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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

FOR THE QUARTERLY PERIOD ENDED December 31, 2019

FOR THE TRANSITION PERIOD FROM                      TO                      .

Commission file number: 0-26680

 

NICHOLAS FINANCIAL, INC.

(Exact Name of Registrant as Specified in its Charter) 

 

 

 

 

(727) 726-0763

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

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  ☒    No  ☐

Indicate by check mark whether the Registrant has submitted electronically, 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 such files).     Yes  ☒    No  ☐

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

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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   ☒

As of February 12, 2020, approximately 12.6 million shares, no par value, of the Registrant were outstanding (of which 4.7 million shares were held by the Registrant’s principal operating subsidiary and pursuant to applicable law, not entitled to vote and 7.9 million shares were entitled to vote).

 

 

NICHOLAS FINANCIAL, INC.

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FORM 10-Q

TABLE OF CONTENTS

 

 

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PART I. FINANCIAL INFORMATION

Nicholas Financial, Inc. and Subsidiaries

Consolidated Balance Sheets

(In thousands)

 

 

See Notes to the Consolidated Financial Statements.

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Nicholas Financial, Inc. and Subsidiaries

Consolidated Statements of Income (Loss)

(Unaudited)

(In thousands, except per share amounts)

 

 

See Notes to the Consolidated Financial Statements.

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Nicholas Financial, Inc. and Subsidiaries

Consolidated Statements of Shareholders’ Equity

(Unaudited)

(In thousands)

 

 

See Notes to the Consolidated Financial Statements.

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Nicholas Financial, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

 

 

See Notes to the Consolidated Financial Statements.

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Notes to the Consolidated Financial Statements

1. Basis of Presentation

Nicholas Financial, Inc. (“Nicholas Financial – Canada”) is a Canadian holding company incorporated under the laws of British Columbia with several wholly-owned United States subsidiaries, including Nicholas Financial, Inc., a Florida corporation (“NFI”). The accompanying consolidated balance sheet as of March 31, 2019, which has been derived from audited financial statements, and the accompanying unaudited interim consolidated financial statements of Nicholas Financial – Canada, and its wholly-owned subsidiaries (collectively, the “Company”), have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information, with the instructions to Form 10-Q pursuant to the Securities and Exchange Act of 1934, as amended, and with Article 8 of Regulation S-X thereunder. Accordingly, they do not include all of the information and notes to the consolidated financial statements 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, 2020. 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, 2019 as filed with the Securities and Exchange Commission on June 28, 2019. The March 31, 2019 consolidated balance sheet included herein has been derived from the March 31, 2019 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 fair value of the assets and liabilities for business combination.

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 is contractually delinquent for 61 days or more, or the collateral is repossessed, whichever is earlier. The Company reverses the accrual of interest income when the loan is contractually delinquent 61 days or more.

As of February 2019, Chapter 13 bankruptcy accounts are charged-off at the time the bankruptcy status is confirmed on the account. Chapter 13 bankruptcy accounts, for which the corresponding bankruptcy plan has not been confirmed by the relevant court as of December 31, 2019 are accounted for under the cost-recovery method. Interest income on Chapter 13 bankruptcy accounts does not resume until all principal amounts are recovered.

A dealer discount represents the difference between the finance receivable 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, 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, 2019 and 2018 was 7.6% and 8.1% and 7.9% and 8.3% for the nine months ended December 31, 2019 and 2018, respectively, in relation to the total amount financed.

Unearned insurance and fee commissions 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, involuntary unemployment insurance coverage, and forced placed automobile insurance. These commissions are amortized over the life of the contract using the interest method.

 

 

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3. Earnings Per Share

The Company has granted stock compensation awards with nonforfeitable dividend rights which are considered participating securities. Earnings per share is calculated using the two-class method, as such awards are more dilutive under this method than the treasury stock method. Basic earnings per share is calculated by dividing net income allocated to common shareholders by the weighted average number of common shares outstanding during the period, which excludes the participating securities. Diluted earnings per share includes the dilutive effect of additional potential common shares from stock compensation awards. Earnings per share have been computed based on the following weighted average number of common shares outstanding:

 

 

Diluted earnings per share do not include the effect of certain stock options as their impact would be anti-dilutive. For the three months ended December 31, 2019 and 2018, potential shares of common stock from stock options totaling 62,400 and 35,000, respectively, were not included in the diluted earnings per share calculation because their effect is anti-dilutive. For the nine months ended December 31, 2019 and 2018, potential shares of common stock from stock options totaling 62,400 and 68,600, respectively, were not included in the diluted earnings per share calculation because their effect is anti-dilutive.

4. Finance Receivables

Finance Receivables Portfolio

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

 

 

During the quarter ended December 31, 2019, the Company completed a bulk asset purchase of $1.1 million of Contract loans.

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Contracts and Direct Loans each comprise a portfolio segment. The following tables present selected information on the entire portfolio of the Company:

 

 

 

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 predominantly for used vehicles. As of December 31, 2019, the average model year of vehicles collateralizing the portfolio was a 2011 vehicle.

Direct Loans are typically for amounts ranging from $500 to $11,000 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 better credit risk than the typical Contract due to the customer’s prior payment history with the Company; however, the underlying collateral is “typically” less valuable. In deciding whether 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 the Direct Loans made by the Company to date have been made to current or former customers, the payment history of the borrower is a significant factor in making the loan decision. As of December 31, 2019, loans made by the Company pursuant to its Direct Loan program constituted approximately 5.4% 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 primarily by consideration the composition of the portfolio, current economic conditions, the estimated net realizable value of the underlying collateral, historical loan loss experience, delinquency, non-performing assets, and bankrupt accounts when determining management’s estimate of probable credit losses and adequacy of the allowance for credit losses. If the allowance for credit losses is determined to be inadequate, then an additional charge to the provision would be recorded to maintain adequate reserves based on management’s evaluation of the risk inherent in the loan portfolio. Additionally, credit loss trends over several reporting periods are utilized in estimating future losses and overall portfolio performance. Conversely, the Company could identify abnormalities in the composition of the portfolio, which would indicate the calculation is overstated and management judgement may be required to determine the allowance of credit losses for both Contracts and Direct Loans.

