indebtedness for
the six-month period ended September 30, 2005 increased to $69.8 million as compared to $63.4
million for the corresponding period ended September 30, 2004. The Companys average cost of
borrowed funds increased to 5.84% for the six months ended September 30, 2005 as compared to 5.71%
for the corresponding period ended September 30, 2004.
13
Table of Contents
Contract Procurement
The Company purchases Contracts in the ten states listed in the table below. The Company has
been expanding its Contract procurement in Kentucky, Maryland, Virginia and Indiana. See Future
Expansion below. The Contracts purchased by the Company are predominately for used vehicles; for
the three and six-month periods ended September 30, 2005 and 2004, less than 3% were new. As of
September 30, 2005, the average model year of vehicles collateralizing the portfolio was 2000.
The amounts shown in the tables below represent information on finance receivables, net of
unearned interest of Contracts purchased.
Three months ended | Six months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
State | 2005 | 2004 | 2005 | 2004 | ||||||||||||
FL |
$ | 13,012,013 | $ | 9,500,663 | $ | 24,831,034 | $ | 20,521,502 | ||||||||
GA |
2,819,508 | 1,798,615 | 4,752,551 | 4,309,158 | ||||||||||||
NC |
3,311,071 | 2,342,704 | 5,902,662 | 4,495,934 | ||||||||||||
SC |
1,049,646 | 930,773 | 1,865,373 | 2,065,391 | ||||||||||||
OH |
3,348,157 | 3,319,862 | 6,446,621 | 6,571,070 | ||||||||||||
MI |
642,703 | 861,955 | 1,000,078 | 1,813,086 | ||||||||||||
VA |
2,083,987 | 1,492,136 | 3,669,665 | 2,869,886 | ||||||||||||
IN |
739,037 | | 1,252,205 | | ||||||||||||
KY |
683,413 | | 1,116,505 | | ||||||||||||
MD |
375,913 | | 650,716 | | ||||||||||||
Total |
$ | 28,065,448 | $ | 20,246,708 | $ | 51,487,410 | $ | 42,646,027 | ||||||||
Three months ended | Six months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
Contracts | 2005 | 2004 | 2005 | 2004 | ||||||||||||
Purchases |
$ | 28,065,448 | $ | 20,246,708 | $ | 51,487,410 | $ | 42,646,027 | ||||||||
Weighted APR |
23.79 | % | 23.91 | % | 23.88 | % | 24.01 | % | ||||||||
Average discount |
8.71 | % | 8.67 | % | 8.63 | % | 8.71 | % | ||||||||
Weighted average
term (months) |
46 | 44 | 45 | 44 | ||||||||||||
Average loan |
$ | 8,884 | $ | 8,391 | $ | 8,801 | $ | 8,329 | ||||||||
Number of Contracts |
3,159 | 2,413 | 5,850 | 5,120 | ||||||||||||
Loan Origination
The following table presents information on direct loans originated by the Company, net of
unearned interest.
Three months ended | Three months ended | |||||||||||||||
Direct Loans | September 30, | September 30, | ||||||||||||||
Originated | 2005 | 2004 | 2005 | 2004 | ||||||||||||
Originations |
$ | 1,837,236 | $ | 1,308,918 | $ | 3,751,867 | $ | 2,464,441 | ||||||||
Weighted APR |
26.02 | % | 26.14 | % | 25.88 | % | 26.13 | % | ||||||||
Weighted average
term (months) |
27 | 26 | 28 | 26 | ||||||||||||
Average loan |
$ | 3,275 | $ | 3,023 | $ | 3,347 | $ | 3,013 | ||||||||
Number of loans |
561 | 433 | 1,121 | 818 | ||||||||||||
14
Table of Contents
Analysis of Credit Losses
Because of the nature of the customers under the Companys Contracts, the Company considers
the establishment of adequate reserves for credit losses to be imperative. The Company segregates
its Contracts into static pools for purposes of establishing reserves for losses. All Contracts
purchased by a branch during a fiscal quarter comprise a static pool. The Company pools Contracts
according to branch location because the branches purchase Contracts in different geographic
markets. This method of pooling by branch and quarter allows the Company to evaluate the different
markets where the branches operate. The pools also allow the Company to evaluate the different
levels of customer income, stability, credit history, and the types of vehicles purchased in each
market. Each such static pool consists of the Contracts purchased by a Company branch office
during a fiscal quarter. As of September 30, 2005, the Company had 629 active static pools. The
average pool consisted of 70 Contracts with aggregate finance receivables, net of unearned
interest, of approximately $592,000.
