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QCCO > SEC Filings for QCCO > Form 10-Q on 15-May-2013All Recent SEC Filings

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Form 10-Q for QC HOLDINGS, INC.


Quarterly Report

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations


The discussion below includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 regarding, among other things, our plans, strategies and prospects, both business and financial. All statements other than statements of current or historical fact contained in this discussion are forward-looking statements. The words "believe," "expect," "anticipate," "should," "would," "could," "plan," "will," "may," "intend," "estimate," "potential," "objective", "continue" or similar expressions or the negative of these terms are intended to identify forward-looking statements.

These forward-looking statements are based on our current expectations and are subject to a number of risks and uncertainties, which could cause actual results to differ materially from those forward-looking statements. These risks include
(1) changes in laws or regulations or governmental interpretations of existing laws and regulations governing consumer protection or payday lending practices, including particularly changes in Washington, South Carolina, Virginia, Illinois and Arizona, (2) uncertainties relating to the interpretation, application and promulgation of regulations under the Dodd-Frank Wall Street Reform and Consumer Protection Act, including the impact of future regulations proposed or adopted by the Bureau of Consumer Financial Protection (CFPB), which was created by that Act, (3) uncertainties related to the examination process by the CFPB and the potential for indirect rulemaking through the examination process, (4) ballot referendum initiatives by industry opponents to cap the rates and fees that can be charged to customers, (5) litigation or regulatory action directed towards us or the payday loan industry, (6) volatility in our earnings, primarily as a result of fluctuations in loan loss experience and the rate of growth in or closure of branches, (7) risks associated with the leverage of the Company,
(8) negative media reports and public perception of the payday loan industry and the impact on federal and state legislatures and federal and state regulators,
(9) changes in our key management personnel, (10) integration risks and costs associated with acquisitions, including our recent Canadian acquisition, and
(11) the other risks detailed under Item 1A. "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2012 filed with the Securities and Exchange Commission.

In light of these risks, uncertainties and assumptions, the forward-looking statements in this report may not occur, and actual results could differ materially from those anticipated or implied in the forward-looking statements. When investors consider these forward-looking statements, they should keep in mind the risk factors and other cautionary statements in this discussion.

Our forward-looking statements speak only as of the date they are made. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

The discussion in this item is intended to clarify and focus on our results of operations, certain changes in financial position, liquidity, capital structure and business developments for the periods covered by the consolidated financial statements included under Item 1 of this Form 10-Q. This discussion should be read in conjunction with these consolidated financial statements, the audited financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2012, and the related notes thereto and is qualified by reference thereto.


We operate primarily through our wholly-owned subsidiaries, QC Financial Services, Inc., QC Auto Services, Inc., QC Loan Services, Inc., QC E-Services, Inc., QC Canada Holdings Inc. and QC Capital, Inc. QC Financial Services, Inc. is the 100% owner of QC Financial Services of California, Inc., Financial Services of North Carolina, Inc., QC Financial Services of Texas, Inc., Express Check Advance of South Carolina, LLC, QC Advance, Inc., Cash Title Loans, Inc. and QC Properties, LLC. QC Canada Holdings Inc. is the 100% owner of Direct Credit Holdings Inc. and its wholly owned subsidiaries (collectively, Direct Credit).

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We derive our revenues primarily by providing short-term consumer loans, known as payday loans, which represented approximately 65.8% of our total revenues for the three months ended March 31, 2013. We earn fees for various other financial services, such as installment loans, credit services, check cashing services, title loans, open-end credit, debit cards, money transfers and money orders. We operated 437 branches in 23 states at March 31, 2013. In all states in which we offer payday loans, we fund our payday loans directly to the customer and receive a fee. Fees charged to customers vary from state to state, generally ranging from $15 to $20 per $100 borrowed, and in most cases, are limited by state law.

We began offering branch-based installment loans to customers in our Illinois branches during second quarter 2006 and expanded that product offering to customers in additional states during 2009 and 2010. In 2012, we introduced new installment loan products (signature loans and auto equity loans) to meet high customer demand for longer-term loan options. These new products are higher-dollar and longer-term installment loans that are centrally underwritten and distributed through our existing branch network. As of March 31, 2013, we offered the installment loan products to our customers in Arizona, California, Colorado, Idaho, Illinois, Missouri, New Mexico, South Carolina, Utah and Wisconsin. The installment loans are payable in monthly installments (principal plus accrued interest) with terms typically ranging from four months to 48 months, and all loans are pre-payable at any time without penalty. The fee for the installment loan varies based on the amount borrowed and the term of the loan. Generally, the amount that we advance under an installment loan ranges from $400 to $3,000. The average principal amount across all installment loan products originated during the three months ended March 31, 2013 was approximately $643.

