NICHOLAS FINANCIAL INC - FORM 10-Q

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EX-32.2 - CERTIFICATION OF THE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER - NICHOLAS FINANCIAL INC	d103021dex322.htm
EX-32.1 - CERTIFICATION OF THE PRESIDENT AND CHIEF EXECUTIVE OFFICER - NICHOLAS FINANCIAL INC	d103021dex321.htm
EX-10.8 - FORM OF DEALER AGREEMENT AND SCHEDULE - NICHOLAS FINANCIAL INC	d103021dex108.htm
EX-31.1 - CERTIFICATION OF THE PRESIDENT AND CHIEF EXECUTIVE OFFICER - NICHOLAS FINANCIAL INC	d103021dex311.htm
EX-31.2 - CERTIFICATION OF THE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER - NICHOLAS FINANCIAL INC	d103021dex312.htm

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, 2015

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO .

Commission file number: 0-26680

NICHOLAS FINANCIAL, INC.

(Exact Name of Registrant as Specified in its Charter)

British Columbia, Canada

8736-3354

(State or Other Jurisdiction of

Incorporation or Organization)

(I.R.S. Employer

Identification No.)

2454 McMullen Booth Road, Building C

Clearwater, Florida

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 ¨

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)

Yes ¨ No x

As of February 1, 2016, 12,463,285 shares, no par value, of the Registrant were outstanding (of which 4,713,804 shares were held by the Registrant’s principal operating subsidiary and pursuant to applicable law, not entitled to vote and 7,749,481 shares were entitled to vote).

NICHOLAS FINANCIAL, INC.

FORM 10-Q

TABLE OF CONTENTS


Part I.	Financial Information	Page

Item 1.	Financial Statements (Unaudited)

	Consolidated Balance Sheets as of December 31, 2015 and March 31, 2015		2

	Consolidated Statements of Income for the three and nine months ended December 31, 2015 and 2014		3

	Consolidated Statements of Cash Flows for the nine months ended December 31, 2015 and 2014		4

	Notes to the Consolidated Financial Statements		5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		13

Item 3.	Quantitative and Qualitative Disclosures about Market Risk		21

Item 4.	Controls and Procedures		21

Part II.	Other Information

Item 1.	Legal Proceedings		22

Item 1A.	Risk Factors		22

Item 6.	Exhibits		22

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Nicholas Financial, Inc. and Subsidiaries

Consolidated Balance Sheets


	December 31, 2015 (Unaudited)			March 31, 2015
Assets
Cash	$	3,005,807		$	3,388,193
Finance receivables, net		310,314,093			288,904,060
Assets held for resale		1,931,962			1,746,887
Income taxes receivable		418,597			112,984
Prepaid expenses and other assets		772,283			1,143,754
Property and equipment, net		1,380,234			872,134
Interest rate swap agreements		6,487			—
Deferred income taxes		6,656,941			6,360,579

Total assets	$	324,486,404		$	302,528,591


Liabilities and shareholders’ equity
Line of credit	$	213,000,000		$	199,000,000
Drafts payable		1,999,285			2,475,573
Interest rate swap agreements		59,092			180,775
Accounts payable and accrued expenses		5,638,824			7,841,070
Deferred revenues		3,799,980			3,143,231

Total liabilities		224,497,181			212,640,649

Shareholders’ equity
Preferred stock, no par: 5,000,000 shares authorized; none issued
Common stock, no par: 50,000,000 shares authorized; 12,463,285 and 12,415,785 shares issued, respectively; and 7,749,481 and 7,701,981 shares outstanding, respectively		33,153,177			32,655,130
Treasury stock: 4,713,804 common shares, at cost		(70,459,323	)		(70,408,854	)
Retained earnings		137,295,369			127,641,666

Total shareholders’ equity		99,989,223			89,887,942

Total liabilities and shareholders’ equity	$	324,486,404		$	302,528,591

See accompanying notes.

Nicholas Financial, Inc. and Subsidiaries

Consolidated Statements of Income

(Unaudited)


	Three months ended December 31,					Nine months ended December 31,
	2015			2014		2015			2014
Interest and fee income on finance receivables	$	22,757,325		$	21,800,765	$	67,469,297		$	64,856,351
Expenses:
Marketing		384,021			333,813		1,140,326			1,196,069
Salaries and employee benefits		5,539,203			5,100,035		16,623,037			15,441,864
Professional Fees		306,331			314,124		1,131,273			1,124,912
Administrative		2,323,162			2,422,678		7,175,237			7,272,577
Provision for credit losses		7,599,189			5,796,648		18,765,745			15,182,698
Depreciation		120,023			92,070		333,742			276,194
Interest expense		2,310,848			1,457,919		6,750,471			4,391,697
Change in fair value of interest rate swap agreements		(250,798	)		144,999		(128,170	)		105,878

		18,331,979			15,662,286		51,791,661			44,991,889

Operating income before income taxes		4,425,346			6,138,479		15,677,636			19,864,462
Income tax expense		1,698,445			2,368,923		6,023,933			6,856,017

Net income	$	2,726,901		$	3,769,556	$	9,653,703		$	13,008,445

Earnings per share:
Basic	$	0.36		$	0.31	$	1.27		$	1.07

Diluted	$	0.35		$	0.30	$	1.24		$	1.05

See accompanying notes.

Nicholas Financial, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)


	Nine months ended December 31,
	2015			2014
Cash flows from operating activities
Net income	$	9,653,703		$	13,008,445
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		333,742			276,194
(Gain) loss on sale of property and equipment		(12,247	)		6,691
Provision for credit losses		18,765,745			15,182,698
Amortization of dealer discounts		(9,885,851	)		(10,204,562	)
Deferred income taxes		(296,362	)		270,675
Share-based compensation		416,335			382,883
Change in fair value of interest rate swap agreements		(128,170	)		105,878
Changes in operating assets and liabilities:
Prepaid expenses and other assets		396,471			13,280
Accounts payable and accrued expenses		(2,202,246	)		(2,572,286	)
Income taxes (receivable) and payable		(305,613	)		447,340
Deferred revenues		656,749			574,862

Net cash provided by operating activities		17,392,256			17,492,098


Cash flows from investing activities
Purchase and origination of finance receivables		(131,416,115	)		(119,758,892	)
Principal payments received		101,126,188			101,279,098
Increase in assets held for resale		(185,075	)		(345,644	)
Purchase of property and equipment		(877,677	)		(377,859	)
Proceeds from sale of property and equipment		48,082			58,319

Net cash used in investing activities		(31,304,597	)		(19,144,978	)


Cash flows from financing activities
Net draws on line of credit		14,000,000			2,100,000
Change in drafts payable		(476,288	)		(669,956	)
Payment of debt costs		(25,000	)		—
Expenses related to prior purchase of treasury shares		(50,469	)		—
Proceeds from exercise of stock options		75,946			154,575
Excess tax benefits from share-based compensation		5,766			69,016

Net cash provided by financing activities		13,529,955			1,653,635

Net (decrease) increase in cash		(382,386	)		755
Cash, beginning of period		3,388,193			2,635,036

Cash, end of period	$	3,005,807		$	2,635,791

See accompanying notes.