Contracts are purchased from many different dealers and all are purchased on an individual
Contract by Contract basis. Individual Contract pricing is determined by the automobile dealerships
and is generally the lesser of the applicable state maximum interest rate or the maximum interest
rate at which the customer will accept. In certain markets, competitive forces will drive down
Contract rates from the maximum allowable rate to a level where an individual competitor is willing
to buy an individual Contract. The Company only buys Contracts on an individual basis and never
purchases Contracts in batches, although the Company does consider portfolio acquisitions as part
of its growth strategy.
A dealer discount represents the difference between the finance receivable, net of unearned
interest, of a Contract and the amount of money the Company actually pays for the Contract. The
discount negotiated by the Company is a function of the credit quality of the customer and the
wholesale value of the vehicle. The automotive dealer accepts these terms by executing a dealer
agreement with the Company. The entire amount of discount is related to credit quality and is
considered to be part of the credit loss reserve. In evaluating the adequacy of the credit loss
reserve the Company utilizes a static pool approach to track portfolio performance.
Prior to the six-month period ended September 30, 2005, in situations where, at the date of
purchase, the dealer discount was determined to be insufficient to absorb all potential credit
losses associated with a static pool, a portion of unearned income associated with the static pool
was allocated to the reserve for dealer discounts. For loans purchased prior to the six-month
period ended September 30, 2005, the Company recognized revenue on the basis of interest expected
to be collected, which was the gross contractual interest less amounts allocated to the reserve for
dealer discounts.
Effective with loans purchased during the six-month period ending September 30, 2005, the
Company discontinued the practice of allocating a portion of unearned income to the reserve for
dealer discounts. This change was made to reflect the predominate practice in the industry and
improve comparability with other companies within the finance industry. Effective with loans
purchased during the six-month period ended September 30, 2005 the Company began recognizing
interest income based upon the contractual rate of the loan. In situations where, at the date of
purchase, the discount is determined to be insufficient to absorb all potential losses associated
with the static pool, a charge to income is calculated and amortized into provision for credit
losses over the life of the pool.
The change in the practice of allocating a portion of the unearned income to reserves for
dealer discounts is not expected to have a significant effect on the periodic net operating
results, but rather will result in differences in the classification of amounts within the
statement of income. It is expected that both interest income and provisions for credit losses will
be higher for those pools acquired during the six-month period ended September 30, 2005 and
thereafter than those pools acquired prior to such date. In addition, while this change is not
expected to change the net finance receivables as reported, the components of net finance
receivables will change as unearned interest as a percentage of gross Contracts will increase
initially as a result of the change and will be followed in subsequent periods by increases in the
allowance for credit losses.
15
Table of Contents
Certain tabular information and the discussions pertaining to credit losses presented herein
address the change in the methodology. The table below, which is reflective of the change in
allocation, presents net finance receivables as a percentage of gross Contracts as of September 30,
2005 and 2004.