Each portfolio segment consists of smaller balance homogeneous loans which are collectively evaluated for impairment.

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Allowance for Credit Losses

The following table sets forth a reconciliation of the changes in the allowance for credit losses on Contracts and Direct Loans for the three months ended December 31, 2019 and 2018:

 

 

During the first quarter of the fiscal year ending March 31, 2019, the Company began using the trailing six-month charge-offs, annualized, to calculate the allowance for credit losses. Additionally, the Company completed bulk sales of charge-off accounts, which included $1.5 million of bankruptcy accounts and $0.1 million of non-performing accounts. These bulk sales impacted the provision for credit losses, charge-off, and recoveries amounts for the three and nine months ended for December 31, 2019, respectively. The Company’s allowance for credit losses also incorporates recent trends such as delinquency, non-performing assets, and bankruptcy. The Company believes that this approach reflects the current trends of incurred losses within the portfolio and better aligns the allowance for credit losses with the portfolio’s performance indicators.

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

 

 

A performing account is defined as an account that is less than 61 days past due. The Company defines an automobile contract as delinquent when more than 10% of a payment contractually due by a certain date has not been paid by the immediately following due date, which date may have been extended within limits specified in the servicing agreements or as a result of a deferral. The period of delinquency is based on the number of days payments are contractually past due, as extended where applicable.

 

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In certain circumstances, the Company will grant obligors one-month payment extensions. The only modification of terms in those circumstances is to advance the obligor’s next due date by one month and extend the maturity date of the receivable. There are no other concessions, such as a reduction in interest rate, or forgiveness of principal or of accrued interest. Accordingly, the Company considers such extensions to be insignificant delays in payments rather than troubled debt restructurings.

A non-performing account is defined as an account that is contractually delinquent for 61 days or more or is a Chapter 13 bankruptcy account for which the corresponding bankruptcy plan has not been confirmed by the relevant court. Once the account is deemed non-performing, the accrual of interest income is suspended. As of February 2019, the Company changed the charge-off policy from 181 days contractually delinquent to 121 days contractually delinquent. Also, as of February 2019, once Chapter 13 bankruptcy plans are confirmed by the relevant court, the corresponding accounts are charged off.

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 Company does consider Chapter 13 bankruptcy accounts, for which the corresponding bankruptcy plan has not been confirmed as of the period end to be troubled debt restructurings and included in the Company’s allowance for credit losses is a specific reserve of approximately $774,000 for these accounts as of December 31, 2018. Based on declining balances of the bankruptcy accounts and the overall portfolio, the Company determined that no additional reserves for bankruptcy accounts was warranted as of December 31, 2019.

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

 

 

 

 

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5. Goodwill and Intangibles

On April 30, 2019, the Company completed an acquisition of three branches, representing substantially all of the assets, of ML Credit Group, LLC (d/b/a Metrolina Credit Company) (“Metrolina”). Two acquired branches are located in the state of North Carolina and one branch is located in South Carolina. Based on its evaluation of the agreement, the Company accounted for the acquisition as a business combination. In conjunction with the acquisition, the Company allocated the purchase price, tangible assets, and intangible assets among the acquired branches based on the fair values of their respective acquired assets. As of December 31, 2019, the accounting related to this acquisition is preliminary. The final determination of the fair value of the customer lists and goodwill will be completed within the twelve-month measurement period from the date of the acquisition as required by FASB ASC Topic 805-10-25. The Company recorded the following goodwill and intangibles in its preliminary accounting for this acquisition.

 

 

 

For the measurement period adjustment, for three months ended as of December 31, 2019, the Company reduced an insignificant amount of liabilities related to the purchase of Metrolina with a corresponding reduction to goodwill. For the nine months ended as of December 31, 2019, the Company incurred approximately $278,000 in expenses related to the purchase of the Metrolina assets.

 

6. Credit Facility

Senior Secured Credit Facility

On March 29, 2019, NF Funding I, wholly-owned, special purpose financing subsidiary of NFI entered into a senior secured credit facility (the “Credit Facility”) pursuant to a credit agreement with Ares Agent Services, L.P., as administrative agent and collateral agent, and the lenders that are party thereto (the “Credit Agreement”). The Company’s prior credit facility was paid off in connection with this Credit Facility.

Pursuant to the Credit Agreement, the lenders have agreed to extend to NF Funding I a line of credit of up to $175,000,000, which will be used to purchase motor vehicle retail installment sale contracts from NFI on a revolving basis pursuant to a related receivables purchase agreement between NF Funding I and NFI (the “Receivables Purchase Agreement”). Under the terms of the Receivables Purchase Agreement, NFI will sell to NF Funding I the receivables under the installment sale contracts. NFI will continue to service the motor vehicle retail installment sale contracts transferred to NF Funding I pursuant to a related servicing agreement (the “Servicing Agreement”).

The availability of funds under the Credit Facility is generally limited to 82.5% of the value of non-delinquent receivables, and outstanding advances under the Credit Facility will accrue interest at a rate of LIBOR plus 3.75%. The commitment period for advances under the Credit Facility is three years. At the end of the commitment period, the outstanding balance would be paid off over a four-year amortization period.

In connection with the Credit Facility, NFI has guaranteed NF Funding I ’s obligations under the Credit Agreement up to 10% of the highest aggregate principal amount outstanding under the Credit Agreement at any time pursuant to a limited guaranty. The Company is also obligated to cover any losses of the lender parties resulting from certain “bad acts” of the Company or its subsidiaries, such as fraud, misappropriation of funds or unpermitted disposition of the assets.