In Texas, through one of our subsidiaries, we operate as a credit service organization (CSO) on behalf of consumers in accordance with Texas laws. We charge the consumer a CSO fee for arranging for an unrelated third-party to make a loan to the consumer and for providing related services to the consumer, including a guarantee of the consumer's obligation to the third-party lender.

In September 2007, we entered into the buy here, pay here segment of the used automotive market in connection with ongoing efforts to evaluate alternative products that serve our customer base. In January 2009, we purchased two buy here, pay here locations in Missouri for approximately $4.2 million. In May 2009, we opened a service center to provide reconditioning services on our inventory of vehicles and repair services for our customers. As of March 31, 2013, we operated five buy here, pay here lots, which are located in Missouri and Kansas. These locations sell used vehicles and earn finance charges from the related vehicle financing contracts. The average principal amount for buy here, pay here loans originated during the three months ended March 31, 2013 was approximately $10,051 and the average term of the loan was 33 months.

On September 30, 2011, QC Canada Holdings Inc, our wholly-owned subsidiary, acquired 100% of the outstanding stock of Direct Credit Holdings Inc. (Direct Credit), a British Columbia company engaged in short-term, consumer Internet lending in certain Canadian provinces. Direct Credit was founded in 1999 and has developed and grown a proprietary Internet-based platform in Canada. The acquisition of Direct Credit is part of the implementation of our strategy to diversify by increasing our product offerings and distribution, as well as expanding our presence into international markets.

We have elected to organize and report on our business units as three operating segments (Financial Services, Automotive and E-Lending). The Financial Services segment includes branches that offer payday loans, installment loans, credit services, check cashing services, title loans, open-end credit, debit cards, money transfers and money orders. The Automotive segment consists of our buy here, pay here operations. The E-Lending segment includes the Internet lending operations in Canada. We evaluate the performance of our segments based on, among other things, gross profit, income from continuing operations before income taxes and return on invested capital.

Our expenses primarily relate to the operations of our branch network and automotive locations. The most significant expenses include salaries and benefits for our branch employees, provisions for losses, cost of sales and occupancy expense for our leased real estate. Regional and corporate expenses, which include compensation of employees, professional fees and equity award charges, are our other primary costs.

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We also evaluate our Financial Services branches, automotive locations, and our Direct Credit operations based on revenue growth and loss ratio (which is losses as a percentage of revenues). With respect to our branch network, we also consider the length of time the branch has been open and its geographic location. We monitor newer branches for their progress to profitability and rate of loan growth.

With respect to our cost structure, salaries and benefits are one of our largest costs and are generally driven by changes in number of branches and loan volumes. Our provision for losses is also a significant expense. If a customer's check is returned by the bank as uncollected, we make an immediate charge-off to the provision for losses for the amount of the customer's loan, which includes accrued fees and interest. Any recoveries on amounts previously charged off are recorded as a reduction to the provision for losses in the period recovered.

We have experienced seasonality in our Financial Services segment, with the first and fourth quarters typically being our strongest periods as a result of broader economic factors, such as holiday spending habits at the end of each year and income tax refunds during the first quarter. Our Automotive locations experience seasonality as automobile sales peak during the first quarter of each year, primarily as a result of the receipt by customers of their income tax refunds, which are used as down payments for a vehicle. Automobile sales in the final three quarters are generally lower than the first quarter. In addition, vehicle acquisition costs tend to increase in the second half of the year as companies build inventories for the expected first quarter volumes.

In response to changes in the overall market, including particularly changes to laws under which we operate, we have closed a significant number of branches over the past five years. The following table sets forth our de novo branch openings, branch acquisitions and branch closings since January 1, 2008.

                                                                                                       March 31,
                                               2008       2009       2010       2011       2012          2013
Beginning branch locations                       596        585        556        523        482              466
De novo branches opened during period             12          3          1          2          8                5
Acquired branches during period                    1
Branches closed/sold during period (a)           (24 )      (32 )      (34 )      (43 )      (24 )            (34 )

Ending branch locations                          585        556        523        482        466              437

(a) In December 2012, we announced that we would close 38 branches during the first half of 2013. The branches closed during first quarter 2013 include 33 of these branches and the remaining five are expected to close during second quarter 2013. These 38 branches were included as part of discontinued operations beginning in 2012.

In recent years, we have focused on growing revenue by introducing new products that serve our existing loyal customer base and increasing profitability by streamlining operations. As part of our efforts to introduce new products and diversify our revenue stream, we are currently in the process of accelerating the growth of our longer-term, centrally underwritten installment loan product to our existing branch network. We continually evaluate opportunities for product and geographic expansion and for new branch development to complement existing branches within a given state or market. Additionally, we utilize a disciplined acquisition strategy for both the payday and the buy here, pay here businesses.

