UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 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
(I.R.S. Employer
Incorporation or Organization)
Identification No.)
   
2454 McMullen Booth Road, Building C
  
Clearwater, Florida
33759
(Address of Principal Executive Offices)
(Zip Code)

(727) 726-0763
(Registrant's 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 x 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 x

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

As of January 31, 2006, the registrant had 9,879,631 shares of common stock outstanding.

 
 
 

NICHOLAS FINANCIAL, INC.
FORM 10-Q
Table of Contents

Part I. Financial Information Page
     
Item 1.
Financial Statements (Unaudited)
  
     
 
Condensed Consolidated Balance Sheets as of December 31, 2005 and as of March 31, 2005
2
     
 
Condensed Consolidated Statements of Income for the three and nine months ended December 31, 2005 and 2004
3
     
 
Condensed Consolidated Statements of Cash Flows for the nine months ended December 31, 2005 and 2004
4
     
 
Notes to the Condensed Consolidated Financial Statements
5
     
Item 2.
Management’s Discussion and Analysis of Financial
  
 
Condition and Results of Operations
10
     
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
22
     
Item 4.
Controls and Procedures
22
     
Part II. Other Information
  
     
Item 6.
Exhibits
23

 
1
 

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS
 
Nicholas Financial, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets

   
December 31,
  
March 31,
  
   
2005
  
2005
  
   
(Unaudited)
      
Assets
              
Cash
  
$
1,670,913
  
$
853,494
  
Finance receivables, net
    
133,038,643
    
113,708,122
  
Accounts receivable
    
8,284
    
12,849
  
Assets held for resale
    
899,877
    
530,230
  
Prepaid expenses and other assets
    
563,900
    
507,952
  
Property and equipment, net
    
840,583
    
763,247
  
Derivatives
    
1,134,571
    
740,223
  
Deferred income taxes
    
3,825,097
    
3,699,324
  
Total assets
 
$
141,981,868
  
$
120,815,441
  
               
Liabilities
              
Line of credit
  
$
78,396,965
  
$
65,330,897
  
Drafts payable
    
934,611
    
973,268
  
Notes payable - related party
    
600,000
    
1,000,000
  
Accounts payable and accrued expenses
    
5,576,824
    
4,852,787
  
Income taxes payable
    
67,577
    
540,899
  
Deferred revenues
    
1,563,323
    
1,359,696
  
Total liabilities
    
87,139,300
    
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; 9,879,631 and 9,840,531 shares issued and outstanding, respectively
    
15,346,777
    
15,127,922
  
Accumulated other comprehensive income
    
703,434
    
458,949
  
Retained earnings
    
38,792,357
    
31,171,023
  
Total shareholders’ equity
    
54,842,568
    
46,757,894
  
Total liabilities and shareholders' equity
  
$
141,981,868
  
$
120,815,441
  
 
See accompanying notes.
 
2
 

Nicholas Financial, Inc. and Subsidiaries
Condensed Consolidated Statements of Income
(Unaudited)

   
Three months ended
  
Nine months ended
  
   
December 31,
  
December 31,
  
   
2005
  
2004
  
2005
 
2004
  
Revenue:
                          
Interest income on finance receivables
  
$
11,065,071
  
$
8,484,354
  
$
30,372,675
  
$
23,495,609
  
Sales
    
42,177
    
56,357
    
133,684
    
155,422
  
     
11,107,248
    
8,540,711
    
30,506,359
    
23,651,031
  
                           
Expenses:
                          
Cost of sales
    
15,123
    
17,043
    
37,407
    
45,904
  
Marketing
    
345,277
    
227,009
    
890,126
    
642,697
  
Salaries and employee benefits
    
2,916,558
    
2,261,867
    
8,229,528
    
6,495,515
  
Administrative
    
1,061,235
    
941,466
    
3,215,706
    
2,583,715
  
Provision for credit losses
    
1,172,108
    
565,758
    
2,432,142
    
1,806,203
  
Depreciation
    
86,342
    
58,147
    
242,601
    
162,973
  
Interest expense
    
1,122,358
    
909,468
    
3,161,390
    
2,719,551
  
     
6,719,001
    
4,980,758
    
18,208,900
    
14,456,558
  
Operating income before income taxes
    
4,388,247
    
3,559,953
    
12,297,459
    
9,194,473
  
                           
Income tax expense:
                          
Current
    
1,771,348
    
1,640,355
    
4,951,761
    
4,532,854
  
Deferred
    
(101,431
)
  
(294,049
)
  
(275,636
)
  
(1,050,092
)
     
1,669,917
    
1,346,306
    
4,676,125
    
3,482,762
  
Net Income
  
$
2,718,330
  
$
2,213,647
  
$
7,621,334
  
$
5,711,711
  
                           
Earnings per share:
                          
Basic
  
$
0.28
  
$
0.23
  
$
0.77
  
$
0.61
  
Diluted
  
$
0.26
  
$
0.21
  
$
0.73
  
$
0.57
  
Dividends declared per share
    
-
    
-
    
-
  
$
0.07
  
 
See accompanying notes.
 