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Pursuant to a related security agreement (the “Security Agreement”), NF Funding I granted a security interest in substantially all of its assets as collateral for its obligations under the Credit Facility. In addition, NFI pledged the equity interests of NF Funding I, as additional collateral.

The Credit Agreement and the other loan documents contain customary events of default and negative covenants, including but not limited to those governing indebtedness, liens, fundamental changes, investments, and sales of receivables. If an event of default occurs, the lenders could increase borrowing costs, restrict NF Funding I ’s ability to obtain additional advances under the Credit Facility, accelerate all amounts outstanding under the Credit Facility, enforce their interest against collateral pledged under the Credit Facility or enforce their rights under the Company’s guarantees.

Once sold to NF Funding I, the assets described above are separate and distinct from the Company’s own assets and will not be available to the Company’s creditors should the Company become insolvent, although they will be presented on a consolidated basis on the Company’s balance sheet.

Future maturities of debt as of December 31, 2019 are as follows:

 

 

Prior Line of Credit

Prior to March 29, 2019, the Company utilized a line of credit facility (the “Line of Credit”) ranging from $140 million to $225 million during fiscal years 2019 and 2018.  On March 29, 2019 the Company paid-off in full the Line of Credit in connection with the new Credit Facility.  Pledged as collateral for this Line of Credit were all the assets of the Company.

The credit agreement for the Line of Credit required compliance with certain financial ratios and covenants and satisfaction of specified financial tests, including maintenance of asset quality and performance tests. The Company’s operating results in prior years provided indicators that the Company may not have been able to continue to comply with certain of the required financial ratios, covenants and financial tests prior to the maturity date of the Line of Credit in the absence of amendments to the corresponding credit agreement or waivers. On November 2, 2018, the Company entered into a Waiver and Amendment No. 9 (“Amendment No. 9”) to the credit agreement governing the Line of Credit. Among other things, Amendment No. 9 waived compliance with the minimum interest coverage ratio and minimum loss reserve requirements for the measurement period ending August 31, 2018. On February 12, 2019, the Company entered into a Waiver and Amendment No. 10 (Amendment No. 10) to the credit agreement. Among other things, Amendment No. 10:

  

 

Note 7. Income Taxes

The Company recorded an income tax expense of approximately $229,000 for the three months ended December 31, 2019 compared to income tax benefit of approximately $376,000 for the three months ended December 31, 2018. The Company’s effective tax rate increased to 42.4% for the three months ended December 31, 2019 from 29.4% for the three months ended December 31, 2018. The Company recorded an income tax expense of approximately $527,000 for the nine months ended December 31, 2019 compared to income tax expense of approximately $293,000 for the nine months ended December 31, 2018. The Company’s effective tax rate increased to 31.1% for the nine months ended December 31, 2019 from 21.1% for the nine months ended December 31, 2018. The changes in the effective tax rate was attributed to discrete items, primarily related to state apportionment rates, for the three months ended and for the nine months ended, December 31, 2019, respectively.

 

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Note 8. Leases

The Company adopted a new lease accounting standard in April 2019. See Note 11, “Summary of Significant Accounting Policies,” for an overview of the transition to this standard.

The Company maintains lease agreements related to its branch network and for its corporate headquarters. The branch lease agreements range from one to five years and generally contain options to extend from one to three years. The corporate headquarters lease agreement expires in April 2020 and the Company is in the process of negotiating a new lease agreement. All of the Company’s lease agreements are considered operating leases. None of the Company’s lease payments are dependent on a rate or index that may change after the commencement date, other than the passage of time.

The Company’s lease liability was $2.2 million as of December 31, 2019. This liability is based on the present value of the remaining minimum rental payments using a discount rate that is determined based on the Company’s incremental borrowing rate on its senior revolving credit facility. The lease asset was $2.2 million as of December 31, 2019. This asset includes right-of-use assets equaling the lease liability, net of prepaid rent and deferred rents that existed as of the adoption of the new lease standard.

The Company has made several policy elections related to lease assets and liabilities. The Company elected to utilize the package of transition practical expedients, which includes not reassessing the following at adoption: (i) whether existing contracts contained leases, (ii) the existing classification of leases as operating or financing, or (iii) the initial direct costs of leases. In addition, the Company did not use hindsight to determine the lease term or include options to extend for leases existing at the transition date.

The Company had elected the practical expedient of combining lease and non-lease components for its real estate leases in calculating the present value of the fixed payments without having to perform an allocation between the types of lease components. Future minimum lease payments under non-cancellable operating leases in effect as of December 31, 2019, are as follows:

 

 

 

The following table reports information about the Company’s lease cost for the three months ended December 31, 2019 (in thousands):

 

 

The following table reports information about the Company’s lease cost for the nine months ended December 31, 2019 (in thousands):

 

 

The following table reports other information about the Company’s leases for the three months ended December 31, 2019 (dollar amounts in thousands):

 

 

 

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The following table reports other information about the Company’s leases for the nine months ended December 31, 2019 (dollar amounts in thousands):

 

 

 

9. 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.

The Company’s financial instruments consist of cash, finance receivables, repossessed assets, and the Credit Facility. For each of these financial instruments, the carrying value approximates fair value.  

Finance receivables, net, approximates fair value based on the price paid to acquire Contracts. 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 generally range from 12 to 72 months. Beginning in December 2017, the maximum initial term of a Contract was reduced to 60 months. The initial terms of the Direct Loans generally range from 12 to 60 months. If liquidated outside of the normal course of business, the amount received may not be the carrying value.

Repossessed assets are valued at the lower of the finance receivable balance prior to repossession or the estimated net realizable value of the repossessed asset. The Company estimates the net realizable value using the projected cash value upon liquidation plus insurance claims outstanding, if any.