Nicholas Financial, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

1. Basis of Presentation

The accompanying consolidated balance sheet as of March 31, 2015, which has been derived from audited financial statements, and the accompanying unaudited interim 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 (“U.S. GAAP”) 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 U.S. GAAP for complete consolidated financial statements, although the Company believes that the disclosures made are adequate to ensure the information is not misleading. 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, 2016. It is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements and accompanying notes thereto included in the Company’s Annual Report on Form 10-K for the year ended March 31, 2015 as filed with the Securities and Exchange Commission on June 15, 2015. The March 31, 2015 consolidated balance sheet included herein has been derived from the March 31, 2015 audited consolidated balance sheet included in the aforementioned Form 10-K.

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for credit losses on finance receivables and the fair value of interest rate swap agreements.

2. Revenue Recognition

Finance receivables consist of automobile finance installment contracts (“Contracts”) and direct consumer loans (“Direct Loans”). Interest income on finance receivables is recognized using the interest method. Accrual of interest income on finance receivables is suspended when a loan enters bankruptcy status, is contractually delinquent for 60 days or more or the collateral is repossessed, whichever is earlier. Chapter 13 bankrupt accounts are accounted for under the cost-recovery method. Interest income on Chapter 13 bankrupt accounts does not resume until all principal amounts are recovered (see Note 4).

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 lender, the wholesale value of the vehicle and competition in any given market. In making decisions regarding the purchase of a particular Contract the Company considers the following factors related to the borrower: place and length of residence; current and prior job status; history in making installment payments for automobiles; current income; and credit history. In addition, the Company examines its prior experience with Contracts purchased from the dealer from which the Company is purchasing the Contract, and the value of the automobile in relation to the purchase price and the term of the Contract. The entire amount of discount is amortized as an adjustment to yield using the interest method over the life of the loan. The average dealer discount associated with new volume for the three months ended December 31, 2015 and 2014 was 7.59% and 8.04%, respectively in relation to the total amount financed. The average dealer discount associated with new volume for the nine months ended December 31, 2015 and 2014 was 7.56% and 8.13%, respectively in relation to the total amount financed.

Gross finance receivables represent principal balance plus unearned income, excluding unearned income from Chapter 13 bankrupt accounts. The amount of future unearned income is computed as the product of the Contract rate, the Contract term, and the Contract amount.

Deferred revenues consist primarily of commissions received from the sale of ancillary products. These products include automobile warranties, roadside assistance programs, accident and health insurance, credit life insurance, and involuntary unemployment insurance. These commissions are amortized over the life of the contract using the interest method.

The Company’s net costs for originating direct loans are recognized as an adjustment to the yield and are amortized over the life of the loan using the interest method.

Nicholas Financial, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements (Continued)

(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 and other share awards. Basic and diluted earnings per share have been computed as follows:


	Three months ended December 31,				Nine months ended December 31,
	2015		2014		2015		2014
Numerator for earnings per share – net income	$	2,726,901	$	3,769,556	$	9,653,703	$	13,008,445

Denominator:
Denominator for basic earnings per share – weighted average shares		7,622,981		12,197,125		7,620,423		12,188,778
Effect of dilutive securities: Stock options and other share awards		148,404		178,214		157,141		183,220

Denominator for diluted earnings per share		7,771,385		12,375,339		7,777,564		12,371,998

Earnings per share:
Basic	$	0.36	$	0.31	$	1.27	$	1.07

Diluted	$	0.35	$	0.30	$	1.24	$	1.05

For the three months ended December 31, 2015 and 2014, potential shares of common stock from stock options totaling 165,000 and 130,870, respectively, were not included in the diluted earnings per share calculation because their effect is anti-dilutive. For the nine months ended December 31, 2015 and 2014, potential shares of common stock from stock options totaling 160,091 and 83,036, respectively, were not included in the diluted earnings per share calculation because their effect is anti-dilutive. Please see Note 10 – “Tender Offer” for information regarding the decrease of the weighted average shares for the three and nine months ended December 31, 2015.

4. Finance Receivables

Finance receivables consist of automobile finance installment Contracts and Direct Loans and are detailed as follows:


	December 31,			March 31,
	2015			2015
Finance receivables, gross contract	$	494,808,526		$	457,974,758
Unearned interest		(153,498,759	)		(139,262,996	)

Finance receivables, net of unearned interest		341,309,767			318,711,762
Unearned dealer discounts		(18,633,833	)		(17,779,690	)

Finance receivables, net of unearned interest and unearned dealer discounts		322,675,934			300,932,072
Allowance for credit losses		(12,361,841	)		(12,028,012	)

Finance receivables, net	$	310,314,093		$	288,904,060

The terms of the Contracts range from 12 to 72 months and the Direct Loans range from 12 to 60 months. The Contracts and Direct Loans bear a weighted average effective interest rate of 22.71% and 25.75% as of December 31, 2015, respectively and 22.86% and 26.14% as of March 31, 2015, respectively.

Finance receivables consist of Contracts and Direct Loans, each of which comprises a portfolio segment. Each portfolio segment consists of smaller balance homogeneous loans which are collectively evaluated for impairment.

Nicholas Financial, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements (Continued)

(Unaudited)

4. Finance Receivables (continued)

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


	Three months ended December 31,						Nine months ended December 31,
	2015			2014			2015			2014
Balance at beginning of period	$	10,953,844		$	11,942,694		$	11,325,222		$	12,889,082
Current period provision		7,437,522			5,658,695			18,402,211			14,799,782
Losses absorbed		(7,583,543	)		(6,948,034	)		(20,453,767	)		(18,844,447	)
Recoveries		694,452			682,830			2,228,609			2,491,768

Balance at end of period	$	11,502,275		$	11,336,185		$	11,502,275		$	11,336,185

The Company purchases Contracts from automobile dealers at a negotiated price that is less than the original principal amount being financed by the purchaser of the automobile. The Contracts are predominately for used vehicles. As of December 31, 2015, the average model year of vehicles collateralizing the portfolio was a 2007 vehicle. The average loan to value ratio, which expresses the amount of the Contract as a percentage of the value of the automobile, is approximately 97%. The Company utilizes a static pool approach to track portfolio performance. If the allowance for credit losses is determined to be inadequate for a static pool, then an additional charge to income through the provision is used to maintain adequate reserves 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 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 allowance for credit losses.