3
 

Nicholas Financial, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)

   
Nine months ended
December 31,
  
   
2005
  
2004
  
Cash flows from operating activities  
              
Net income
  
$
7,621,334
  
$
5,711,711
  
Adjustments to reconcile net income to net cash provided
              
by operating activities: 
              
Depreciation
    
242,601
    
162,973
  
Gain on sale of property and equipment
   
(14,366
)
  
-
  
Provision for credit losses
    
2,432,142
    
1,806,203
  
Deferred income taxes
    
(275,636
)
  
(1,050,092
)
Changes in operating assets and liabilities: 
              
Accounts receivable
    
4,565
    
1,207
  
Prepaid expenses, other assets and assets held for resale
    
(425,595
)
  
(144,357
)
Accounts payable and accrued expenses
    
724,037
    
379,745
  
Income taxes payable
    
(473,322
)
  
470,277
  
Deferred revenues
    
203,627
    
259,057
  
Net cash provided by operating activities 
    
10,039,387
    
7,596,724
  
               
Cash flows from investing activities 
              
Purchase and origination of finance contracts  
    
(75,321,061
)
  
(58,189,372
)
Principal payments received 
    
53,558,398
    
46,630,886
  
Purchase of property and equipment 
    
(319,937
)
  
(243,160
)
Proceeds from sale of property and equipment
    
14,366
    
-
  
Net cash used in investing activities 
    
(22,068,234
)
  
(11,801,646
)
               
Cash flows from financing activities 
              
(Repayment) issuance of notes payable - related party 
    
(400,000
)
  
318,470
  
Net proceeds from (repayment of) line of credit 
    
13,066,068
    
(5,302,619
)
Payment of dividend
    
-
    
(324,915
)
Decrease in drafts payable 
    
(38,657
)
  
(358,797
)
Proceeds from exercise of stock options and income tax benefit
related thereto
    
218,855
    
377,652
  
Proceeds from the issuance of common stock
    
-
    
10,416,000
  
Payment of offering costs
    
-
    
(384,470
)
Net cash provided by financing activities 
    
12,846,266
    
4,741,321
  
Net increase in cash
    
817,419
    
536,399
  
               
Cash, beginning of period  
    
853,494
    
957,684
  
Cash, end of period 
  
$
1,670,913
  
$
1,494,083
  
 
See accompanying notes.
 
4
 

Nicholas Financial, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
(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 Company's 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 Company’s 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 Company’s 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
 

Nicholas Financial, Inc. and Subsidiaries
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
  
Nine months ended
  
   
December 31,
  
December 31,
  
   
2005
  
2004
  
2005
  
2004
  
                   
Numerator for earnings per share - net income
  
$
2,718,330
  
$
2,213,647
  
$
7,621,334
  
$
5,711,711
  
Denominator:
                         
Denominator for basic earnings per share -
weighted average shares
    
9,875,864
    
9,771,950
    
9,866,288
    
9,340,694
  
                           
Effect of dilutive securities:
Stock options
   
585,756
    
622,929
    
604,094
    
603,901
  
Denominator for diluted earnings per share
    
10,461,620
    
10,394,879
    
10,470,382
    
9,944,595
  
Earnings per share - basic
  
$
0.28
  
$
0.23
  
$
0.77
  
$
0.61
  
Earnings per share - diluted
  
$
0.26
  
$
0.21
  
$
0.73
  
$
0.57
  

 
6
 

Nicholas Financial, Inc. and Subsidiaries
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:
 
   
December 31,
  
March 31,
  
   
2005
  
2005
  
Finance receivables, gross Contract
  
$
211,198,167
  
$
182,386,735
  
Unearned interest
    
(55,402,704
)
  
(43,432,023
)
Finance receivables, net of unearned interest
    
155,795,463
    
138,954,712
  
               
Dealer discounts
    
(14,758,242
)
  
(18,598,147
)
Allowance for credit losses
    
(7,998,578
)
  
(6,648,443
)
Finance receivables, net
  
$
133,038,643
  
$
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 nine months ended December 31, 2005.