 

Based on current market conditions, any new or renewed credit facility would be expected to contain pricing that approximates the Company’s current Credit Facility. Based on these market conditions, the fair value of the Credit Facility as of December 31, 2019 was estimated to be equal to the book value. The interest rate for the Credit Facility is a variable rate based on LIBOR pricing options.

 

 

The Company may be required, from time to time, to measure certain assets and liabilities at fair value on a nonrecurring basis. At each reporting period, all assets and liabilities for which the fair value measurement is based on significant unobservable inputs are classified as Level 3.

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10. 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.

11. Summary of Significant Accounting Policies

Reclassifications

The Company made certain reclassifications from drafts payable to accounts payable and accrued expenses on the Consolidated Balance Sheets. A portion of net assets acquired from branches, primarily loans used in investing activities was reclassified to repossessed assets used in operating activities on the Consolidated Statements of Cash Flows. Originations of finance receivables were reclassed from the payments received the cashflows from financing activities to the purchases and originations of finance receivables. Net income and shareholders’ equity were not changed.

Recently Adopted Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board (“FASB”) issued an accounting update to increase transparency and comparability of accounting for lease transactions. The update required: (i) all leases to be recognized on the balance sheet as lease (right-of-use) assets and lease liabilities and (ii) both quantitative and qualitative disclosures regarding key information about leasing arrangements. The update was effective for annual and interim periods beginning after December 15, 2018. The Company completed the implementation of third-party software to facilitate compliance with the accounting and reporting requirements of the lease standard. Prior to adoption, all of the Company’s leases were classified as operating leases, with no lease assets or liabilities recorded. The Company transitioned to this accounting change on a modified retrospective basis by recording the cumulative effect of lease assets and liabilities for active leases as of April 1, 2019. The Company did not restate comparative periods in transition and elected to use the effective date of April 1, 2019 as the initial date of transition. The Company also elected to utilize the package of transition practical expedients, which included not reassessing the following: (i) whether existing contracts contain leases, (ii) the existing classification of leases as operating or financing, or (iii) the initial direct costs of leases. The Company did not use hindsight to determine the lease term or include options to extend for leases existing at the transition date. In addition, the Company elected not to apply the new lease standard to leases with terms of twelve months or less.

As a result of the adoption of the new lease standard on April 1, 2019, the Company recorded $2.7 million for both lease liabilities and the corresponding lease assets. The lease liabilities were based on the present value of the remaining minimum rental payments using discount rates as of the effective date. There was no impact to the consolidated statements of income related to the adoption of this standard. The adoption of this standard did not require the Company to alter its debt covenants. Reconciliation of the new accounting standard was completed in the prior quarter.

In August 2017, the Financial Accounting Standards Board (“FASB”) issued ASU 2017-12 Derivatives and Hedging (Topic 815). The guidance is intended to better align an entity’s risk management activities and financial reporting for hedging relationships. This guidance was effective for fiscal years beginning after December 15, 2018 and for interim periods within those fiscal years. The impact of the adoption of this guidance on its Consolidated Financial Statements and related disclosures was not material.

Recent Accounting Pronouncements

In June 2016, the FASB issued an accounting update to change the impairment model for estimating credit losses on financial assets. The current incurred loss impairment model requires the recognition of credit losses when it is probable that a loss has been incurred. The incurred loss model will be replaced by an expected loss model, which requires entities to estimate the lifetime expected credit loss on such instruments and to record an allowance to offset the amortized cost basis of the financial asset. This update is effective for annual and interim periods beginning after December 15, 2019, and early adoption is permitted. The Company believes the implementation of the accounting update will have a material adverse effect on the Company’s consolidated financial statements and is in the process of quantifying the potential impacts.  Recently, the FASB voted to delay the implementation date for this accounting standard, for smaller reporting companies, the new effective date is beginning after December 15, 2022, and early adoption is permitted.

In August 2018, the FASB issued an accounting update to provide additional guidance on the accounting for costs of implementation activities performed in a cloud computing arrangement that is a service contract. The amendments align the capitalization requirements for hosting arrangements that are service contracts with the capitalization principles for internal-use software. This update is effective for annual and interim periods beginning after December 15, 2019, and early adoption is permitted. The Company is currently evaluating the potential impact of this update on its consolidated financial statements. The impact of the adoption of this guidance on its Consolidated Financial Statements and related disclosures was not material.

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.

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12. Variable Interest Entity

 

In March 2019, the Company entered into a new senior secured credit facility collateralized by customer financed receivables by transferring the receivables into a bankruptcy-remote variable interest entity (VIE).  Under the terms of the transaction, all cash collections and other cash proceeds of the customer receivables go first to the servicer and the holders of the asset-backed notes, and then to the residual equity holder. The Company retains the servicing of the portfolio and receives a monthly fee of 2.5% (annualized) based on the outstanding balance of the financed receivables, and the Company currently holds all of the residual equity. In addition, the Company, rather than the VIE, retains certain credit insurance income together with certain recoveries related to credit insurance and on charge-offs of the financed receivables, which will continue to be reflected as a reduction of net charge-offs on a consolidated basis for as long as the Company consolidates the VIE.

 

The Company consolidates the VIE when the Company determines that it is the primary beneficiary, the Company has the power to direct the activities that most significantly impact the performance of the VIE and it has the obligation to absorb losses and the right to receive significant residual returns.

 

The assets of the VIE serve as collateral for the obligations of the VIE.  The lender has no recourse to assets outside of the VIE.

 

The following table presents the assets and liabilities held by the VIE (for legal purposes, the assets and the liabilities of the VIE remain distinct from the Company):

 

 

Note 13. Stock Plans

 

In May 2019, the Company’s Board of Directors (“Board”) authorized a new stock repurchase program allowing for the repurchase of up to $8.0 million of the Company’s outstanding shares of common stock in open market purchases, privately negotiated transactions, or through other structures in accordance with applicable federal securities laws. The authorization was effective immediately.