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


	Three months ended December 31,						Nine months ended December 31,
	2015			2014			2015			2014
Balance at beginning of period	$	779,921		$	734,500		$	702,789		$	590,278
Current period provision		161,667			137,953			363,534			382,916
Losses absorbed		(83,454	)		(82,948	)		(223,740	)		(202,063	)
Recoveries		1,432			3,403			16,983			21,777

Balance at end of period	$	859,566		$	792,908		$	859,566		$	792,908

Direct Loans are originated directly between the Company and the consumer. These loans are typically for amounts ranging from $1,000 to $9,000 and are generally secured by a lien on an automobile, watercraft or other permissible tangible personal property. The majority of Direct Loans are originated with current or former customers under the Company’s automobile financing program. The typical Direct Loan represents a significantly better credit risk than our typical Contract due to the customer’s historical payment history with the Company. In deciding whether or not to make a loan, the Company considers the individual’s credit history, job stability, income and impressions created during a personal interview with a Company loan officer. Additionally, because most of Direct Loans made by the Company to date have been made to borrowers under Contracts previously purchased by the Company, the payment history of the borrower under the Contract is a significant factor in making the loan decision. As of December 31, 2015, loans made by the Company pursuant to its Direct Loan program constituted approximately 2% of the aggregate principal amount of the Company’s loan portfolio.

Changes in the allowance for credit losses for both Contracts and Direct Loans were driven by current economic conditions and trends over several reporting periods which are useful in estimating future losses and overall portfolio performance.

Nicholas Financial, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements (Continued)

(Unaudited)

4. Finance Receivables (continued)

A performing account is defined as an account that is less than 61 days past due. A non-performing account is defined as an account that is contractually delinquent for 61 days or more and the accrual of interest income is suspended. When an account is 120 days contractually delinquent, the account is written off. Upon notification of a Chapter 13 bankruptcy, an account is monitored for collection with other Chapter 13 bankrupt accounts. In the event the debtors balance has been reduced by the bankruptcy court, the Company will record a loss equal to the amount of principal balance reduction. The remaining balance will be reduced as payments are received by the bankruptcy court. In the event an account is dismissed from bankruptcy, the Company will decide, based on several factors, to begin repossession proceedings or to allow the customer to begin making regularly scheduled payments.

The following table is an assessment of the credit quality by creditworthiness:


	December 31, 2015				December 31, 2014
	Contracts		Direct Loans		Contracts		Direct Loans
Performing accounts	$	467,285,487	$	11,931,941	$	422,592,527	$	11,575,091
Non-performing accounts		11,111,916		100,393		9,284,558		105,818

Total	$	478,397,403	$	12,032,334	$	431,877,085	$	11,680,909
Chapter 13 bankrupt accounts		4,340,698		38,091		3,872,186		26,774

Finance receivables, gross contract	$	482,738,101	$	12,070,425	$	435,749,271	$	11,707,683

The following tables present certain information regarding the delinquency rates experienced by the Company with respect to Contracts and under its Direct Loans, excluding Chapter 13 bankrupt accounts:


Contracts	Gross Balance Outstanding		31 – 60 days			61 – 90 days			Over 90 days			Total
December 31, 2015	$	478,397,403	$	23,970,608		$	7,029,791		$	4,082,125		$	35,082,524
				5.01	%		1.47	%		0.85	%		7.33	%
December 31, 2014	$	431,877,085	$	21,749,891		$	6,103,607		$	3,180,951		$	31,034,449
				5.04	%		1.41	%		0.74	%		7.19	%


Direct Loans	Gross Balance Outstanding		31 – 60 days			61 – 90 days			Over 90 days			Total
December 31, 2015	$	12,032,334	$	211,921		$	63,543		$	36,850		$	312,314
				1.76	%		0.53	%		0.31	%		2.60	%
December 31, 2014	$	11,680,909	$	164,347		$	59,043		$	46,776		$	270,166
				1.40	%		0.51	%		0.40	%		2.31	%

5. Line of Credit

The Company has a line of credit facility (the “Line”) up to $225,000,000. The pricing of the Line, which expires on January 30, 2018, is 300 basis points above 30-day LIBOR with a 1% floor on LIBOR (4.00% at December 31, 2015 and March 31, 2015). Pledged as collateral for this Line are all of the assets of the Company. The outstanding amount of the Line was $213,000,000 and $199,000,000 as of December 31, 2015 and March 31, 2015, respectively. The amount available under the Line was approximately $12,000,000 and $26,000,000 as of December 31, 2015 and March 31, 2015, respectively.

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 do not require consent in writing by the agent and majority lenders under the new facility as long as the Company is in compliance with a net income covenant. As of December 31, 2015, the Company was in full compliance with all debt covenants.

Nicholas Financial, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements (Continued)

(Unaudited)

6. Interest Rate Swap Agreements

The Company utilizes interest rate swap agreements to manage exposure to variability in expected cash flows attributable to interest rate risk. The interest rate swap agreements convert a portion of the floating rate debt to a fixed rate, more closely matching the interest rate characteristics of finance receivables.

As of the nine months ended December 31, 2015 and 2014 no new contracts were initiated and no contracts matured.

The Company currently has two interest rate swap agreements. A June 4, 2012 interest rate swap agreement provides for a five-year interest rate swap in which the Company pays a fixed rate of 1% and receives payments from the counterparty on the 1-month LIBOR rate. This interest rate swap agreement had an effective date of June 13, 2012 and a notional amount of $25,000,000. A July 30, 2012 agreement provides for a five-year interest rate swap in which the Company pays a fixed rate of 0.87% and receives payments from the counterparty on the 1-month LIBOR rate. This interest rate swap agreement had an effective date of August 13, 2012 and a notional amount of $25,000,000.

The locations and amounts of (gains) losses in income are as follows:


	Three months ended December 31,					Nine months ended December 31,
	2015			2014		2015			2014
Periodic change in fair value of interest rate swap agreements	$	(250,798	)	$	144,999	$	(128,170	)	$	105,878
Periodic settlement differentials included in interest expense		89,360			98,517		278,838			297,355

Total	$	(161,438	)	$	243,516	$	150,668		$	403,233

Net realized gains and losses from the interest rate swap agreements were recorded in the interest expense line item of the consolidated statements of income. The following table summarizes the average variable rates received and average fixed rates paid under the swap agreements.