5. Line of Credit

At December 31, 2005 the Company had an $85.0 million line of credit facility (the Line) expiring on November 30, 2008. 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. See note 9 regarding subsequent amendment to the Line. For the three months ended December 31, 2005, $78.0 million of borrowings under the Line used LIBOR plus 175.0 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 Company’s 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 5.85% and 5.90% for the three and nine months ended December 31, 2005, respectively, as compared to 5.69% and 5.70% for the three and nine-month period ended December 31, 2004, respectively. Pledged as collateral for this credit facility are all of the assets of the Company’s subsidiary, Nicholas Financial, Inc. As of December 31, 2005, the amount outstanding under the Line was approximately $78.4 million and the amount available under the Line was approximately $6.6 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 December 31, 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 December 31, 2005 and March 31, 2005, respectively. For the three and nine months ended December 31, 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 25.0 basis points (6.15% at December 31, 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 $9,400 and $16,500 for the three months ended December 31, 2005 and 2004, respectively. The Company incurred interest expense on the above notes of approximately $29,800 and $45,300 for the nine months ended December 31, 2005 and 2004, respectively. 
 
 
7
 

Nicholas Financial, Inc. and Subsidiaries
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.

At December 31, 2005, $60.0 million of the Company’s borrowings were designated as hedged items to interest rate swap agreements. Under the swap agreements, the Company received an average variable rate of 4.08% and 2.06% for the three months ended December 31, 2005 and 2004, respectively. During the same period the Company paid an average fixed rate of 3.82% and 3.59%, respectively. Under the swap agreements, the Company received an average variable rate of 3.58% and 1.55% for the nine months ended December 31, 2005 and 2004, respectively. During the same period the Company paid an average fixed rate of 3.72% and 3.75%, respectively. A gain of $1,134,571 related to the fair value of the swaps at December 31, 2005 has been recorded in the caption derivatives on the balance sheet. Accumulated other comprehensive income at December 31, 2005, in the amount of $703,434 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.

 
Date Entered
 
Effective Date
 
Notional Amount
Fixed Rate
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 Company’s floating rate debt to a fixed rate, more closely matching the interest rate characteristics of the Company’s finance receivables. There has historically been no ineffectiveness associated with the Company’s hedges.

The following table reconciles net income with comprehensive income.

   
Three months ended
December 31,
  
Nine months ended
December 31,
  
   
2005
 
2004
  
2005
 
2004
  
Net Income
  
$
2,718,330
  
$
2,213,647
  
$
7,621,334
  
$
5,711,711
  
Mark to market interest rate swaps
                          
(net of tax)
    
188,393
    
263,808
    
244,485
    
1,026,737
  
Comprehensive income
  
$
2,906,723
  
$
2,477,455
  
$
7,865,819
  
$
6,738,448
  

 
8
 

Nicholas Financial, Inc. and Subsidiaries
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
 
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 265,300 shares were remaining available for future grants as of December 31, 2005. Of the 265,300 shares remaining available for future grants 250,000 shares are available for directors and 15,300 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 Company’s 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
  
Nine months ended
  
   
December 31,
  
December 31,
  
   
2005
  
2004
  
2005
  
2004
  
Reported net income
  
$
2,718,330
  
$
2,213,647
  
$
7,621,334
  
$
5,711,711
  
Stock based employee compensation cost
under the fair value method, net of tax
   
13,183
    
11,759
    
40,369
    
35,149
  
                           
Pro forma net income
  
$
2,705,147
  
$
2,201,888
  
$
7,580,965
  
$
5,676,562
  
Reported basic earnings per share
  
$
0.28
  
$
0.23
  
$
0.77
  
$
0.61
  
Pro forma basic earnings per share
  
$
0.27
  
$
0.23
  
$
0.77
  
$
0.61
  
Reported diluted earnings per share
  
$
0.26
  
$
0.21
  
$
0.73
  
$
0.57
  
Pro forma diluted earnings per share
  
$
0.26
  
$
0.21
  
$
0.72
  
$
0.57
  

9. Subsequent Events

On February 1, 2006 the Company executed Amendment No. 7 to its Line increasing the total Line from $85.0 million to $100.0 million. All other terms and conditions of Amendment No. 6, dated September 14, 2005 remain in effect.
 