 

The timing and actual number of sharers will depend on a variety of factors, including stock price, corporate and regulatory requirements and other market and economic conditions. The Company’s stock repurchase program may be suspended or discontinued at any time.

 

In August 2019, the Company’s Board authorized additional repurchase of up to $1.0 million of the Company’s outstanding shares.

 

The table shown on the next page summarizes treasury share transactions under the Company’s stock repurchase program.

 

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During 2019, the Company repurchased a total of 24,000 shares of common stock at an aggregate cost of $0.2 million and average cost per share of $8.88.  The Company intends to continue repurchases under its active share repurchase program through open market transactions under trading plans in accordance with Rule 10b5-1 and Rule 10b-18 under the Exchange Act of 1934.

 

Note 14. Subsequent Event

Bulk Purchase: In January 2020, the Company completed a bulk purchase of Contract loans of approximately $0.9 million.

 

Share Repurchases: For the period January 1, 2020 through February 12, 2020, the Company repurchased an additional 20,000 shares of our common stock for $0.2 million at an average price of $8.49 per share. The total shares repurchased through February 12, 2020 under the plan in aggregate is 44,000 shares for $0.4 million an average price of $8.75.

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Forward-Looking Information

This Quarterly Report on Form 10-Q contains various forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such statements are based on management’s current beliefs and assumptions, as well as information currently available to management. When used in this document, the words “anticipate”, “estimate”, “expect”, “will”, “may”, “plan,” “believe”, “intend” and similar expressions are intended to identify forward-looking statements. Although Nicholas Financial, Inc., including its subsidiaries (collectively, the “Company,” “we,” “us,” or “our”) believes that the expectations reflected or implied 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, including but not limited to the risk factors discussed under “Item 1A – Risk Factors” in our Annual Report on Form 10-K, and our other filings made with the U.S. Securities and Exchange Commission (“SEC”). 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 cause actual results to differ materially from those projected in forward-looking statements include the availability of capital (including the ability to access bank financing), recently enacted, proposed or future legislation and the manner in which it is implemented, including the effect of changes in tax law, fluctuations in the economy, the degree and nature of competition and its effects on the Company’s financial results, fluctuations in interest rates, the effectiveness of the Company’s internal control over financial reporting and disclosure controls and procedures, 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 and Direct Loans, adverse regulatory changes in the Company’s existing and future markets, the Company’s intentions regarding strategic alternatives, the Company’s ability to expand its business, including its ability to complete acquisitions and integrate the operations of any acquired businesses and to expand into new markets, and the Company’s ability to recruit and retain qualified employees. All forward-looking statements included in this Quarterly Report are based on information available to the Company as of the date of filing of this Quarterly Report, and the Company assumes no obligation to update any such forward-looking statement.

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 the Contracts and the Direct Loans that we offer, including explicit supervisory authority to examine, audit, and investigate companies offering a consumer financial product such as ourselves. Although the Dodd-Frank Act expressly provides that the CFPB has no authority to establish usury limits, efforts to create a federal usury cap, applicable to all consumer credit transactions and substantially below rates at which the Company could continue to operate profitably, are still ongoing. Any federal legislative or regulatory action that severely restricts or prohibits the provision of consumer credit and similar services on terms substantially similar to those we currently provide could if enacted have a material, adverse impact on our business, prospects, results of operations and financial condition. 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 operations 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.

 

On October 5, 2017, the CFPB issued a final rule (the “Rule”) imposing limitations on (i) short-term consumer loans, (ii) longer-term consumer installment loans with balloon payments, and (iii) higher-rate consumer installment loans repayable by a payment authorization. The Rule requires lenders originating short-term loans and longer-term balloon payment loans to evaluate whether each consumer has the ability to repay the loan along with current obligations and expenses (“ability to repay requirements”). The Rule also curtails repeated unsuccessful attempts to debit consumers’ accounts for short-term loans, balloon payment loans, and installment loans that involve a payment authorization and an Annual Percentage Rate over 36% (“payment requirements”). The Rule has significant differences from the CFPB’s proposed rules announced on June 2, 2016, relating to payday, vehicle title, and similar loans.

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On February 6, 2019, the CFPB issued two notices of proposed rulemaking regarding potential amendments to the Rule. First, the CFPB is proposing to rescind provisions of the Rule, including the ability to repay requirements. Second, the CFPB is proposing to delay the August 19, 2019 compliance date for part of the Rule, including the ability to repay requirements. These proposed amendments are not yet final. The Company does not believe that the Rule will have a material impact on the Company’s existing lending procedures because the Company currently does not make short-term consumer loans or longer-term consumer installment loans with balloon payments that would subject the Company to the Rule’s ability to repay requirements. However, the Company may have to comply with the Rule’s payment requirements as the Company does allows consumers to set up future recurring payments online if such loans meet the definition of having a “leveraged payment mechanism” under the Rule. The payment provisions of the Rule are expected to go into effect on November 19, 2019. If the payment provisions of the Rule apply, the Company may have to modify its loan payment procedures to comply with the required notices within the mandated timeframes set forth in the Rule. On June 6, 2019, the CFPB delayed the compliance date for the mandatory ability-to-repay (ATR) provisions to November 19, 2020.

The CFPB also has stated that it expects to conduct separate rulemaking to identify larger participants in the installment lending market for purposes of its supervision program. This initiative was classified as “inactive” on the CFPB’s Spring 2018 rulemaking agenda, but the CFPB indicated that such action was not a decision on the merits. Though the likelihood and timing of any such rulemaking is uncertain, the Company believes that the threshold of at least 10,000 aggregate annual direct loan originations would likely bring this reporting segment of the Company’s business under the CFPB’s supervisory authority which, among other things, would subject the Company to reporting obligations to, and on-site compliance examinations by the CFPB.