	Three months ended December 31,						Nine months ended December 31,
	2015			2014			2015			2014
Variable rate received		0.24	%		0.16	%		0.21	%		0.15	%
Fixed rate paid		0.94	%		0.94	%		0.94	%		0.94	%

7. Income Taxes

The provision for income taxes decreased to approximately $1.7 million for the three months ended December 31, 2015 from approximately $2.4 million for the three months ended December 31, 2014. The Company’s effective tax rate decreased to 38.38% for the three months ended December 31, 2015 from 38.59% for the three months ended December 31, 2014. The provision for income taxes decreased to approximately $6.0 million for the nine months ended December 31, 2015 from approximately $6.9 million for the nine months ended December 31, 2014. The Company’s effective tax rate increased to 38.42% for the nine months ended December 31, 2015 from 34.51% for the nine months ended December 31, 2014. The effective tax rate for the nine months ended December 31, 2014 was unusually low due to certain professional fees totaling approximately $1.2 million associated with the potential sale of the Company becoming deductible during the three months ended June 30, 2014 when the Arrangement Agreement was terminated.

Nicholas Financial, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements (Continued)

(Unaudited)

8. Fair Value Disclosures

The Company measures specific assets and liabilities at fair value, which is an exit price, representing the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When applicable, the Company utilizes market data or assumptions that market participants would use in pricing the asset or liability under a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs about which little or no market data exists, therefore requiring an entity to develop its own assumptions.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The Company estimates the fair value of interest rate swap agreements based on the estimated net present value of the future cash flows using a forward interest rate yield curve in effect as of the measurement period, adjusted for nonperformance risk, if any, including a quantitative and qualitative evaluation of both the Company’s credit risk and the counterparty’s credit risk. Accordingly, the Company classifies interest rate swap agreements as Level 2.


	Fair Value Measurement Using
Description	Level 1		Level 2			Level 3		Fair Value
Interest rate swap agreements:
December 31, 2015 – asset:	$	—	$	6,487		$	—	$	6,487
December 31, 2015 – liability:	$	—	$	(59,092	)	$	—	$	(59,092	)
March 31, 2015 – liabilities:	$	—	$	(180,775	)	$	—	$	(180,775	)

Financial Instruments Not Measured at Fair Value

The Company’s financial instruments consist of cash, finance receivables and the Line. For finance receivables and the Line- the carrying value approximates fair value.

Finance receivables, net approximates fair value based on the price paid to acquire indirect loans. The price paid reflects competitive market interest rates and purchase discounts for the Company’s chosen credit grade in the economic environment. This market is highly liquid as the Company acquires individual loans on a daily basis from dealers. The initial terms of the Contracts range from 12 to 72 months. The initial terms of the Direct Loans range from 12 to 60 months. In addition, there have been minimal changes in interest rates and purchase discounts related to these types of loans. If liquidated outside of the normal course of business, the amount received may not be the carrying value.

Based on current market conditions, any new or renewed credit facility would contain pricing that approximates the Company’s current Line. Based on these market conditions, the fair value of the Line as of December 31, 2015 was estimated to be equal to the book value. The interest rate for the Line is a variable rate based on LIBOR pricing options.


	Fair Value Measurement Using						Fair
Description	Level 1		Level 2		Level 3		Value
Finance receivables:
December 31, 2015	$	—	$	—	$	310,314,000	$	310,314,000
March 31, 2015	$	—	$	—	$	288,904,000	$	288,904,000
Line of credit:
December 31 , 2015	$	—	$	213,000,000	$	—	$	213,000,000
March 31, 2015	$	—	$	199,000,000	$	—	$	199,000,000

Nicholas Financial, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements (Continued)

(Unaudited)

8. Fair Value Disclosures (continued)

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain assets and liabilities at fair value on a nonrecurring basis. The Company does not currently have any assets or liabilities measured at fair value on a nonrecurring basis.

9. Contingencies

The Company currently is not a party to any pending legal proceedings other than ordinary routine litigation incidental to its business, none of which, if decided adversely to the Company, would, in the opinion of management, have a material adverse effect on the Company’s financial condition or results of operations.

10. Tender Offer

On March 19, 2015, the Company announced the final results of the modified “Dutch auction” tender offer for the purchase of approximately 4.7 million shares of the Company’s common shares by its principal operating subsidiary. The tender offer expired on March 13, 2015. Total payments for common shares, including costs were approximately $70,459,000. Such costs were recorded as an increase to treasury stock, reducing shareholders’ equity.

The aggregate number of common shares purchased in the tender offer by Nicholas represented approximately 38.0% of the Company’s outstanding common shares as of March 17, 2015. Following settlement of the tender offer, the Company had approximately 7,701,981 common shares outstanding.

11. Recently Issued Accounting Standards

In January 2016, the FASB issued ASU No. 2016-01, “Financial Instruments—Recognition and Measurement of Financial Assets and Liabilities,” which is intended to improve the recognition and measurement of financial instruments by requiring: equity investments (other than equity method or consolidation) to be measured at fair value with changes in fair value recognized in net income; public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; eliminating the requirement to disclose the fair value of financial instruments measured at amortized cost for organizations that are not public business entities; eliminating the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; and requiring a reporting organization to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk (also referred to as “own credit”) when the organization has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. This ASU is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. This ASU permits early adoption of the instrument-specific credit risk provision. Management is still currently evaluating the impact of the pending adoption of this ASU on the Company’s Consolidated Condensed Financial Statements.

In April 2015, the FASB issued ASU No. 2015-03, “Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” The amendments in this ASU require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. In August 2015, the FASB issued ASU No. 2015-15, since 2015-03 did not address presentation or subsequent measurement of debt issuance costs related to line-of-credit arrangements. The SEC staff indicated they would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. The amendments are effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption of the amendments is permitted.The Company does not believe the adoption of this ASU will have a significant impact on the consolidated financial statements.

Nicholas Financial, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements (Continued)

(Unaudited)

11. Recently Issued Accounting Standards (continued)

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)”. The ASU requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The standard permits the use of either the retrospective or cumulative effect transition method. On July 9, 2015, the FASB approved the deferral of the effective date of ASU 2014-09 by one year. As a result, ASU 2014-09 will be effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The ASU would permit public entities to adopt the ASU early, but not before the original effective date (i.e., annual periods beginning after December 15, 2016). Management has not yet selected a transition method and is currently evaluating the impact of the pending adoption of this ASU on the Company’s Consolidated Condensed Financial Statements.

The Company does not believe there are any other recently issued accounting standards that have not yet been adopted that will have a material impact on the Company’s consolidated financial statements.

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.

Litigation and Legal Matters

See “Item 1. Legal Proceedings” in Part II of this quarterly report below.