 
9
 

ITEM 2. MANAGEMENT'S 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 management's 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 Company's 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 Company's products and services, increases in the default rates experienced on Contracts, adverse regulatory changes in the Company's existing and future markets, the Company's 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 Company’s 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 Company’s critical accounting policy relates to the allowance for losses on loans. It is based on management’s 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 management’s 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, management’s 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 $2.7 million for the three-month period ended December 31, 2005 as compared to $2.2 million for the three-month period ended December 31, 2004. Consolidated net income increased to $7.6 million for the nine-month period ended December 31, 2005 as compared to $5.7 million for the nine-month period ended December 31, 2004. Earnings were favorably impacted by an increase in the outstanding loan portfolio and a reduction in the charge-off rate. The Company’s software subsidiary, Nicholas Data Services (NDS), did not contribute significantly to consolidated operations in the three or nine-month periods ended December 31, 2005 or 2004.

 
10
 
Portfolio Summary
  
Three months ended
December 31,
  
Nine months ended
December 31,
  
   
2005
  
2004
  
2005
  
2004
  
Average finance receivables, net of unearned interest (1)
  
$
153,011,496
  
$
130,157,442
  
$
146,526,954
  
$
127,149,953
  
Average indebtedness (2)
  
$
76,791,186
  
$
63,908,352
  
$
71,499,601
  
$
63,564,709
  
Finance revenue (3)
  
$
11,065,071
  
$
8,484,354
  
$
30,372,375
  
$
23,495,609
  
Interest expense
    
1,122,358
    
909,468
    
3,161,390
    
2,719,551
  
Net finance revenue
  
$
9,942,713
  
$
7,574,886
  
$
27,210,985
  
$
20,776,058
  
Weighted average contractual rate (4)
    
23.99
%
  
23.80
%
  
24.01
%
  
24.03
%
Average cost of borrowed funds (2)
    
5.85
%
  
5.69
%
  
5.90
%
  
5.70
%
Gross portfolio yield (5)
    
28.93
%
  
26.07
%
  
27.64
%
  
24.63
%
Interest expense as a percentage of average finance receivables, net of unearned interest
    
2.93
%
  
2.79
%
  
2.88
%
  
2.85
%
Provision for credit losses as a percentage of average finance receivables, net of unearned interest
   
3.06
%
  
1.74
%
  
2.21
%
  
1.89
%
Net portfolio yield (5)
   
22.94
%
  
21.54
%
  
22.55
%
  
19.89
%
Operating expenses as a percentage of average finance receivables, net of unearned interest (6)
   
11.41
%
  
10.54
%
  
11.27
%
  
10.18
%
Pre-tax yield as a percentage of average finance receivables, net of unearned interest (7)
    
11.53
%
  
11.00
%
  
11.28
%
  
9.71
%
Write-off to liquidation (8)
    
6.19
%
  
7.45
%
  
5.92
%
  
6.99
%
Net charge-off percentage (9)
    
5.47
%
  
6.52
%
  
5.28
%
  
6.03
%

Note: All three and nine-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
 

Three months ended December 31, 2005 compared to three months ended December 31, 2004

Interest Income and Loan Portfolio

Interest income on finance receivables, predominately finance charge income, increased 30% to $11.1 million for the three-month period ended December 31, 2005, from $8.5 million for the corresponding period ended December 31, 2004. Average finance receivables, net of unearned interest equaled $153.0 million for the three-month period ended December 31, 2005, an increase of 18% from $130.2 million for the corresponding period ended December 31, 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 23% to $211.2 million at December 31, 2005 from $171.2 million at December 31, 2004. The primary reason interest income increased was the increase in the outstanding loan portfolio. The gross portfolio yield increased from 26.07% for the three-month period ended December 31, 2004 to 28.93% for the three-month period ended December 31, 2005. The net portfolio yield increased from 21.54% for the three-month period ended December 31, 2004 to 22.94% for the corresponding period ended December 31, 2005. The primary reason for the increase in the net portfolio yield was a decrease in charge-offs for the period ended December 31, 2005. Reserves accreted into income for the three months ended December 31, 2005 were approximately $2,091,000 as compared to $1,557,000 for the three months ended December 31, 2004. There were no provisions reversed for the three months ended December 31, 2005 or December 31, 2004. The primary reasons for the increase in reserves accreted during the three months ended December 31, 2005 as compared to the three months ended December 31, 2004 was a decrease in the net charge-off percentage from 6.52% to 5.47% and an increase in the size of the portfolio.

Computer Software Business

Sales for the three-month period ended December 31, 2005 were approximately $42,000 as compared to $56,000 for the corresponding period ended December 31, 2004, a decrease of 25%. This decrease was primarily due to lower revenue from the existing customer base during the period ended December 31, 2005. Cost of sales and operating expenses decreased from approximately $77,000 for the three-month period ended December 31, 2004 to $61,000 for the corresponding period ended December 31, 2005. The primary reason for the decrease was a reduction in personnel associated with NDS.