September 30, 2005 | September 30, 2004 | |||||||||||||||
% of Gross | % of Gross | |||||||||||||||
Amount | Contracts | Amount | Contracts | |||||||||||||
Finance receivables, gross Contract |
$ | 201,566,731 | 100.00 | $ | 169,428,401 | 100.00 | ||||||||||
Unearned interest |
(51,928,343 | ) | (25.76 | ) | (40,357,244 | ) | (23.82 | ) | ||||||||
Finance receivables, net of
unearned interest |
149,638,388 | 74.24 | 129,071,157 | 76.18 | ||||||||||||
Dealer discounts |
(16,355,319 | ) | (8.11 | ) | (17,432,841 | ) | (10.29 | ) | ||||||||
Allowance for credit losses |
(7,141,586 | ) | (3.54 | ) | (6,492,452 | ) | (3.83 | ) | ||||||||
Finance receivables, net |
$ | 126,141,483 | 62.59 | $ | 105,145,864 | 62.06 | ||||||||||
Subsequent to the purchase, if the reserve for credit losses is determined to be inadequate
for a static pool which is not fully liquidated, then an additional charge to income through the
provision is used to reestablish adequate reserves. If a static pool is fully liquidated and has
any remaining reserves, the excess discounts are immediately recognized into income and the excess
provision is immediately reversed during the period. For static pools not fully liquidated that are
determined to have excess discounts, such excess amounts are accreted into income over the
remaining life of the static pool. For static pools not fully liquidated that are deemed to have
excess provision, such excess amounts are reversed against provision for credit losses during the
period. Reserves accreted into income for the three months ended September 30, 2005 were
approximately $1,927,000 as compared to $1,056,000 for the three months ended September 30, 2004.
Reserves accreted into income for the six-months ended September 30, 2005 were approximately
$3,559,000 as compared to $1,941,000 for the six-months ended September 30, 2004. There were no
provisions reversed for the three and six months ended September 30, 2005 or September 30, 2004.
The primary reasons for the increase in reserves accreted during the six months ended September 30,
2005 as compared to the six months ended September 30, 2004 was a decrease in the net charge-off
percentage from 5.77% to 5.13% and an increase in the size of the portfolio.
The Company experienced a lower net charge-off percentage during the six months ended
September 30, 2005 as compared to the six months ended September 30, 2004. This resulted in static
pools having reserves in excess of estimates currently needed to liquidate these pools. The Company
is in the process of accreting these excess reserves from these more mature static pools over their
remaining life. Static pools originated during the fiscal year ended March 31, 2005 have seen
losses lower than their most recent predecessors; however, there can be no assurances that this
trend will continue.
The Company has detailed underwriting guidelines it utilizes to determine which Contracts to
purchase. These guidelines are specific and are designed to cause all of the Contracts that the
Company purchases to have common risk characteristics. The Company utilizes its District Managers
to evaluate their respective branch locations for adherence to these underwriting guidelines. The
Company also utilizes an internal audit department to assure adherence to its underwriting
guidelines. The Company utilizes the branch model, which allows for Contract purchasing to be done
on the branch level. Each Branch Manager may interpret the guidelines differently, and as a result,
the common risk characteristics tend to be the same on an individual branch level but not
necessarily compared to another branch.
In analyzing a static pool, the Company considers the performance of prior static pools
originated by the branch office, the performance of prior Contracts purchased from the dealers
whose Contracts are included in the current static pool, the credit rating of the customers under
the Contracts in the static pool, and current market and economic conditions. Each static pool is
analyzed monthly to determine if the loss reserves are adequate and adjustments are made if they
are determined to be necessary.
16
Table of Contents
The following table sets forth a reconciliation of the changes in dealer discount on
Contracts.