Regulatory Developments

As previously reported, Title X of the Dodd-Frank Act established the Consumer Financial Protection Bureau (“CFPB”), which became operational on July 21, 2011. Under the Dodd-Frank Act, the CFPB has regulatory, supervisory and enforcement powers over providers of consumer financial products, such as Contracts and the Direct Loans that we offer, including explicit supervisory authority to examine and require registration of installment lenders such as ourselves. Included among the powers afforded to the CFPB is the authority to adopt rules describing specified acts and practices as being “unfair,” “deceptive” or “abusive,” and hence unlawful. Although the Dodd-Frank Act expressly provides that the CFPB has no authority to establish usury limits, some consumer advocacy groups have suggested that certain forms of alternative consumer finance products, such as installment loans, should be a regulatory priority and it is possible that at some time in the future the CFPB could propose and adopt rules making such lending or other products that we may offer materially less profitable or impractical. Further, the CFPB may target specific features of loans by rulemaking that could cause us to cease offering certain products. Any such rules could have a material adverse effect on our business, results of operation and financial condition. The CFPB could also adopt rules imposing new and potentially burdensome requirements and limitations with respect to any of our current or future lines of business, which could have a material adverse effect on our operations and financial performance.

The CFPB recently issued rules regarding the supervision and examination of non-depository “larger participants” in the automobile finance business, including us. Since we are deemed a larger participant, we are subject to supervision and examination by the CFPB. The CFPB’s stated objectives of such examinations are: to assess the quality of a larger participant’s compliance management systems for preventing violations of federal consumer financial laws; to identify acts or practices that materially increase the risk of violations of federal consumer finance laws and associated harm to consumers; and to gather facts that help determine whether the larger participant engages in acts or practices that are likely to violate federal consumer financial laws in connection with its automobile finance business. Thus, as a larger participant, we will be subject to examination by the CFPB for, among other things, ECOA compliance; unfair, deceptive or abusive acts or practices (“UDAAP”) compliance; and the adequacy of our compliance management systems.

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 incurred 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 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 probable 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.

Introduction

Diluted net earnings increased 17% to $0.35 as compared to $0.30 for the three months ended December 31, 2014. Net earnings were $2,727,000 and $3,770,000 for the three months ended December 31, 2015 and 2014, respectively. Revenue increased 4% to $22,757,000 for the three months ended December 31, 2015 as compared to $21,801,000 for the three months ended December 31, 2014.

For the nine months ended December 31, 2015, per share diluted net earnings increased 18% to $1.24 as compared to $1.05 for the nine months ended December 31, 2014. Net earnings were $9,654,000 and $13,008,000 for the nine months ended December 31, 2015 and 2014, respectively. Revenue increased 4% to $67,469,000 for the nine months ended December 31, 2015 as compared to $64,856,000 for the nine months ended December 31, 2014.

Our net earnings for the three months ended December 31, 2015 were adversely affected by a reduction in the gross portfolio yield, an increase in interest expense and an increase in the provision for credit losses. Gross portfolio yield and provision for credit losses changes were primarily the result of increased competition. Our net earnings were positively affected by a reduction in operating expenses as a percentage of net finance receivables and were also favorably impacted by a change in the fair value of our interest rate swap agreements. The interest rate swap agreements resulted in a pre-tax gain of $251,000 for the three-month period ended December 31, 2015 compared to a pre-tax loss of $145,000 for the comparable three-month period ended December 31, 2014. Our per share diluted net earnings for the three months ended December 31, 2015, were positively impacted by the Company’s purchase of 4.7 million of the Company’s common shares by its principal operating subsidiary on March 19, 2015.

Our net earnings for the nine months ended December 31, 2015 were adversely affected by a reduction in the gross portfolio yield, an increase in interest expense and an increase in the provision for credit losses. Gross portfolio yield and provision for credit losses changes were primarily the result of increased competition.Our net earnings were positively affected by a reduction in operating expenses as a percentage of net finance receivables and were also favorably impacted by a change in the fair value of our interest rate swap agreements. The interest rate swap agreements resulted in a pre-tax gain of $128,000 for the nine-month period ended December 31, 2015 compared to a pre-tax loss of $106,000 for the comparable nine-month period ended December 31, 2014. Our per share diluted net earnings for the nine months ended December 31, 2015, were positively impacted by the Company’s purchase of 4.7 million of the Company’s common shares by its principal operating subsidiary on March 19, 2015. Results for the nine months ended December 31, 2014 were also positively affected by a decrease in income tax expense of $804,000 or $0.07 per share. This reduction related to professional fees associated with the previously announced potential sale of the Company that were not initially deductible for income tax purposes, but became deductible as a result of the termination of the Arrangement Agreement as announced on July 1, 2014.


	Three months ended December 31,						Nine months ended December 31,
	2015			2014			2015			2014
Portfolio Summary
Average finance receivables, net of unearned interest (1) Average Net Finance Receivables (1)	$	340,306,851		$	310,882,006		$	333,005,943		$	308,351,789

Average indebtedness (2)	$	212,684,576		$	130,112,500		$	207,071,567		$	130,580,000

Interest and fee income on finance receivables	$	22,757,326		$	21,800,764		$	67,469,297		$	64,851,435
Interest expense		2,310,848			1,457,919			6,750,471			4,391,697

Net interest and fee income on finance receivables	$	20,446,478		$	20,342,845		$	60,718,826		$	60,459,738

Weighted average contractual rate (3)		22.78	%		23.02	%		22.78	%		23.02	%

Average cost of borrowed funds (2)		4.35	%		4.48	%		4.35	%		4.48	%

Gross portfolio yield (4)		26.75	%		28.05	%		27.01	%		28.04	%
Interest expense as a percentage of average finance receivables, net of unearned interest		2.72	%		1.88	%		2.70	%		1.90	%
Provision for credit losses as a percentage of average finance receivables, net of unearned interest		8.93	%		7.46	%		7.51	%		6.57	%

Net portfolio yield (4)		15.10	%		18.71	%		16.80	%		19.57	%
Marketing, salaries, employee benefits, depreciation, administrative and professional fee expenses as a percentage of average finance receivables, net of unearned interest (5)		10.19	%		10.63	%		10.57	%		10.94	%

Pre-tax yield as a percentage of average finance receivables, net of unearned interest (6)		4.91	%		8.08	%		6.23	%		8.63	%

Write-off to liquidation (7)		10.31	%		9.60	%		8.99	%		8.38	%
Net charge-off percentage (8)		8.19	%		8.16	%		7.38	%		7.15	%

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

(3)

Weighted average contractual rate represents the weighted average annual percentage rate (“APR”) of all Contracts and Direct Loans as of the period ending date.

(4)

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.

(5)

The numerator for the nine-month period ended December 31, 2014 includes expenses associated with the potential sale of the Company. Absent these expenses, the percentage would have been 10.79%.