Operating Expenses

Operating expenses, excluding provision for credit losses and interest expense and costs associated with NDS, increased to $4.4 million for the three-month period ended December 31, 2005 from $3.4 million for the corresponding period ended December 31, 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 10.54% for the three-month period ended December 31, 2004 to 11.41% for the corresponding period ended December 31, 2005.

Interest Expense

Interest expense increased from approximately $909,000 for the three-month period ended December 31, 2004 to $1,122,000 for the corresponding period ended December 31, 2005. The average indebtedness for the three-month period ended December 31, 2005 increased to $76.8 million as compared to $63.9 million for the corresponding period ended December 31, 2004. The Company’s average cost of borrowed funds increased to 5.85% for the three months ended December 31, 2005 as compared to 5.69% for the corresponding period ended December 31, 2004.
 
 
12
 

Nine months ended December 31, 2005 compared to nine months ended December 31, 2004

Interest Income and Loan Portfolio

Interest income on finance receivables, predominately finance charge income, increased 29% to $30.4 million for the nine-month period ended December 31, 2005, from $23.5 million for the corresponding period ended December 31, 2004. Average finance receivables, net of unearned interest equaled $146.5 million for the nine-month period ended December 31, 2005, an increase of 15% from $127.1 million for the corresponding period ended December 31, 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 23% to $211.2 million at December 31, 2005 from $171.2 million at December 31, 2004. The primary reason interest income increased was the increase in the outstanding loan portfolio. The gross portfolio yield increased from 24.63% for the nine-month period ended December 31, 2004 to 27.64% for the nine-month period ended December 31, 2005. The net portfolio yield increased from 19.89% for the nine-month period ended December 31, 2004 to 22.55% for the corresponding period ended December 31, 2005. The primary reason for the increase in the net portfolio yield was a decrease in charge-offs for the period ended December 31, 2005. Reserves accreted into income for the nine months ended December 31, 2005 were approximately $5,651,000 as compared to $3,498,000 for the nine months ended December 31, 2004. There were no provisions reversed for the nine months ended December 31, 2005 or December 31, 2004. The primary reasons for the increase in reserves accreted during the nine months ended December 31, 2005 as compared to the nine months ended December 31, 2004 was a decrease in the net charge-off percentage from 6.03% to 5.28% and an increase in the size of the portfolio.

Computer Software Business

Sales for the nine-month period ended December 31, 2005 were approximately $134,000 as compared to $155,000 for the corresponding period ended December 31, 2004, a decrease of 14%. This decrease was primarily due to lower revenue from the existing customer base during the nine-months ended December 31, 2005. Cost of sales and operating expenses increased from approximately $221,000 for the nine-month period ended December 31, 2004 to $231,000 for the corresponding period ended December 31, 2005.

Operating Expenses

Operating expenses, excluding provision for credit losses and interest expense and costs associated with NDS, increased to $12.4 million for the nine-month period ended December 31, 2005 from $9.7 million for the corresponding period ended December 31, 2004. This increase of 28% 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 10.18% for the nine-month period ended December 31, 2004 to 11.27% for the corresponding period ended December 31, 2005.

Interest Expense

Interest expense increased from approximately $2,720,000 for the nine-month period ended December 31, 2004 to $3,161,000 for the corresponding period ended December 31, 2005. The average indebtedness for the nine-month period ended December 31, 2005 increased to $71.5 million as compared to $63.6 million for the corresponding period ended December 31, 2004. The Company’s average cost of borrowed funds increased to 5.90% for the nine months ended December 31, 2005 as compared to 5.70% for the corresponding period ended December 31, 2004.

 
13
 

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 nine-month periods ended December 31, 2005 and 2004, less than 3% were new. As of December 31, 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
December 31,
  