 

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 incurred in the existing portfolio. Because of the nature of the customers under the Company’s Contracts and its Direct Loan program, the Company considers the establishment of adequate reserves for credit losses to be imperative.

During the first quarter of fiscal year ending March 31, 2019, the Company began using the trailing six-month charge-offs, annualized, to calculate the allowance for credit losses. This change was made to reflect changes in the Company’s lending policies and underwriting standards, which resulted from the Company changing its business strategies. The Company re-focused on financing primary transportation to and from work for the subprime borrower. This change resulted in purchasing higher yielding loans, smaller amounts financed and shorter monthly terms. A trailing six-month, annualized, is also more in line with the industry practice, which uses a trailing twelve-month. Management believes a trailing six-month will more quickly reflect changes in the portfolio.

In addition, the Company takes into consideration the composition of the portfolio, current economic conditions, the estimated net realizable value of the underlying collateral, historical loan loss experience, delinquency, non-performing assets, and bankrupt accounts when determining management’s estimate of probable credit losses and adequacy of the allowance for credit losses. If the allowance for credit losses is determined to be inadequate, then an additional charge to the provision would be recorded to maintain adequate reserves based on management’s evaluation of the risk inherent in the loan portfolio.

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 the applicable state maximum interest rate, if any, or the maximum interest rate which the customer will accept. In most 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 generally purchases Contracts on an individual basis.

The Company utilizes the branch model, which allows for Contract purchasing to be done at the branch level. The Company has detailed underwriting guidelines it utilizes to determine which Contracts to purchase. These guidelines are specific and are designed to provide reasonable assurance that the Contracts that the Company purchases have common risk characteristics. The Company utilizes its District Managers to evaluate their respective branch locations for adherence to these underwriting guidelines, as well as approve underwriting exceptions. The Company also utilizes internal audit (“IA”) to assure adherence to its underwriting guidelines. Any Contract that does not meet our underwriting guidelines can be submitted by a branch manager for approval from the Company’s District Managers or senior management.

Introduction

For the three months ended December 31, 2019, the net dilutive earnings per share increased to $0.04 as compared to net dilutive loss per share of $0.12 for the three months ended December 31, 2018. Net income was $0.3 million for the three months ended December 31, 2019 as compared to a net loss of $0.9 million for the three months ended December 31, 2018. Revenue decreased 10.6% to $15.0 million for the three months ended December 31, 2019 as compared to $16.7 million for the three months ended December 31, 2018, due to a 15.9% decrease in average finance receivables, compared to the prior year quarter.

For the nine months ended December 31, 2019, per share diluted earnings increased to $0.15 as compared to $0.14 for the nine months ended December 31, 2018. Net income was $1.2 million and $1.1 million for the nine months ended December 31, 2019 and 2018,

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respectively. Revenue decreased 14.0% to $47.2 million for the nine months ended December 31, 2019 as compared to $54.9 million for the nine months ended December 31, 2018, due to 17.4% decrease in average finance receivables compared to the prior year period.

With the Company’s renewed focus on its core business of financing primary transportation to and from work for the subprime borrower, the Company has been able to increase an average yield above 27%. The average portfolio yield for the three months ended December 31, 2019 was 27.3% compared to 25.7% for the three months ended December 31, 2018, and for the nine months ended December 31, 2019 was 27.3% compared to 26.2% for the nine months ended December 31, 2018.

 

Aggressive competition had previously influenced the Company to purchase lower credit quality Contracts. Historically, the Company was able to expand its automobile finance business in the non-prime credit market by offering to purchase Contracts on terms that were competitive with those of other companies. However, it became increasingly difficult for the Company to match or exceed pricing of its competitors, which resulted in declining Contract acquisition rates since fiscal year 2016. Beginning in December 2017, the Company changed its focus to be more disciplined when underwriting loans. The Company believes that now it can begin to focus on growing the portfolio.  

 

 

Note: All three-month and six-month statement of income performance indicators expressed as percentages have been annualized.

Operating Strategy

Beginning in December 2017, the Company elected to remain committed to its branch-based model and its core product of financing primary transportation to and from work for the subprime borrower. The Company strategically employs the use of centralized servicing departments to supplement the branch operations and improve operational efficiencies, but its focus is on its core business model of decentralized operations. The Company’s strategy also includes pricing based on risk (rate, yield, advance, etc.) and a commitment to the underwriting discipline required for optimal portfolio performance.  

 

The Company’s principal goals are to increase its profitability and its long-term shareholder value through the measured acquisition of Contracts in existing markets and broadening the geographic area in which its current branches operate. The Company seeks to strengthen its automobile financing program in 16 states—Alabama, Florida, Georgia, Illinois, Indiana, Kansas, Kentucky, Michigan,

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Missouri, Nevada, North Carolina, Ohio, Pennsylvania, South Carolina, Tennessee, and Wisconsin—in which it currently operates by employing its core branch-based business model in each market it services, while supporting its branch network with targeted centralized servicing departments. The Company is exploring expansion of automobile financing programs in 3 states—Idaho, Iowa, and Utah.

Being cognizant of the Company’s increasing operating expenses as a percent of income, as a result of its shrinking portfolio due to the increased focus on deal structure and pricing over volume, the Company decided to exit the states of Texas and Virginia resulting in the closure of four branches, during the fourth quarter of fiscal 2019. Additionally, the Company merged the Raleigh and Charlotte, NC markets and merged some of the Atlanta, GA branches. The Company also continues to look for expansion opportunities both in states in which it currently operates and in new states. Recently, the Company has expanded operations into Columbia, South Carolina; Milwaukee, Wisconsin; and Wichita, Kansas; while continuing to evaluate new states, including Iowa, Nevada, Arizona, and Utah. Although the Company cannot assert how many new markets it will enter (if any) in the foreseeable future, it does remain focused on growing the branch network where conditions are favorable.