(6)

Pre-tax yield represents net portfolio yield minus administrative expenses (marketing, salaries, employee benefits, depreciation, administrative, and professional fees) as a percentage of average finance receivables, net of unearned interest.

(7)

Write-off to liquidation percentage is defined as net charge-offs divided by liquidation. Liquidation is defined as beginning gross receivable balance plus current period purchases minus voids and refinances minus ending gross receivable balance.

(8)

Net charge-off percentage represents net charge-offs divided by average finance receivables, net of unearned interest, outstanding during the period.

Three months ended December 31, 2015 compared to three months ended December 31, 2014

Interest Income and Loan Portfolio

Interest and fee income on finance receivables, predominately finance charge income, increased 4.6% to approximately $22.8 million for the three-month period ended December 31, 2015 from $21.8 million for the corresponding period ended December 31, 2014. Average finance receivables, net of unearned interest equaled approximately $340.3 million for the three-month period ended December 31, 2015, an increase of 9.5% from $310.9 million for the corresponding period ended December 31, 2014. The primary reason average finance receivables, net of unearned interest increased was the increase of the receivable base of several existing branches in younger markets (see “Contract Procurement” and “Loan Origination” below). The gross finance receivable balance increased 10.6% to approximately $494.8 million as of December 31, 2015, from $447.5 million as of December 31, 2014. The primary reason interest income increased was the increase in the outstanding loan portfolio. The gross portfolio yield decreased to 26.75% for the three-month period ended December 31, 2015 compared to 28.05% for the three-month period ended December 31, 2014. The gross portfolio yield decreased primarily due to the decrease in the average dealer discount and a decrease in the average APR, which is primarily the result of increased competition. The average dealer discount associated with new volume for the three months ended December 31, 2015 and 2014 was 7.59% and 8.04%, respectively in relation to the total amount financed. The net portfolio yield decreased to 15.10% for the three-month period ended December 31, 2015 from 18.71% for the corresponding period ended December 31, 2014. The net portfolio yield decreased due to a decrease in the gross portfolio yield, an increase in the provision for credit losses, and an increase in interest expense (see “Analysis of Credit Losses” and “Interest Expense” below).

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

Marketing, salaries, employee benefits, depreciation, administrative, and professional fee expenses increased to approximately $8.7 million for the three-month period ended December 31, 2015 from approximately $8.3 million for the corresponding period ended December 31, 2014. The increase was primarily related to an increase in costs associated with maintaining the finance receivable portfolio. The Company increased average headcount to 340 for the three-month period ended December 31, 2015 from 331 for the three-month period ended December 31, 2014. Marketing, salaries, employee benefits, depreciation, administrative, and professional fee expenses as a percentage of finance receivables, net of unearned interest, decreased to 10.19% for the three-month period ended December 31, 2015 from 10.63% for the three-month period ended December 31, 2014.

Interest Expense

Interest expense increased to approximately $2.3 million for the three-month period ended December 31, 2015 from $1.5 million for the three-month period ended December 31, 2014. The following table summarizes the Company’s average cost of borrowed funds:


	Three months ended December 31,
	2015			2014
Variable interest under the line of credit facility		0.39	%		0.33	%
Settlements under interest rate swap agreements		0.17	%		0.30	%
Credit spread under the line of credit facility		3.79	%		3.85	%

Average cost of borrowed funds		4.35	%		4.48	%

The Company’s average cost of funds decreased mostly due to the interest rate swap agreements not increasing proportionately to total average debt as of December 31, 2015 as compared to December 31, 2014. The total average debt increased in March 2015 due to the tender offer. LIBOR rates have also increased, which has caused the credit spread to decrease and the variable interest to increase. The variable interest rate also includes a decrease in the unused line fees offset with an increase in amortized debt fees.

The notional amount of interest rate swap agreements was $50.0 million at a weighted average fixed rate of 0.94% for each of the three-month periods ended December 31, 2015 and 2014. For further discussions regarding the effect of interest rate swap agreements see Note 6 – “Interest Rate Swap Agreements”.

Nine months ended December 31, 2015 compared to nine months ended December 31, 2014

Interest Income and Loan Portfolio

Interest and fee income on finance receivables, predominately finance charge income, increased 4.0% to approximately $67.5 million for the nine-month period ended December 31, 2015 from $64.9 million for the corresponding period ended December 31, 2014. Average finance receivables, net of unearned interest equaled approximately $333.0 million for the nine-month period ended December 31, 2015, an increase of 8.0% from $308.4 million for the corresponding period ended December 31, 2014. The primary reason average finance receivables, net of unearned interest increased was the increase of the receivable base of several existing branches in younger markets (see “Contract Procurement” and “Loan Origination” below). The gross finance receivable balance increased 10.6% to approximately $494.8 million as of December 31, 2015, from $447.5 million as of December 31, 2014. The primary reason interest income increased was the increase in the outstanding loan portfolio. The gross portfolio yield decreased to 27.01% for the nine-month period ended December 31, 2015 compared to 28.04% for the nine-month period ended December 31, 2014. The gross portfolio yield decreased primarily due to the decrease in the average dealer discount and a decrease in the average APR, which is primarily the result of increased competition. The average dealer discount associated with new volume for the nine months ended December 31, 2015 and 2014 was 7.56% and 8.13%, respectively in relation to the total amount financed. The net portfolio yield decreased to 16.80% for the nine-month period ended December 31, 2015 from 19.57% for the corresponding period ended December 31, 2014. The net portfolio yield decreased due to a decrease in the gross portfolio yield, an increase in the provision for credit losses, and an increase in interest expense (see “Analysis of Credit Losses” and “Interest Expense” below).

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

Marketing, salaries, employee benefits, depreciation, administrative, and professional fee expenses increased to approximately $26.4 million for the nine-month period ended December 31, 2015 from approximately $25.3 million for the corresponding period ended December 31, 2014. The increase was primarily related to an increase in costs associated with maintaining the finance receivable portfolio. The Company increased average headcount to 339 for the nine-month period ended December 31, 2015 from 328 for the nine-month period ended December 31, 2014. Marketing, salaries, employee benefits, depreciation, administrative, and professional fee expenses as a percentage of finance receivables, net of unearned interest, decreased to 10.57% for the nine-month period ended December 31, 2015 from 10.94% for the nine-month period ended December 31, 2014. The nine months ended December 31, 2014 calculation includes expenses associated with the potential sale of the Company. Absent these expenses, the percentage would have been 10.79%.