Nine months ended
December 31,
  
State
  
2005
  
2004
  
2005
  
2004
  
FL
  
$
11,691,315
  
$
10,121,741
  
$
36,522,349
  
$
30,643,243
  
GA
    
2,500,377
    
1,238,711
    
7,252,928
    
5,547,869
  
NC
    
3,069,148
    
2,081,482
    
8,971,810
    
6,577,416
  
SC
    
957,810
    
781,675
    
2,823,183
    
2,847,066
  
OH
    
3,195,775
    
2,064,868
    
9,642,396
    
8,635,938
  
MI
    
727,318
    
412,137
    
1,727,396
    
2,225,223
  
VA
    
1,793,698
    
1,400,228
    
5,463,363
    
4,270,114
  
IN
    
774,614
    
-
    
2,026,819
    
-
  
KY
    
1,162,032
    
234,820
    
2,278,537
    
234,820
  
MD
    
826,508
    
414,908
    
1,477,224
    
414,908
  
Total
  
$
26,698,595
  
$
18,750,570
  
$
78,186,005
  
$
61,396,597
  

   
Three months ended
December 31,
  
Nine months ended
December 31,
  
Contracts
  
2005
  
2004
  
2005
  
2004
  
Purchases
  
$
26,698,595
  
$
18,750,570
  
$
78,186,005
  
$
61,396,597
  
Weighted APR
    
23.86
%
  
23.65
%
  
23.88
%
  
23.90
%
Average discount
    
8.90
%
  
8.73
%
  
8.72
%
  
8.72
%
Weighted average
term (months)
    
45
    
45
    
45
    
44
  
Average loan
  
$
8,829
  
$
8,504
  
$
8,811
  
$
8,382
  
Number of Contracts
    
3,024
    
2,205
    
8,874
    
7,325
  

Loan Origination

The following table presents information on direct loans originated by the Company, net of unearned interest.

Direct Loans
  
Three months ended
December 31,
  
Nine months ended
December 31,
  
Originated
  
2005
  
2004
  
2005
  
2004
  
Originations
  
$
2,206,382
  
$
1,446,259
  
$
5,958,249
  
$
3,910,700
  
Weighted APR
    
25.57
%
  
25.80
%
  
25.77
%
  
26.01
%
Weighted average
term (months)
    
28
    
26
    
28
    
26
  
Average loan
 
$
3,274
  
$
3,158
  
$
3,319
  
$
3,065
  
Number of loans
    
674
    
458
    
1,795
    
1,276
  

 
14
 

Analysis of Credit Losses

Because of the nature of the customers under the Company’s 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 December 31, 2005, the Company had 658 active static pools. The average pool upon inception consisted of 72 Contracts with aggregate finance receivables, net of unearned interest, of approximately $611,000.

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 April 1, 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 April 1, 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 after March 31, 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 after March 31, 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 did not have a significant effect on the periodic net operating results, but rather resulted in differences in the classification of amounts within the statement of income. Both interest income and provisions for credit losses were higher for those pools acquired during the nine-month period ended December 31, 2005 than those pools acquired prior to such period. In addition, while this change has not significantly changed the net finance receivables as reported, the components of net finance receivables have changed as unearned interest as a percentage of gross Contracts has increased as a result of the change and will be followed in subsequent periods by increases in the allowance for credit losses.

 
15
 

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 December 31, 2005 and 2004.

 
   
December 31, 2005
  
December 31, 2004
  
       
% of Gross
      
% of Gross
  
   
Amount
  
Contracts
  
Amount
  
Contracts
  
                   
Finance receivables, gross Contract
  
$
211,198,167
    
100.00
  
$
171,166,964
    
100.00
  
Unearned interest
    
(55,402,704
)
  
(26.23
)
  
(40,310,612
)
  
(23.55
)
Finance receivables, net of unearned interest
    
155,795,463
    
73.77
    
130,856,352
    
76.45
  
                           
Dealer discounts
    
(14,758,242
)
  
(6.99
)
  
(17,306,489
)
  
(10.11
)
Allowance for credit losses
    
(7,998,578
)
  
(3.79
)
  
(6,561,064
)
  
(3.83
)
Finance receivables, net
  
$
133,038,643
    
62.99
  
$
106,988,799
    
62.51
  

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 reserves, such excess amounts are reversed against provision for credit losses during the period. Reserves accreted into income for the three months ended December 31, 2005 were approximately $2,091,000 as compared to $1,557,000 for the three months ended December 31, 2004. Reserves accreted into income for the nine-months ended December 31, 2005 were approximately $5,651,000 as compared to $3,498,000 for the nine-months ended December 31, 2004. There were no provisions reversed for the three and nine months ended December 31, 2005 or December 31, 2004. The primary reasons for the increase in reserves accreted during the nine months ended December 31, 2005 as compared to the nine months ended December 31, 2004 was a decrease in the net charge-off percentage from 6.03% to 5.28% and an increase in the size of the portfolio.

The Company experienced a lower net charge-off percentage during the nine months ended December 31, 2005 as compared to the nine months ended December 31, 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
 

The following table sets forth a reconciliation of the changes in dealer discount on Contracts.

