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NICK > SEC Filings for NICK > Form 10-Q on 9-Aug-2013All Recent SEC Filings

Show all filings for NICHOLAS FINANCIAL INC

Form 10-Q for NICHOLAS FINANCIAL INC


9-Aug-2013

Quarterly Report


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 ability to access bank financing, 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 Forms 10-K, 10-Q, 8-K and annual reports to shareholders.

Strategic Alternatives

On March 20, 2013, the Company announced that its Board of Directors has retained Janney Montgomery Scott LLC as its independent financial advisor to assist the Board of Directors in evaluating possible strategic alternatives for the Company, including, but not limited to, the possible sale of the Company or certain of its assets, potential acquisition and expansion opportunities, and/or a possible debt or equity financing. The Company also announced that it has received an unsolicited, non-binding indication of interest from a potential third-party acquirer. As of the date of this Report, the Board of Directors is continuing to evaluate possible strategic alternatives and their implications. No assurances can be given as to whether any particular strategic alternative for the Company will be recommended or undertaken or, if so, upon what terms and conditions.

Corrections to Consolidated Financial Statements

In connection with the audit of our consolidated financial statements for the fiscal year ended March 31, 2013, the Company determined that it was necessary to correct its consolidated financial statements.

One of the corrections is related to the accounting treatment for dealer discounts. A dealer discount represents the difference between the amount of a finance receivable, net of unearned interest, based on the terms of a Contract with the borrower, and the amount of money the Company actually pays the dealer for the Contract. Prior to the correction, Contracts were recorded at the net initial investment, with the gross Contract balances recorded offset by the dealer discounts which were recorded as an allowance for credit losses for the acquired Contracts. The Company determined that this accounting treatment was incorrect as U.S. GAAP prohibits carrying over valuation allowances in the initial accounting for acquired loans. Accordingly, the Company has now applied an acceptable method under U.S. GAAP, deferring and netting dealer discounts against finance receivables as unearned discounts, and recognizing dealer discounts into income as an adjustment to yield over the life of the each loan using the interest method.

As a result, the allowance for loan losses is now established solely through charges to earnings through the provision for credit losses. The Company has evaluated the significance of the departure from U.S. GAAP to the consolidated financial statements. Under both the former accounting policy and U.S. GAAP, the dealer discount remains a reduction of gross finance receivables in arriving at the carrying amount of finance receivables, net. Accordingly, finance receivables continue to be initially recorded at the net initial investment at the time of purchase. Subsequently, the allowance for credit losses is maintained at an amount that reduces the net carrying amount of finance receivables for incurred losses. The change in this accounting presentation does not result in a change to the net carrying amount of finance receivables or to net income as historical losses incurred, and estimated incurred losses as of the balance sheet date, are generally in excess of the original dealer discount. The removal of the dealer discount from the allowance requires an equal replacement of provision expense as that portion of the allowance is necessary to absorb probable incurred losses. This correction also did not have an impact on previously reported assets, liabilities, working capital, equity, earnings, or cash flows.

The second correction related to the accounting treatment and presentation of certain fees charged to dealers and costs incurred in purchasing loans from dealers. Such costs related principally to evaluating borrowers subject to Contracts in relation to the Company's underwriting guidelines in making a determination to acquire Contracts. Prior to the correction,


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fees charged to dealers were reduced by certain costs incurred to purchase Contracts, deferred on a net basis and then amortized into income over the lives of the loans using the interest method. Under U.S. GAAP, the fees charged to dealers are considered to be a part of the unearned dealer discount as they are a determinant of the net amount of cash paid to the dealer. Further, U.S. GAAP specifies that costs incurred in connection with acquiring purchased loans or committing to purchase loans shall be charged to expense as incurred. Such costs do not qualify as origination costs to be deferred as the Contracts have already been originated by the dealers. The Company evaluated the significance of the departure from U.S. GAAP to the consolidated financial statements. After an adjustment to beginning equity and the opening balance of unearned dealer discounts, net of tax, for the initial period presented, there is a limited effect on earnings and no impact on cash flows.