Interest Expense

Interest expense increased to approximately $6.8 million for the nine-month period ended December 31, 2015 from $4.4 million for the nine-month period ended December 31, 2014. The following table summarizes the Company’s average cost of borrowed funds:


	Nine months ended December 31,
	2015			2014
Variable interest under the line of credit facility		0.36	%		0.31	%
Settlements under interest rate swap agreements		0.18	%		0.30	%
Credit spread under the line of credit facility		3.81	%		3.87	%

Average cost of borrowed funds		4.35	%		4.48	%

The notional amount of interest rate swap agreements was $50.0 million at a weighted average fixed rate of 0.94% for each of the nine-month periods ended December 31, 2015 and 2014. For further discussions regarding the effect of interest rate swap agreements see Note 6 – “Interest Rate Swap Agreements”.

Contract Procurement

The Company purchases Contracts in the seventeen states listed in the table below. The Contracts purchased by the Company are predominately for used vehicles; for the three- and nine-month periods ended December 31, 2015 and 2014, 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 December 31,				Nine months ended December 31,
State	2015		2014		2015		2014
FL	$	12,002,478	$	12,479,607	$	42,533,294	$	40,126,531
GA		3,780,927		4,406,896		13,745,246		13,890,638
NC		3,636,266		3,415,112		10,785,173		11,313,314
SC		1,255,546		738,420		4,768,997		2,701,344
OH		5,254,303		5,788,850		19,076,315		17,486,943
MI		2,149,302		2,043,383		5,634,218		5,465,002
VA		989,475		848,809		3,500,305		3,513,891
IN		2,106,307		1,649,495		6,367,763		5,435,903
KY		1,895,726		2,421,467		6,600,671		6,912,724
MD		482,664		797,697		2,046,591		3,133,351
AL		932,507		1,710,827		4,465,438		4,647,562
TN		1,439,404		1,289,402		4,824,247		3,696,904
IL		1,651,512		1,925,892		6,191,599		4,402,104
MO		1,671,979		1,688,515		6,129,249		5,275,282
KS		762,417		563,344		2,182,603		1,412,568
TX		1,487,738		64,833		3,210,627		64,833
WI		106,759		—		106,759		—

Total	$	41,605,310	$	41,832,549	$	142,169,095	$	129,478,894


	Three months ended December 31,						Nine months ended December 31,
Contracts	2015			2014			2015			2014
Purchases	$	41,605,310		$	41,832,549		$	142,169,095		$	129,478,894
Weighted APR		22.55	%		22.77	%		22.66	%		22.95	%
Average discount		7.59	%		8.04	%		7.56	%		8.13	%
Weighted average term (months)		56			55			56			55
Average loan	$	11,346		$	11,041		$	11,363		$	11,005
Number of Contracts		3,667			3,789			12,512			11,765

Loan Origination

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


	Three months ended December 31,						Nine months ended December 31,
Direct Loans Originated	2015			2014			2015			2014
Originations	$	2,785,776		$	2,665,407		$	7,962,767		$	7,696,461
Weighted APR		25.89	%		26.25	%		25.84	%		26.57	%
Weighted average term (months)		30			28			29			29
Average loan	$	3,526		$	3,357		$	3,568		$	3,473
Number of loans		790			794			2,232			2,216

Analysis of Credit Losses

As of December 31, 2015, the Company had 1,447 active static pools. The average pool upon inception consisted of 63 Contracts with aggregate finance receivables, net of unearned interest, of approximately $692,488.

The Company anticipates losses absorbed as a percentage of liquidation (see note 7 in the Portfolio Summary table on page 15 for the definition of write-off to liquidation) will be in the 8%-12% 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 continued fierce competition. The longer-term outlook for portfolio performance will depend largely on the competition. Other indicators include the overall economic conditions, the unemployment rate, repossessed car resale rates, 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; however, the weighted average term increased to 56 months from 55 months of Contracts purchased during the three and nine months ended December 31, 2015 as compared to the three and nine months ended December 31, 2014.

The provision for credit losses increased to approximately $7.6 million from approximately $5.8 million for the three months ended December 31, 2015 and 2014, respectively. The provision for credit losses increased to approximately $18.8 million from approximately $15.2 million for the nine months ended December 31, 2015 and 2014, 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. However, due to increased competition in more recent periods, the percentage of loans acquired that are categorized in the lower tiers of the Company’s guidelines has increased Static pools originated during fiscal 2016 and 2015, while still performing at acceptable net charge-off levels, have experienced losses higher than static pools originated in previous years. Consequently, if this trend continues, the Company would expect the provision for credit losses to remain higher for future static pools. Accordingly, the amount of additional provision necessary to maintain an adequate allowance to absorb incurred losses in the existing portfolio was greater than the provision compared to the three and nine months ended December 31, 2014. The Company’s losses as a percentage of liquidation increased to 10.31% from 9.60% for the three months ended December 31, 2015 and 2014, respectively. The Company’s losses as a percentage of liquidation increased to 8.99% from 8.38% for the nine months ended December 31, 2015 and 2014, respectively. The Company has also experienced increased losses in part due to a decrease in auction proceeds from repossessed vehicles, and an increase in our advance rates. These proceeds are dependent upon several variables including the general market for repossessed vehicles. During the three months ended December 31, 2015 and 2014, auction proceeds from the sale of repossessed vehicles averaged approximately 40% and 44%, respectively, of the related principal balance. During the nine months ended December 31, 2015 and 2014, auction proceeds from the sale of repossessed vehicles averaged approximately 43% and 46%, respectively, of the related principal balance.

The Company considers competition and its effect on loss rates as the largest driver of the loss reserve levels; however, the Company also considers the following factors to assist in determining the appropriate loss reserve levels: unemployment rates; the number of bankruptcy filings; the results of internal branch audits; consumer sentiment; consumer spending; economic growth (i.e., changes in GDP); the condition of the housing sector; and other leading economic indicators. The Company continues to evaluate reserve levels on a pool-by-pool basis during each reporting period. The longer-term outlook for portfolio performance will depend on overall economic conditions, the unemployment rate, the rational or irrational behavior of the Company’s competitors, 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 delinquency percentage for Contracts more than thirty days past due as of December 31, 2015 was 7.33% as compared to 7.19% as of December 31, 2014. The delinquency percentage for Direct Loans more than thirty days past due as of December 31, 2015 was 2.60% as compared to 2.31% as of December 31, 2014. See Note 4 – “Finance Receivables” for changes in allowance for credit losses, credit quality and delinquencies. Such increases in the delinquency percentage for Contracts and the losses as a percentage of liquidation were contemplated in determining the appropriate reserve levels, particularly for less seasoned pools.