   
Three months ended
  
Nine months ended
  
   
December 31,
  
December 31,
  
   
2005
  
2004
  
2005
  
2004
  
Balance at beginning of period
  
$
16,355,319
  
$
17,432,841
  
$
18,598,147
  
$
15,377,582
  
Discounts acquired on new volume
    
2,356,995
    
3,101,373
   
6,741,659
    
10,132,595
 
Losses absorbed
    
(2,215,649
)
  
(1,976,361
)
  
(5,966,904
)
  
(5,644,300
)
Recoveries
    
353,071
    
305,387
   
1,036,325
    
938,337
 
Discounts accreted
    
(2,091,494
)
  
(1,556,751
)
  
(5,650,985
)
  
(3,497,725
)
Balance at end of period
  
$
14,758,242
  
$
17,306,489
  
$
14,758,242
  
$
17,306,489
  
Dealer discounts as a percent of
                          
gross indirect Contracts
    
7.26
%
  
10.45
%
  
7.26
%
  
10.45
%

The following table sets forth a reconciliation of the changes in the allowance for credit losses on Contracts   

   
Three months ended
  
Nine months ended
  
   
December 31,
  
December 31,
  
   
2005
  
2004
  
2005
  
2004
  
Balance at beginning of period
  
$
6,914,361
  
$
6,312,213
  
$
6,448,790
  
$
5,787,764
  
Current period provision
    
1,106,958
    
514,119
   
2,259,590
    
1,680,596
 
Losses absorbed
    
(275,901
)
  
(467,770
)
  
(962,962
)
  
(1,109,798
)
Balance at end of period
  
$
7,745,418
  
$
6,358,562
  
$
7,745,418
  
$
6,358,562
  
Allowance as a percent of gross
                          
indirect Contracts
    
3.81
%
  
3.84
%
  
3.81
%
  
3.84
%
 
The following table sets forth a reconciliation of the changes in the allowance for credit losses on direct loans.

   
Three months ended
  
Nine months ended
  
   
December 31,
  
December 31,
  
   
2005
  
2004
  
2005
  
2004
  
Balance at beginning of period
  
$
227,225
  
$
180,239
  
$
199,653
  
$
184,334
  
Current period provision
    
53,532
    
41,476
   
142,340
    
94,258
 
Losses absorbed
    
(36,685
)
  
(24,744
)
  
(113,047
)
  
(98,939
)
Recoveries
    
9,088
    
5,531
   
24,214
    
22,849
 
Balance at end of period
  
$
253,160
  
$
202,502
  
$
253,160
  
$
202,502
  
Allowance as a percent of gross
                          
direct loan receivables
    
3.20
%
  
3.63
%
  
3.20
%
  
3.63
%

The average dealer discount associated with new volume for the three months ended December 31, 2005 and 2004 were 8.90% and 8.73%, respectively. The average dealer discount associated with new volume for the nine months ended December 31, 2005 and 2004 were 8.72% and 8.72%, respectively. The Company believes the average dealer discount may decrease in future pools as the result of competition in the markets the Company is currently operating in.
 
 
17
 

The provision for credit losses increased from approximately $566,000 for the three months ended December 31, 2004 to $1,172,000 for the three months ended December 31, 2005. The provision for credit losses increased from approximately $1,806,000 for the nine months ended December 31, 2004 to $2,432,000 for the nine months ended December 31, 2005. The Company’s losses as a percentage of liquidation decreased from 7.45% for the three months ended December 31, 2004 to 6.19% for the three months ended December 31, 2005. The Company’s losses as a percentage of liquidation decreased from 6.99% for the nine months ended December 31, 2004 to 5.92% for the nine months ended December 31, 2005. The Company anticipates losses as a percentage of liquidation will be in the 5-7% 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 Company’s 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 nine months ended December 31, 2005 that would have contributed to the decrease in losses.

Recoveries as a percentage of charge-offs were 17.3% and 14.1% for the three months ended December 31, 2005 and 2004, respectively. Recoveries as a percentage of charge-offs were 17.7% and 16.1% for the nine months ended December 31, 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 December 31, 2005 and 2004 were approximately $2,091,000 and $1,557,000, respectively.  Reserves accreted into income for the nine months ended December 31, 2005 and 2004 were approximately $5,651,000 and $3,498,000, 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 Company’s current reserve levels are adequate for the foreseeable future. The number of bankruptcy filings by customers increased slightly during the three and nine months ended December 31, 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 Company’s current reserve levels are adequate for the foreseeable future.