Three months ended | Six months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Balance at beginning of period |
$ | 17,893,618 | $ | 16,817,393 | $ | 18,598,147 | $ | 15,377,582 | ||||||||
Discounts acquired on new volume |
2,419,454 | 3,349,986 | 4,384,664 | 7,030,792 | ||||||||||||
Losses absorbed |
(2,351,280 | ) | (1,994,088 | ) | (3,751,255 | ) | (3,667,937 | ) | ||||||||
Recoveries |
320,575 | 315,550 | 683,254 | 633,378 | ||||||||||||
Discounts accreted |
(1,927,048 | ) | (1,056,000 | ) | (3,559,491 | ) | (1,940,974 | ) | ||||||||
Balance at end of period |
16,355,319 | $ | 17,432,841 | $ | 16,355,319 | $ | 17,432,841 | |||||||||
Dealer discounts as a percent of
gross indirect Contracts |
8.41 | % | 10.61 | % | 8.41 | % | 10.61 | % | ||||||||
The following table sets forth a reconciliation of the changes in the allowance for credit
losses on Contracts
Three months ended | Six months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Balance at beginning of period |
$ | 6,288,330 | $ | 6,224,932 | $ | 6,448,790 | $ | 5,787,764 | ||||||||
Current period provision |
771,025 | 618,777 | 1,152,632 | 1,166,478 | ||||||||||||
Losses absorbed |
(144,994 | ) | (531,496 | ) | (687,061 | ) | (642,029 | ) | ||||||||
Balance at end of period |
$ | 6,914,361 | $ | 6,312,213 | $ | 6,914,361 | $ | 6,312,213 | ||||||||
Allowance as a percent of gross
indirect Contracts |
3.56 | % | 3.84 | % | 3.56 | % | 3.84 | % | ||||||||
The following table sets forth a reconciliation of the changes in the allowance for credit
losses on direct loans.
Three months ended | Six months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Balance at beginning of period |
$ | 210,794 | $ | 189,837 | $ | 199,653 | $ | 184,334 | ||||||||
Current period provision |
49,290 | 26,138 | 88,808 | 52,782 | ||||||||||||
Losses absorbed |
(39,468 | ) | (46,434 | ) | (76,362 | ) | (74,194 | ) | ||||||||
Recoveries |
6,609 | 10,698 | 15,126 | 17,317 | ||||||||||||
Balance at end of period |
$ | 227,225 | $ | 180,239 | $ | 227,225 | $ | 180,239 | ||||||||
Allowance as a percent of gross
direct loan receivables |
3.21 | % | 3.51 | % | 3.21 | % | 3.51 | % | ||||||||
The average dealer discount associated with new volume for the three months ended September
30, 2005 and 2004 were 8.71% and 8.67%, respectively. The average dealer discount associated with
new volume for the six months ended September 30, 2005 and 2004 were 8.63% and 8.71%, respectively.
The Company believes the average dealer discount may continue to decrease as the result of
competition in the markets the Company is currently operating in.
The provision for credit losses increased from approximately $660,000 for the three months
ended September 30, 2004 to $832,000 for the three months ended September 30, 2005. The provision
for credit losses increased from approximately $1,240,000 for the six months ended September 30,
2004 to $1,260,000 for the six months ended September 30, 2005. The Companys losses as a
percentage of liquidation decreased from 7.99% for the three months ended September 30, 2004 to
6.48% for the three months ended September 30, 2005. The Companys losses as a percentage of
liquidation decreased from 6.75% for the six months ended September 30, 2004 to 5.77% for the six
months ended September 30, 2005. The Company anticipates losses as a percentage of liquidation will
be in the 7-10% range during the remainder of the current fiscal year. The longer term outlook for
portfolio performance will depend on the overall economic conditions, the unemployment rate and the
Companys ability to monitor, manage and implement its underwriting philosophy in additional
geographic areas as it strives to continue its expansion. The Company does not believe there have
been any significant changes in loan concentrations, terms or quality of Contracts purchased during
the six months ended September 30, 2005 that would have contributed to the decrease in losses.
17
Table of Contents
Recoveries as a percentage of charge-offs were 15.5% and 14.6% for the three months ended
September 30, 2005 and 2004, respectively. Recoveries as a percentage of charge-offs were 17.9% and
17.3% for the six months ended September 30, 2005 and 2004, respectively. The Company believes that
as it continues to expand its operations, it will become more difficult to implement its loss
recovery model in geographic areas further away from its Corporate headquarters, and as a result,
the Company will likely experience declining recovery rates over the long term.