On April 30, 2019 the Company acquired substantially all of the assets of ML Credit Group, LLC (d/b/a Metrolina Credit Company) (“Metrolina”).  Metrolina provides automobile financing to consumers through direct loans and through purchases of retail installment sales contracts originated by automobile dealers in the states of North Carolina and South Carolina. This acquisition represents.  If other opportunities arise, the Company may consider possible acquisitions of portfolios of seasoned Contracts from dealers or lenders in bulk transactions as a means of further penetrating its existing markets or expanding its presence in targeted geographic locations, although it can provide no assurances as to whether or when it will make any such acquisitions.

The Company is currently licensed to provide Direct Loans in 13 states— Alabama, Florida, Georgia (over $3,000), Illinois, Indiana, Kansas, Kentucky, Michigan, Missouri, North Carolina, Ohio, South Carolina, and Tennessee. The Company solicits current and former customers in these states for the purpose of selling Direct Loans to such customers, and the expansion of its Direct Loan capabilities to the other states in which it acquires Contracts. Even with this targeted expansion, the Company expects its total Direct Loans portfolio to remain between 2% and 10% of its total portfolio for the foreseeable future. The Company cannot provide any assurances that it will be able to expand in either its current markets or any targeted new markets.

Analysis of Credit Losses

In December 2017, the Board appointed our current President and Chief Executive Officer. Under his leadership, the Company redefined its business strategy, which resulted in more restrictive lending policies and underwriting standards. On an aggregate basis, this change generally resulted in loans with higher yields, smaller amounts financed and shorter terms.

During the first quarter of fiscal 2019, the Company began using a trailing six-month charge-off analysis, annualized, to calculate the allowance for credit losses. Management believes that using the trailing six-month charge-off analysis, annualized, will more quickly reflect changes in the portfolio as compared to a trailing twelve-month charge-off analysis.

In addition, the Company takes into consideration the composition of the portfolio, current economic conditions, estimated net realizable value of the underlying collateral, historical loan loss experience, delinquency, non-performing assets, and bankrupt accounts when determining management’s estimate of probable credit losses and adequacy of the allowance for credit losses. If the allowance for credit losses is determined to be inadequate, then an additional charge to the provision is recorded to maintain adequate reserves based on management’s evaluation of the risk inherent in the loan portfolio. Conversely, the Company could identify abnormalities in the composition of the portfolio, which would indicate the calculation is overstated and management judgement may be required to determine the allowance of credit losses for both Contracts and Direct Loans. During the quarter, the Company completed bulk sales of charge-off accounts, which included $1.5 million of bankruptcy accounts and $0.1 million of non-performing accounts. These bulk sales impacted the provision for credit losses, net charge-off, and allowance percentages for December 31, 2019. The Company’s allowance for credit losses also incorporates recent trends such as delinquency, non-performing assets, and bankruptcy. The Company believes that this approach reflects the current trends of incurred losses within the portfolio and better aligns the allowance for credit losses with the portfolio’s performance indicators.

Non-performing assets are defined as accounts that are contractually delinquent for 61 or more days past due or Chapter 13 bankruptcy accounts. For these accounts, the accrual of interest income is suspended, and any previously accrued interest is reversed. Upon notification of a bankruptcy, an account is monitored for collection with other Chapter 13 accounts. In the event the debtors’ balance is 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, whether to begin repossession proceedings or allow the customer to begin making regularly scheduled payments.

The Company defines a Chapter 13 bankruptcy account as a Troubled Debt Restructuring (“TDR”). Beginning March 31, 2018, the Company allocated a specific reserve using a look back method to calculate the estimated losses. Based on this look back, management calculated a specific reserve of approximately $0 and $774,000 for these accounts as of December 31, 2019 and December 31, 2018,

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respectively. Based on declining balances of the bankruptcy accounts and the overall portfolio, the Company determine that no additional reserves for bankruptcy accounts was warranted as of December 31, 2019.

 

The provision for credit losses decreased for the three months ended December 31, 2019 compared to the three months ended December 31, 2018. The decreases were largely due to decreases in the average finance receivables balance and by a decrease in the net charge-off percentage (see note 6 in the Portfolio Summary table in the “Introduction” above for the definition of net charge-off percentage). In the three months ended December 31, 2019, the Company completed bulk sales of charge-off accounts, which included $1.5 million of bankruptcy accounts and $0.1 million of non-performing accounts. These bulk sales impacted the provision for credit losses, net charge-off, and allowance percentages for December 31, 2019. The Company’s allowance for credit losses also incorporates recent trends such as delinquency, non-performing assets, and bankruptcy. The Company believes that this approach reflects the current trends of incurred losses within the portfolio and better aligns the allowance for credit losses with the portfolio’s performance indicators.

The delinquency percentage for Contracts more than twenty-nine days past due, excluding Chapter 13 bankruptcy accounts, as of December 31, 2019 was 12.5%, a decrease from 14.1% as of December 31, 2018. The delinquency percentage for Direct Loans more than twenty-nine days past due, excluding Chapter 13 bankruptcy accounts, was 4.6%, for both December 31, 2019 and December 31, 2018. The changes in delinquency percentage for both Contracts and Direct Loans was driven primarily by the Company’s renewed focus on local branch-based servicing. As of March 2019, the Company changed its charge-off policy from 181 days past due to 121 days past due, which aligned with industry standards and the sub-prime nature of the customers. In the event of repossession, the charge-off will occur in the month in which the vehicle is repossessed.  Based on these actions, improving servicing, and stricter underwriting policies, management has seen improvements in the delinquency rates.

The Company has continued to see a significant number of competitors with aggressive underwriting in its operating market. See “Note 4—Finance Receivables” for changes in allowance for credit losses, credit quality and delinquencies.