Recoveries as a percentage of charge-offs decreased to approximately 9.08% for the three months ended December 31, 2015 from approximately 9.77% for the three months ended December 31, 2014. Recoveries as a percentage of charge-offs decreased to approximately 10.86% for the nine months ended December 31, 2015 from approximately 13.20% for the nine months ended December 31, 2014. Historically, recoveries as a percentage of charge-offs fluctuate from period to period, and the Company does not attribute this decrease to any particular change in operational strategy or economic event. From time to time the Company will aggregate charge-off accounts, it deems uncollectable, and sell them to third party recovery specialists.

In accordance with our policies and procedures, certain borrowers qualify for, and the Company offers, one-month principal payment deferrals on Contracts and Direct Loans. For the three months ended December 31, 2015 and December 31, 2014 the Company granted deferrals to approximately 6.26% and 6.98%, respectively, of total Contracts and Direct Loans. For the nine months ended December 31, 2015 and December 31, 2014 the Company granted deferrals to approximately 17.78% and 18.02%, respectively, of total Contracts and Direct Loans. The number of deferrals is influenced by portfolio performance, general economic conditions and the unemployment rate.

Income Taxes

Liquidity and Capital Resources

The Company’s cash flows are summarized as follows:


	Nine months ended December 31,
	2015			2014
Cash provided by (used in):
Operating activities	$	17,392,256		$	17,492,098
Investing activities (primarily purchase of Contracts)		(31,304,597	)		(19,144,978	)
Financing activities		13,529,955			1,653,635

Net (decrease) increase in cash	$	(382,386	)	$	755

The Company’s primary use of working capital during the nine months ended December 31, 2015, was the funding of the purchase of Contracts which are financed substantially through cash from principal payments received and cash from operations in addition to borrowings on the Line. The Line is secured by all of the assets of the Company and has a maturity date of January 31, 2018. The Company may borrow up to $225.0 million. Borrowings under the Line may be under various LIBOR pricing options plus 300 basis points with a 1% floor on LIBOR. As of December 31, 2015, the amount outstanding under the Line was approximately $213 million, and the amount available under the Line was approximately $12 million.

The Company will continue to depend on the availability of the Line, together with cash from operations, to finance future operations. Amounts outstanding under the Line have increased by approximately $14 million during the nine months ended December 31, 2015. The increase of the Line is principally related to the fact that cash needed to fund new contracts exceeded cash received from operations. 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. The Line requires compliance with certain debt covenants including financial ratios, asset quality and other performance tests. The Company is in compliance with all of its debt covenants.

Contractual Obligations

The following table summarizes the Company’s material obligations as of December 31, 2015.


	Payments Due by Period
	Total		Less than 1 year		1 to 3 years		3 to 5 years		More than 5 years

Operating leases	$	5,170,637	$	1,913,566	$	2,556,570	$	700,501	$	—
Line of credit		213,000,000		—		213,000,000		—		—
Interest on Line¹		19,303,125		9,265,500		10,037,625		—		—

Total	$	237,473,762	$	11,179,066	$	225,594,195	$	700,501	$	—

The Company’s Line matures on January 30, 2018. Interest on outstanding borrowings under the Line as of December 31, 2015, is based on an effective interest rate of 4.35% which includes the estimated effect of the interest rate swap agreements settlements through the maturity date. The effective interest rate used in the above table does not contemplate the possibility of entering into interest rate swap agreements in the future.

Future Expansion

The Company currently operates a total of 66 branch locations in sixteen states, including twenty in Florida; eight in Ohio; six in North Carolina and Georgia; three in Kentucky, Indiana, Missouri, Michigan, Illinois; two in Alabama, Virginia, Tennessee, and South Carolina; and one each in Maryland, Kansas, and Texas. 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 gross finance receivables. To date, thirty-four of our branches meet this capacity. During this fiscal year the Company became licensed in Pennsylvania and Wisconsin, however no branch locations have been established within these states. We began purchasing contracts in Wisconsin in October 2015; and in Pennsylvania in January 2016We also continue developing in Texas and plan to open a full service branch location in Dallas prior to March 31, 2016. The Company continues to evaluate potential new markets, however, as a result of continued intense competition; the Company is currently evaluating the long-term sustainability of its current branch-based model. The Company has been experiencing declines in its gross portfolio yield, and if such declines continue into future periods, the Company may restructure its operations in an effort to reduce operating expenses. The likelihood of any material changes in which the Company operates will be evaluated over the next several quarters.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risks relating to the Company’s operations result primarily from changes in interest rates. The Company does not engage in speculative or leveraged transactions, nor does it hold or issue financial instruments for trading purposes.

Interest rate risk

Management’s objective is to minimize the cost of borrowing through an appropriate mix of fixed and floating rate debt. Derivative financial instruments, such as interest rate swap agreements, may be used for the purpose of managing fluctuating interest rate exposures that exist from ongoing business operations. The Company does not use interest rate swap agreements for speculative purposes. As of December 31, 2015, $163,000,000, or approximately 76.5% of our total debt, was subject to floating interest rates; however, due to a 1% floor on the debt these rates are effectively fixed until the variable rates exceed this threshold. As a result, a hypothetical increase in the variable interest rates of 1% or 100 basis points (1.4295% as of December 31, 2015) as of December 31, 2015 applicable to this floating rate debt would have an annual after-tax increase of interest expense of approximately $255,000.

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 Vice President 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 Vice President 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 have been no changes in the Company’s internal control over financial reporting that occurred during the Company’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

ITEM 1A.

RISK FACTORS

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended March 31, 2015, which could materially affect our business, financial condition or future results. The risks described in the Form 10-K are not the only risks facing the Company. Additional risks and uncertainties not currently known to the Company or that the Company currently deems to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

ITEM 6.

EXHIBITS

See exhibit index following the signature page.

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 09, 2016		/s/ Ralph T. Finkenbrink
		Ralph T. Finkenbrink
		Chairman of the Board, President,
		Chief Executive Officer and Director


Date: February 09, 2016		/s/ Katie L. MacGillivary
		Katie L. MacGillivary
		Vice President and
		Chief Financial Officer

EXHIBIT INDEX


Exhibit No.		Description

10.8		Form of Dealer Agreement and Schedule thereto listing dealers that are parties to such agreements

31.1		Certification of the President and Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of the Vice President and Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1*		Certification of the Chief Executive Officer Pursuant to 18 U.S.C. § 1350

32.2*		Certification of the Chief Financial Officer Pursuant to 18 U.S.C. § 1350

101.INS		XBRL Instance Document

101.SCH		XBRL Taxonomy Extension Schema Document

101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document

101.LAB		XBRL Taxonomy Extension Labels Linkbase Document

101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

101.DEF		XBRL Taxonomy Extension Definition Linkbase Document

*	This certification accompanies the Quarterly Report on Form 10-Q and is not filed as part of it.

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company