Management corrected the errors and retroactively adjusted amounts as of and for the quarter ended June 30, 2012 to ensure the errors would not result in a material difference in future periods.

The changes to the Company's consolidated financial statements for the quarter ended June 30, 2012 resulting from such corrections are set forth in "Note 2. Summary of Significant Accounting Policies - Corrections" to the consolidated financial statements of the Company included in "Item 1. Financial Statements (Unaudited)" of this Report.

Prior period interim financial information appearing elsewhere in this Report has also been revised in light of the foregoing corrections. The changes resulting from such corrections are immaterial and, accordingly, we are not amending or restating any previously filed SEC reports or the consolidated financials included therein.

Critical Accounting Policy

The Company's critical accounting policy relates to the allowance for credit losses. 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 a provision for losses based on management's evaluation of the risk inherent in the loan portfolio, the composition of the portfolio, and current economic conditions. Such evaluation, 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.

Because of the nature of the customers under the Company's Contracts and its Direct Loans, 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 branch office during the fiscal quarter.

Contracts are purchased from many different dealers and are all purchased on an individual Contract by Contract basis. Individual Contract pricing is determined by the automobile dealerships and is generally the lesser of state maximum interest rates or the maximum interest rate the customer will accept. In certain markets, competitive forces will drive down Contract rates from the maximum 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 may consider portfolio acquisitions as part of its growth strategy.

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.

The allowance for loan losses is established through charges to earnings through the provision for credit losses. The allowance for credit losses is maintained at an amount that reduces the net carrying amount of finance receivables for incurred losses. If a static pool is fully liquidated and has any remaining reserves, the excess provision is immediately reversed during the period. For static pools that are not fully liquidated that are deemed to have excess reserves, such amounts are reversed against provision for credit losses during the period.

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.


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Introduction

Consolidated net income increased 6% to approximately $5.7 million for the three-month period ended June 30, 2013 as compared to $5.4 million for the corresponding period ended June 30, 2012. Diluted earnings per share increased to $0.46 for the three months ended June 30, 2013 from $0.44 for the three months ended June 30, 2012.

Interest and fee income on finance receivables remained relatively flat for the three months ended June 30, 2013 compared to the three months ended June 30, 2012. Our results for the three months ended June 30, 2013 were positively effected by a non-cash gain related to interest rate swaps and were adversely effected by an increase in operating expenses.

The Company's software subsidiary, Nicholas Data Services, did not contribute significantly to consolidated operations in the three months ended June 30, 2013 or 2012.

                                                              Three months ended
                                                                   June 30,
Portfolio Summary                                         2013                  2012
Average finance receivables, net of unearned
interest (1)                                          $ 285,637,997         $ 279,750,283

Average indebtedness (2)                              $ 125,880,390         $ 110,750,000

Interest and fee income on finance receivables
(3)*                                                  $  20,469,372         $  20,417,957
Interest expense                                          1,404,906             1,192,140

Net interest and fee income on finance
receivables*                                          $  19,064,466         $  19,225,817

Weighted average contractual rate (4)                         22.99 %               23.81 %

Average cost of borrowed funds (2)                             4.46 %                4.31 %

Gross portfolio yield (5)*                                    28.66 %               29.19 %
Interest expense as a percentage of average
finance receivables, net of unearned interest                  1.97 %                1.70 %
Provision for credit losses as a percentage of
average finance receivables, net of unearned
interest *                                                     3.70 %                4.44 %

Net portfolio yield (5)*                                      22.99 %               23.05 %
Marketing, salaries, employee benefits,
depreciation and administrative expenses as a
percentage of average finance receivables, net
of unearned interest (6)                                      11.12 %               10.10 %

Pre-tax yield as a percentage of average finance
receivables, net of unearned interest (7)*                    11.87 %               12.95 %

Write-off to liquidation (8)                                   5.90 %                4.93 %
Net charge-off percentage (9)                                  5.15 %                4.07 %

Note: All three 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. Average cost of borrowed funds represents interest expense as a percentage of average indebtedness.