Reserves accreted into income for the three months ended September 30, 2005 and 2004 were
approximately $1,927,000 and $1,056,000, respectively. Reserves accreted into income for the six
months ended September 30, 2005 and 2004 were approximately $3,559,000 and $1,941,000,
respectively. The amount and timing of reserves accreted into income is a function of individual
static pool performance. The Company has seen improvement in the performance of its Contract
portfolio, more specifically, newer static pools have seen a slight decrease in the default rate
when compared to the preceding year pool performance during their same liquidation cycle. The
Company attributes this decrease to an improvement in overall general economic conditions.
The Company believes there is a correlation between the unemployment rate and future portfolio
performance. The Company does not expect the U.S. unemployment rate to rise or fall significantly
in the foreseeable future. Therefore the Company does not plan on increasing or decreasing reserves
based on the current U.S. unemployment rate. The Company believes its percentage of voluntary
repossessions will stabilize in the current fiscal year, and as a result, management believes that
the Companys current reserve levels are adequate for the foreseeable future. The number of
bankruptcy filings by customers increased slightly during the three and six months ended September
30, 2005 as compared to the corresponding period last year. However, the Company believes the
percentage of bankruptcy filings as a percentage of active receivables will stabilize in the
current fiscal year, and as a result, management believes that the Companys current reserve levels
are adequate for the foreseeable future.
18
Table of Contents
The following tables present certain information regarding the delinquency rates experienced
by the Company with respect to Contracts and under its direct consumer loan program:
At September 30, 2005 | At September 30, 2004 | |||||||||||||||
Contracts |
||||||||||||||||
Gross balance outstanding |
$ | 194,489,189 | $ | 164,289,883 | ||||||||||||
Delinquencies
|
||||||||||||||||
30 to 59 days |
$ | 2,793,371 | 1.44 | % | $ | 2,866,168 | 1.75 | % | ||||||||
60 to 89 days |
707,902 | 0.36 | % | 801,212 | 0.49 | % | ||||||||||
90 + days |
375,156 | 0.19 | % | 253,180 | 0.15 | % | ||||||||||
Total delinquencies |
$ | 3,876,429 | 1.99 | % | $ | 3,920,560 | 2.39 | % | ||||||||
Direct Loans |
||||||||||||||||
Gross balance outstanding |
$ | 7,077,542 | $ | 5,138,518 | ||||||||||||
Delinquencies
|
||||||||||||||||
30 to 59 days |
$ | 42,556 | 0.60 | % | $ | 39,728 | 0.77 | % | ||||||||
60 to 89 days |
21,067 | 0.30 | % | 33,915 | 0.66 | % | ||||||||||
90 + days |
28,138 | 0.40 | % | 27,475 | 0.54 | % | ||||||||||
Total delinquencies |
$ | 91,761 | 1.30 | % | $ | 101,118 | 1.97 | % | ||||||||
The delinquency percentage for Contracts more than thirty days past at September 30, 2005 was
1.99% as compared to 2.39% at September 30, 2004. The delinquency percentage for direct loans more
than thirty days past due at September 30, 2005 was 1.30% as compared to 1.97% at September 30,
2004.
The Company does not give significant consideration to short-term trends in delinquency
percentages when evaluating reserve levels. Delinquency percentages tend to be very volatile and
often are not necessarily an indication of future losses. The Company estimates future portfolio
performance by considering various factors, the most significant of which are described as follows.
The Company analyzes historical static pool performance for each branch location when determining
appropriate reserve levels. The Company utilizes internal branch audits as an indication of future
static pool performance. The Company also considers such things as the current unemployment rate in
markets the Company operates in, the percentage of voluntary repossessions as compared to prior
periods, the percentage of bankruptcy filings as compared to prior periods and other leading
economic indicators.