We are currently in the process of restructuring our Automotive segment. Historically, we have carried all of our automobile loans receivable on our balance sheet; however, in December 2012, we sold roughly 90% of our automobile loans receivable to a third party. Additionally, while the Automotive segment has been funded from our operations, we are evaluating a forward flow arrangement whereby sales of automobiles are funded directly by a third-party lender. We believe these changes will enhance profitability as a result of improved net credit expense, in addition to enabling us to reduce the capital requirements of the business going forward.

We believe the acquisition of Direct Credit broadens our product platform and distribution, as well as expands our presence by entering into international markets. Although the Canadian market is much smaller than the U.S. market, there is still significant room for organic growth, and Direct Credit is a scalable platform with a competitive method for funding loans. In addition, Direct Credit's online technology can be used as a platform for

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future growth into other markets, and we are currently leveraging Direct Credit's online business model to develop an Internet-based lending platform for customers in the United States. A viable U.S. Internet presence will help us further diversify our revenue base and offer our customers another financing alternative.

The payday loan industry began its rapid growth in 1996, when there were an estimated 2,000 payday loan branches in the United States. According to Community Financial Services Association, industry analysts estimate that the industry has approximately 18,300 payday loan branches in the United States and approximately 1,400 payday loan and check cashing retail locations in Canada. During 2012, the branches in the United States extended approximately $30 billion in short-term credit to millions of middle-class households that experienced cash-flow shortfalls between paydays. As the branch count grew over the last decade, a greater number of Internet-based payday loan providers emerged. Industry analysts estimated that Internet-based payday loan providers extended approximately $18.6 billion to their customers during 2012. In the last few years, the rate of growth for these Internet providers has exceeded that of the branch-based lenders. We believe this trend will continue into the foreseeable future as consumers become more comfortable transacting electronically.

We believe our industry is highly fragmented, with the larger companies operating approximately 50% of the total industry branches. After a number of years of growth, the industry has contracted slightly in the past few years, primarily due to changes in laws that govern the payday product. Absent changes in regulations and laws, we do not expect significant fluctuations in the industry's number of branches in the foreseeable future.

The payday loan industry has followed, and continues to be significantly affected by, payday lending legislation and regulation in the various states and on a national level. We actively monitor and evaluate legislative and regulatory initiatives in each of the states and nationally, and are closely involved with the efforts of the Community Financial Services Association. To the extent that states enact legislation or regulations that negatively impacts payday lending, whether through preclusion, fee reduction or loan caps, our business has been adversely affected in the past and could be further adversely affected in the future. Over the past few years, legislatures in certain states (and voter initiatives in a few states) have enacted interest rate caps from 28% to 36% per annum on payday lending. A 36% per annum interest rate translates to approximately $1.38 per $100 loaned, which effectively precludes us from offering payday loans in those states unless other transaction fees may be charged to the customer.

In the last several years, changes in laws governing payday loans have negatively affected our revenues and gross profit.

During 2009, payday loan-related legislation that severely restricts customer access to payday loans was passed in South Carolina, Washington, Virginia and Kentucky. These law changes adversely affected our revenues and operating income during 2010. During 2010, the results from the states in which we have experienced law changes were more negative than we expected, with revenue declines and loss rates exceeding our forecasts. For the year ended December 31, 2010, revenues and gross profit from South Carolina, Washington, Virginia and Kentucky declined by $14.1 million and $9.0 million, respectively, compared to the prior year. During 2011 and 2012, as a group, these states have generated modest profits and will not return to the level of profitability experienced prior to the customer restrictions, indicative of the challenges inherent with a transition to a new law and new products.

In Arizona, the existing payday lending law expired on June 30, 2010. While we are currently offering installment loans to our Arizona customers, our customers have not embraced this product as they did the payday loan product. For the year ended December 31, 2011, revenues and gross profit from our Arizona branches declined by $1.5 million and $1.4 million, respectively, from the prior year. Results in 2012 were slightly ahead of 2011, but we do not expect profitability to return to levels experienced prior to the expiration of the payday law.

In March 2011, a new payday law became effective in Illinois that imposes customer usage restrictions that has negatively affected revenues and profitability. This type of customer restriction, when passed in other states such as Washington, South Carolina and Kentucky, has resulted in a 30% to 60%

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decline in annual revenues and a more significant decline in gross profit, depending on the types of alternative products that competitors may offer within the state. The Illinois law provides for an overlap of the previous lending approach with loans issued under the new law for a period of one year, which extended the time period over which the negative effects of the new law occurred. During 2011, our revenues declined by $2.4 million and our gross profit declined by $2.2 million. During 2012, our revenues declined by $2.0 million and our gross profit declined by $1.8 million. We expect that revenues and gross profit in Illinois for 2013 will be similar to 2012.