(3) Interest and fee income on finance receivables does not include revenue generated by Nicholas Data Services, Inc., ("NDS") the wholly-owned software subsidiary of Nicholas Financial, Inc.

(4) Weighted average contractual rate represents the weighted average annual percentage rate ("APR") of all Contracts purchased and Direct Loans originated during the period.


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(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) Administrative expenses included in the calculation above are net of administrative expenses associated with NDS which approximated $55,000 and $67,000 during the three-month periods ended June 30, 2013 and 2012, respectively.

(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.

* These amounts for June 30, 2012 have been revised as discussed in Note 2 to the consolidated financial statements.

Three months ended June 30, 2013 compared to three months June 30, 2012

Interest Income and Loan Portfolio

Interest and fee income on finance receivables, predominately finance charge income, increased by less than 1% to approximately $20.5 million for the three-month period ended June 30, 2013 from $20.4 million for the corresponding period ended June 30, 2012. Average finance receivables, net of unearned interest of approximately $285.6 million as of June 30, 2013, increased 2% from $279.8 million as of June 30, 2012. The primary reason average finance receivables, net of unearned interest, increased was the increase in the receivable base of several existing branches in younger markets and the recent openings of new branch locations (see "Contract Procurement" and "Loan Origination" below). The gross finance receivable balance increased 3% to approximately $403.4 million as of June 30, 2013, from $392.7 million as of June 30, 2012. The gross portfolio yield decreased to 28.66% for the three-month period ended June 30, 2012 from 29.19% for the three-month period ended June 30, 2012. The net portfolio yield remained fairly consistent at 22.99% for the corresponding period ended June 30, 2013 from 23.05% for the three-month period ended June 30, 2012. The gross portfolio yield decreased due to a lower weighted APR earned on finance receivables.

Marketing, Salaries, Employee Benefits, Depreciation, and Administrative Expenses

Marketing, salaries, employee benefits, depreciation and administrative expenses increased to approximately $8.0 million for the three-month period ended June 30, 2013 from approximately $7.1 million for the corresponding period ended June 30, 2012. The increase of 13% was primarily attributable to new branch locations and an increase in operating expenses. The Company opened additional branches and increased average headcount to 321 for the three-month period ended June 30, 2013 from 303 for the three-month period ended June 30, 2012. Marketing, salaries, employee benefits, depreciation, and administrative expenses as a percentage of finance receivables, net of unearned interest, increased to 11.12% for the three-month period ended June 30, 2013 from 10.10% for the three-month period ended June 30, 2012.

Interest Expense

Interest expense increased to approximately $1.4 million for the three-month period ended June 30, 2013 from $1.2 million for the three-month period ended June 30, 2012. One interest rate swap agreement was entered into during the first quarter ended June 30, 2012. Two interest rate swap agreements were in effect during the entire three-month period ended June 30, 2013. The following table summarizes the Company's average cost of borrowed funds:

                                                            Three months ended
                                                                 June 30,
                                                            2013            2012
    Variable interest under the line of credit facility        0.35 %        0.50 %
    Settlements under interest rate swap agreements            0.30 %        0.05 %
    Credit spread under the line of credit facility            3.81 %        3.75 %

    Average cost of borrowed funds                             4.46 %        4.30 %

The Company's average cost of funds increased due to settlements under the interest rate swap agreements during the three months ended June 30, 2013. The weighted average notional amount of the interest rate swap agreements were $50.0 million at a weighted average fixed rate of .94% for the three months ended June 30, 2013. As of June 30, 2012 only $25.0 million in notional interest rate swap agreements was outstanding at a fixed rate of 1.00% and only for a part of the quarter. For further discussions regarding the effect of interest rate swap agreements see note 6 - "Interest Rate Swap Agreements".


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Contract Procurement

The Company purchases Contracts in the fifteen states listed in the table below. The Contracts purchased by the Company are predominately for used vehicles; for the three-month period ended June 30, 2013 and 2012, less than 1% were for new vehicles.