Income Taxes
The provision for income taxes increased 35% to approximately $1,545,000 for the three months
ended September 30, 2005 from $1,144,000 for the three months ended September 30, 2004, primarily
as a result of higher pre-tax income. The provision for income taxes increased 41% to approximately
$3,006,000 for the six months ended September 30, 2005 from $2,136,000 for the three months ended
September 30, 2004, primarily as a result of higher pre-tax income. The Companys effective tax
rate increased from 38.01% for the three months ended September 30, 2004 to 38.10% for the three
months ended September 30, 2005. The Companys effective tax rate increased from 37.92% for the six
months ended September 30, 2004 to 38.01% for the six months ended September 30, 2005.
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Liquidity and Capital Resources
The Companys cash flows are summarized as follows:
Six months ended September 30, | ||||||||
2005 | 2004 | |||||||
Cash provided by (used in): |
||||||||
Operating
activities |
$ | 5,647,429 | $ | 4,067,827 | ||||
Investing
activities
(primarily purchase of Contracts) |
(13,901,005 | ) | (9,285,713 | ) | ||||
Financing activities |
8,642,509 | 5,945,358 | ||||||
Net increase in cash |
$ | 388,933 | $ | 727,472 | ||||
The Companys primary use of working capital for the six months ended September 30, 2005 was
the funding of the purchase of Contracts. The Contracts were financed substantially through
borrowings under the Companys $85.0 million Line. The Line is secured by all of the assets of the
Companys Nicholas Financial, Inc. subsidiary. The Company may borrow the lesser of $85.0 million
or amounts based upon formulas principally related to a percentage of eligible finance receivables,
as defined. Borrowings under the Line may be under various LIBOR pricing options or at the prime
rate plus 37.5 basis points. Prime rate based borrowings are generally less than $5.0 million. As
of September 30, 2005, the amount outstanding under the Line was approximately $74.2 million and
the amount available under the Line was approximately $10.8 million.
The Company has entered into interest rate swap agreements, each of which effectively converts
a portion of the Companys floating-rate debt to a fixed-rate, thus reducing the impact of interest
rate change on the Companys interest expense. At September 30, 2005, approximately 81% of the
Companys borrowings under the Line were subject to interest rate swap agreements. These swap
agreements have maturities ranging from August 2, 2006 through September 2, 2010.
The self-liquidating nature of Contracts and other loans enables the Company to assume a
higher debt-to-equity ratio than in most businesses. The amount of debt the Company incurs from
time to time under these financing mechanisms depends on the Companys need for cash and ability to
borrow under the terms of the Line. The Company believes that borrowings available under the Line
as well as cash flow from operations will be sufficient to meet its short-term funding needs.
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Future Expansion
The Company currently operates a total of forty branch locations in ten states, including
sixteen in Florida, five in Ohio, five in North Carolina, four in Georgia, three in Virginia, two
in South Carolina, two in Kentucky, and one in each of Michigan, Maryland and Indiana.. Each office
is budgeted (size of branch, number of employees and location) to handle up to 1,000 accounts and
up to $7.5 million in outstanding receivables. To date none of our branches has reached this
capacity.
The Company currently intends to continue its expansion through the purchase of additional
Contracts and the expansion of its direct consumer loan program. In order to increase the size of
the Companys portfolio of Contracts, it will be necessary for the Company to open additional
branch offices and increase the size of its Line, either with its current lender or another
lender. The Company, from time to time, has and will meet with investment bankers and financial
institutions discussing various strategies to meet the future needs of the Company. The Company
believes opportunities for growth continue to exist in states where it currently operates branches
and plans to continue its expansion activities in those states. No assurances can be given,
however, that the Company will be able to continue to expand or, if it does continue to expand,
that it will be able to do so profitably. The Company is also analyzing other markets in states
the Company does not currently operate in, however, no assurance can be given that any expansion
will occur in these new markets.