 
18
 

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 December 31, 2005
  
At December 31, 2004
  
Contracts
                  
Gross balance outstanding
  
$
203,293,741
        
$
165,583,890
        
                           
Delinquencies
                          
30 to 59 days
  
$
3,438,414
    
1.70
%
$
3,056,372
    
1.85
%
60 to 89 days
    
1,144,851
    
0.56
%
  
706,221
    
0.43
%
90 + days
    
409,335
    
0.20
%
  
327,077
    
0.19
%
                           
Total delinquencies
  
$
4,992,600
    
2.46
%
$
4,089,670
    
2.47
%
                           
Direct Loans
                          
Gross balance outstanding
  
$
7,904,426
        
$
5,583,074
        
                           
Delinquencies
                          
30 to 59 days
  
$
89,224
    
1.13
%
$
61,980
    
1.11
%
60 to 89 days
    
35,969
    
0.46
%
  
16,758
    
0.30
%
90 + days
    
28,087
    
0.35
%
  
27,475
    
0.49
%
                           
Total delinquencies
  
$
153,280
    
1.94
%
$
106,213
    
1.90
%

The delinquency percentage for Contracts more than thirty days past at December 31, 2005 was 2.46% as compared to 2.47% at December 31, 2004. The delinquency percentage for direct loans more than thirty days past due at December 31, 2005 was 1.94% as compared to 1.90% at December 31, 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 24% to approximately $1,670,000 for the three months ended December 31, 2005 from $1,346,000 for the three months ended December 31, 2004, primarily as a result of higher pre-tax income. The provision for income taxes increased 34% to approximately $4,676,000 for the nine months ended December 31, 2005 from $3,483,000 for the nine months ended December 31, 2004, primarily as a result of higher pre-tax income. The Company's effective tax rate increased from 37.82% for the three months ended December 31, 2004 to 38.05% for the three months ended December 31, 2005. The Company's effective tax rate increased from 37.88% for the nine months ended December 31, 2004 to 38.03% for the nine months ended December 31, 2005.
 
 
19
 

Liquidity and Capital Resources

The Company's cash flows are summarized as follows:
 
   
Nine months ended December 31,
  
   
2005
  
2004
  
Cash provided by (used in):
              
Operating activities -
  
$
10,039,387
  
$
7,596,724
  
Investing activities -
          
(primarily purchase of Contracts)
    
(22,068,234
)
  
(11,801,646
)
               
Financing activities
    
12,846,266
    
4,741,321
  
               
Net increase in cash 
  
$
817,419
  
$
536,399
  
 
The Company's primary use of working capital for the nine months ended December 31, 2005 was the funding of the purchase of Contracts. The Contracts were financed substantially through borrowings under the Company’s $85.0 million Line. The Line is secured by all of the assets of the Company’s Nicholas Financial, Inc. subsidiary. At December 31, 2005 the Company could 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 plus 175.0 basis points or at the prime rate plus 37.5 basis points. Prime rate based borrowings are generally less than $1.0 million. As of December 31, 2005, the amount outstanding under the Line was approximately $78.4 million and the amount available under the Line was approximately $6.6 million.

On February 1, 2006 the Company executed Amendment No. 7 to its Line increasing the total Line from $85.0 million to $100.0 million. All other terms and conditions of Amendment No. 6, dated September 14, 2005 remain in effect.

The Company has entered into interest rate swap agreements, each of which effectively converts a portion of the Company’s floating-rate debt to a fixed-rate, thus reducing the impact of interest rate change on the Company’s interest expense. At December 31, 2005, approximately 77% of the Company’s 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 Company’s 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.

 
20
 

Future Expansion

The Company currently operates a total of forty-two branch locations in ten states, including seventeen in Florida, five in Ohio, five in North Carolina, four in Georgia, three in Virginia, three in Kentucky, two in South Carolina 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 finance receivables, net of unearned interest. 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 Company’s 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 Company’s 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 Company’s 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. SFAS No. 123(R) will be applicable for the quarter ending June 30, 2006. Thus, the Company’s 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 Company’s 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 Company’s present or future consolidated financial statements.
 
 
21
 

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 Company’s management evaluated, with the participation of the Company’s President and Chief Executive Officer and Senior Vice President-Finance and Chief Financial Officer, the effectiveness of the design and operation of the Company’s 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 Company’s internal control over financial reporting that occurred during the Company’s last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
 
 
22
 

PART II - OTHER INFORMATION

ITEM 6. EXHIBITS
 
See exhibit index following the signature page.

 
23
 
 
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)
     
 
 		  
 		  
 
Date: February 14, 2006   /s/ Peter L. Vosotas
 
Peter L. Vosotas
 
Chairman of the Board, President,
Chief Executive Officer and Director
     
 
 		  
 		  
 
Date: February 14, 2006   /s/ Ralph T. Finkenbrink 
 
Ralph T. Finkenbrink
 
Sr. Vice President -Finance
Chief Financial Officer and Director

 
24
 

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