The following tables present selected information on Contracts purchased by the Company, net of unearned interest.

                                     Three months ended
                                          June 30,
                        State       2013             2012
                        FL      $ 12,109,051     $ 11,073,393
                        GA         4,147,343        3,921,042
                        NC         4,448,482        3,286,300
                        SC         1,400,374          656,869
                        OH         6,065,865        5,350,511
                        MI         1,715,302        1,080,268
                        VA         1,460,241        1,194,789
                        IN         2,134,790        1,913,686
                        KY         2,317,470        2,306,906
                        MD           519,657          378,245
                        AL         1,783,268        1,753,764
                        TN         1,774,514        1,364,078
                        IL           556,335        1,167,098
                        MO         1,133,722        1,600,446
                        KS           316,300          184,537

                        Total   $ 41,882,714     $ 37,231,933

                                                  Three months ended
                                                       June 30,
           Contracts                            2013              2012
           Purchases                        $ 41,882,714      $ 37,231,933
           Weighted APR                            22.81 %           23.67 %
           Average discount*                        8.35 %            9.04 %
           Weighted average term (months)             51                49
           Average loan                     $     10,576      $      9,918
           Number of Contracts                     3,960             3,754

* This amount for June 30, 2012 has been revised as discussed in Note 2 to the consolidated financial statements.

Loan Origination

The following table presents selected information on Direct Loans originated by
the Company, net of unearned interest.



                                                  Three months ended
                                                       June 30,
            Direct Loans Originated             2013             2012
            Originations                     $ 2,639,159      $ 2,054,485
            Weighted APR                           25.82 %          26.38 %
            Weighted average term (months)            29               28
            Average loan                     $     3,491      $     3,287
            Number of loans                          756              625

Analysis of Credit Losses

As of June 30, 2013, the Company had 1,372 active static pools. The average pool upon inception consisted of 58 Contracts with aggregate finance receivables, net of unearned interest, of approximately $595,000.


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The Company anticipates losses absorbed as a percentage of liquidation will be in the 5%-10% range during the remainder of the current fiscal year; however, no assurances can be given that the actual losses absorbed may not be higher as a result of further economic weakness. The longer-term outlook for portfolio performance will depend largely on the competition. Other indicators include the overall economic conditions, the unemployment rate, and the price of oil which impacts the cost of gasoline, food and many other items used or consumed by the average person. Also, the Company's ability to monitor, manage and implement its underwriting philosophy in additional geographic areas as it strives to continue its expansion will impact future portfolio performance. The Company does not believe there have been any significant changes in loan concentrations or terms of Contracts purchased during the three months ended June 30, 2013.

The provision for credit losses decreased to approximately $2.6 million from approximately $3.1 million for the three months ended June 30, 2013 and 2012, respectively. The Company has experienced favorable variances between projected write-offs and actual write-offs on many seasoned pools which has resulted in an increase in expected future cash flows. Accordingly, the amount of additional provision necessary to maintain an adequate allowance to absorb incurred losses in the existing portfolio was less than the provision in fiscal 2013. The Company's losses as a percentage of liquidation increased primarily as a result of increased competition in all markets that the Company presently operates in to 5.90% from 4.93% for the three months ended June 30, 2013 and 2012, respectively. Increased competition has led to a higher percentage of loans acquired that are categorized in the lower tiers of the Company's guidelines. The static pools originated during the three-month period ended June 30, 2013, while still performing at acceptable net charge-off levels, have experienced losses higher than static pools originated during the three-month period ended June 30, 2012. Consequently, if this trend continues, the Company would expect the provision for credit losses to increase for future static pools. The Company has also experienced increased losses in part due to a decrease in auction proceeds from repossessed vehicles. These proceeds are dependent upon several variables including the general market for repossessed vehicles. During the three months ended June 30, 2013 and 2012 auction proceeds from the sale of repossessed vehicles averaged approximately 51% and 57%, respectively of the related principal balance.

The Company believes delinquency trends over several reporting periods are useful in estimating future losses and overall portfolio performance. The Company also 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 . . .

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