Recently Issued Accounting Standards
In October 2003, the AICPA issued Statement of Position (SOP) No. 03-3, Accounting for Loans
or Certain Debt Securities Acquired in a Transfer. SOP No. 03-3 applies to a loan with evidence of
deterioration in credit quality subsequent to its origination that is acquired by completion of a
transfer (as defined in SOP No. 03-3), for which it is probable at acquisition of such loan, that
the acquirer will be unable to collect all contractually required payments receivable. The
Companys finance receivables are acquired shortly after origination and there is no credit
deterioration during the time between origination of the finance receivable and the purchase by the
Company. As a result, the Company does not expect any impact on the Companys consolidated
financial statements.
In December 2004, the FASB issued SFAS No. 123(R), Accounting for Stock-Based Compensation.
SFAS No. 123(R) establishes standards for the accounting for a wide range of share-based
compensation arrangements including share options, restricted share plans, performance-based
awards, share appreciation rights, and employee share purchases plans. SFAS No. 123(R) replaces
SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees. For publicly held companies that are not
Small Business Issuers SFAS No. 123(R) requires the fair value of such equity instruments be
recognized as an expense in the financial statements as services are performed at the beginning of
their next fiscal year. SFAS No. 123(R) will be applicable for the quarter ending June 30, 2006.
Thus, the Companys consolidated financial statements will reflect an expense for (1) all
share-based compensation arrangements granted after March 31, 2006 and for any such arrangements
modified, cancelled, or repurchased after that date, and (2) the portion of previous share-based
awards for which the requisite service has not been rendered as of that date, based on the
grant-date estimated fair value of those awards. Prior to SFAS No. 123(R), only certain pro forma
disclosures of the fair-value method were required and the Company was allowed to continue using
the intrinsic-value-based model of Opinion 25. The Company does not believe the adoption of this
statement will have a material impact on the Companys consolidated financial statements.
Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task
Force), the AICPA, and the SEC did not and are not believed by the Company to have a material
impact on the Companys present or future consolidated financial statements.
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Item 3. Quantitative And Qualitative Disclosures About Market Risk
Note: Pursuant to Instruction 1 to Paragraph (c) of Item 305 of Regulation S-K,
information is not required under Item 305(c) of Regulation S-K until after the first fiscal year
end in which Item 305 is applicable, which for the Company will be the fiscal year ending March 31,
2006.
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures. In accordance with Rule 13a-15(b) of the
Securities Exchange Act of 1934 (the Exchange Act), as of the end of the period covered by this
Quarterly Report on Form 10-Q, the Companys management evaluated, with the participation of the
Companys President and Chief Executive Officer and Senior Vice President-Finance and Chief
Financial Officer, the effectiveness of the design and operation of the Companys disclosure
controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based upon their
evaluation of these disclosure controls and procedures, the President and Chief Executive Officer
and the Senior Vice President-Finance and Chief Financial Officer have concluded that the
disclosure controls and procedures were effective as of the date of such evaluation to ensure that
material information relating to the Company, including its consolidated subsidiaries, was made
known to them by others within those entities, particularly during the period in which this
Quarterly Report on Form 10-Q was being prepared.
Changes in internal controls. There was no change in the Companys internal control over
financial reporting that occurred during the Companys last fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the Companys internal control over
financial reporting.
22
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
NICHOLAS FINANCIAL, INC.
(Registrant)
(Registrant)
Date: November 10, 2005
|
/s/ Peter L. Vosotas | |||
Chairman of the Board, President, | ||||
Chief Executive Officer and Director | ||||
Date: November 10, 2005
|
/s/ Ralph T. Finkenbrink | |||
Sr. Vice President -Finance | ||||
Chief Financial Officer and Director |
24
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EXHIBIT INDEX
Exhibit No. | Description | |
31.1
|
Certification of President and Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2
|
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32.1
|
Written Statement of the Chief Executive Officer Pursuant to 18 U.S.C. § 1350 | |
32.2
|
Written Statement of the Chief Financial Officer Pursuant to 18 U.S.C. § 1350 | |
33.1
|
Amendment No. 6 to Loan Agreement, dated September 15, 2005 |