There was an effort in Missouri to place a voter initiative on the statewide ballot in November 2012, which was intended to preclude any lending in the state with an annual rate over 36%. The supporters of the voter initiative did not submit a sufficient number of valid signatures to place the initiative on the ballot in November 2012. However, a similar initiative was submitted to the Missouri Secretary of State in December 2012 for inclusion on the November 2014 ballot subject to the proponents submitting the required number of valid signatures in support of the initiative. If this initiative is placed on the ballot in 2014 and the measure passes, we would be unable to operate our payday loan branches in Missouri and be forced to close those locations in the state.

Three Months Ended March 31, 2013 Compared with the Three Months Ended March 31, 2012

The following table sets forth our results of operations for the three months ended March 31, 2013 compared to the three months ended March 31, 2012:

                                                       March 31,                      March 31,
                                                   2012          2013          2012                2013
                                                     (in thousands)           (percentage of revenues)
Payday loan fees                                 $ 29,319      $ 27,745            66.3 %            65.8 %
Automotive sales, interest and fees                 6,407         3,628            14.5 %             8.6 %
Installment interest and fees                       4,238         6,887             9.6 %            16.3 %
Other                                               4,270         3,935             9.6 %             9.3 %

Total revenues                                     44,234        42,195           100.0 %           100.0 %

Operating expenses
Salaries and benefits                               9,458         9,429            21.4 %            22.3 %
Provision for losses                                5,597         8,023            12.7 %            19.0 %
Occupancy                                           4,728         4,795            10.7 %            11.4 %
Cost of sales-automotive                            3,178         2,180             7.2 %             5.2 %
Depreciation and amortization                         567           563             1.3 %             1.3 %
Other                                               3,243         3,252             7.2 %             7.7 %

Total operating expenses                           26,771        28,242            60.5 %            66.9 %

Gross profit                                       17,463        13,953            39.5 %            33.1 %
Regional expenses                                   3,083         3,102             7.0 %             7.4 %
Corporate expenses                                  5,615         5,812            12.7 %            13.8 %
Depreciation and amortization                         541           453             1.2 %             1.1 %
Interest expense                                    1,020           456             2.3 %             1.1 %
Other expense (income), net                          (951 )         712            (2.1 )%            1.6 %

Income from continuing operations before
income taxes                                        8,155         3,418            18.4 %             8.1 %
Provision for income taxes                          3,123         1,400             7.0 %             3.3 %

Income from continuing operations                   5,032         2,018            11.4 %             4.8 %
Loss from discontinued operations, net of
income tax                                            103             5             0.2 %             0.0 %

Net income                                       $  4,929      $  2,013            11.2 %             4.8 %

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The following table sets forth selected financial and statistical information for the three months ended March 31, 2012 and 2013:

                                                                 Three Months Ended
                                                                     March 31,
                                                               2012             2013
Financial Services Branch Information:
Number of branches, beginning of period                            482              466
De novo branches opened                                              2                5
Branches closed                                                     (1 )            (34 )

Number of branches, end of period                                  483              437

Average number of branches open during period (excluding
branches reported as discontinued operations)                      424              431

Average revenue per branch (in thousands)                    $      84        $      85
Other Information:
Payday Loans:
Payday loan volume (in thousands)                            $ 194,022        $ 181,198
Average loan (principal plus fee)                               380.34           384.49
Average fees per loan                                            57.94            59.41
Average fee rate per $100                                        17.97            18.27

Installment Loans:
Installment loan volume (in thousands)                       $   6,901        $   9,357
Average loan (principal)                                        567.22           642.83
Average term (days)                                                185              222

Automotive Loans:
Automotive loan volume (in thousands)                        $   5,042        $   2,955
Average loan (principal)                                         9,984           10,051
Average term (months)                                               33               33
Locations, end of period                                             5                5

Income from Continuing Operations. For the three months ended March 31, 2013, income from continuing operations was $2.0 million compared to $5.0 million for the same period in 2012. A discussion of the various components of net income follows.

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Revenues. The following table summarizes our revenues for three months ended March 31, 2012 and 2013 and sets forth the percentage of total revenue for payday loans and the other services we provide.

                                           Three Months Ended                     Three Months Ended
                                                March 31,                             March 31,
                                           2012            2013              2012                     2013
                                             (in thousands)                 (percentage of total revenues)
Payday loan fees                        $   29,319       $ 27,745                  66.3 %                 65.8 %
Automotive sales, interest and fees          6,407          3,628                  14.5 %                  8.6 %
Installment loan fees                        4,238          6,887                   9.6 %                 16.3 %
Credit service fees                          1,808          1,659                   4.1 %                  3.9 %
Check cashing fees                             983            823                   2.2 %                  2.0 %
Title loan fees                                672            358                   1.5 %                  0.8 %
Open-end credit fees                           136            468                   0.3 %                  1.1 %
Other fees                                     671            627                   1.5 %                  1.5 %
. . .
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