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, 2019 and December 31, 2018 the Company granted deferrals to approximately 1.3% and 2.4%, respectively, of total Contracts and Direct Loans. For the nine months ended December 31, 2019 and December 31, 2018 the Company granted deferrals to approximately 1.1% and 9.4%, respectively, of total Contracts and Direct Loans. The number of deferrals is also influenced by portfolio performance, including but not limited to, inflation, credit quality of loans purchased, competition at the time of Contract acquisition, and general economic conditions.

Three months ended December 31, 2019 compared to three months ended December 31, 2018

Interest Income and Loan Portfolio

Interest and fee income on finance receivables, which consist predominantly of finance charge income, decreased 10.6% to $15.0 million for the three months ended December 31, 2019 from $16.7 million for the three months ended December 31, 2018. The decrease was primarily due to a 15.9% decrease in average finance receivables to $219.6 million for the three months ended December 31, 2019 when compared to $261.0 million for the corresponding period ended December 31, 2018. The decrease in average finance receivables was primarily the result of a reduction in the aggregate dollar amount and volume of Contracts purchased, as the Company continued implementing its renewed strategic focus of financing primary transportation to and from work for the subprime borrower. Continuing this operating strategy allowed us to acquire Contracts at the same yields with lower discounts during the three months ended December 31, 2019 compared to acquisitions during the corresponding period ended December 31, 2018, although combination of the same average yield and lower discounts could not entirely offset the reduction in the aggregate dollar amount of Contracts purchased.

The gross portfolio yield increased to 27.3% for the three months ended December 31, 2019 compared to 25.7% for the three months ended December 31, 2018. The net portfolio yield increased to 15.5% for the three months ended December 31, 2019 compared to 10.1% for the three months ended December 31, 2018. The net portfolio yield increased primarily due to the decrease in the provision for credit losses, as described under “Analysis of Credit Losses”.

Operating Expenses

Operating expenses were approximately $7.9 million for the three months ended December 31, 2019 and December 31, 2018, respectively. Operating expenses as a percentage of average finance receivables increased to 14.5% for the three months ended December 31, 2019 from 12.0% for the three months ended December 31, 2018. These increased percentages were primarily attributed to the decrease in the average finance receivables balance. Additionally, the Company completed bulk sales of charge-off accounts, which included $1.5 million of bankruptcy accounts and $0.1 million of non-performing accounts. These bulk sales impacted the provision for credit losses, net charge-off, and allowance percentages for December 31, 2019. The Company’s allowance for credit losses also incorporates recent trends such as delinquency, non-performing assets, and bankruptcy. The Company believes that this approach reflects the current trends of incurred losses within the portfolio and better aligns the allowance for credit losses with the portfolio’s performance indicators.

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Provision Expense

The provision for credit losses decreased to $4.6 million for the three months ended December 31, 2019 from $7.9 million for the three months ended December 31, 2018, largely due to a 15.9% decrease in the average finance receivables and decrease in the net charge-off percentage to 8.8% for the three months ended December 31, 2019 from 10.8% for the three months ended December 31, 2018. Additionally, the Company completed bulk sales of charge-off accounts, which included $1.5 million of bankruptcy accounts and $0.1 million of non-performing accounts. These bulk sales impacted the provision for credit losses, net charge-off, and allowance percentages for December 31, 2019. The Company’s allowance for credit losses also incorporates recent trends such as delinquency, non-performing assets, and bankruptcy. The Company believes that this approach reflects the current trends of incurred losses within the portfolio and better aligns the allowance for credit losses with the portfolio’s performance indicators.

 

Interest Expense

Interest expense was $1.9 million for the three months ended December 31, 2019 and $2.3 million for the three months ended December 31, 2018. The following table summarizes the Company’s average cost of borrowed funds:

 

LIBOR rates have decreased (1.93%, which represents three-month LIBOR rate as required by Credit Facility, as of December 31, 2019 compared to 2.46%, which represents one-month LIBOR rate as required by prior Line of Credit, as of December 31, 2018). For further discussions regarding interest rates see “Note 6—Credit Facility”.

Income Taxes

The Company recorded an income tax expense of approximately $229,000 for the three months ended December 31, 2019 compared to income tax benefit of approximately $376,000 for the three months ended December 31, 2018. The Company’s effective tax rate increased to 42.4% for the three months ended December 31, 2019 from 29.4% for the three months ended December 31, 2018. The changes in the effective tax rate was attributed to discrete items, primarily related to state apportionment rates.

 

Nine months ended December 31, 2019 compared to nine months ended December 31, 2018

Interest Income and Loan Portfolio

Interest and fee income on finance receivables decreased 14.0% to $47.2 million for the nine months ended December 31, 2019 from $54.9 million for the nine months ended December 31, 2018. The decrease was primarily due to 17.4% decrease in average finance receivables to $230.5 million for the nine months ended December 31, 2019 when compared to a $279.0 million for the corresponding period ended December 31, 2018. The decrease in average finance receivables was primarily the result of a reduction in the aggregate dollar amount and volume of Contracts purchased, as the Company continued implementing its renewed strategic focus of financing primary transportation to and from work for the subprime borrower. Continuing this operating strategy allowed us to acquire Contracts at higher yields during the nine months ended December 31, 2019 compared to acquisitions during the corresponding period ended December 31, 2018, although the increase in average yield could not entirely offset the reduction in the aggregate dollar amount of Contracts purchased.

The net portfolio yield increased to 15.9% for the nine months ended December 31, 2019 compared to 12.4% for the nine months ended December 31, 2018. The net portfolio yield increased, primarily because of two factors: (i) an decrease in the provision for credit losses, as described under “Analysis of Credit Losses”, and (ii) an increase in interest expense as a percentage of average finance receivables (3.9% for the nine months ended December 31, 2019 compared to 3.5% for the nine months December 31, 2018).

Operating Expenses

Operating expenses increased to approximately $25.9 million for the nine months ended December 31, 2019 from approximately $24.6 million for the nine months ended December 31, 2018. Increases occurred across expense accounts, including but not limited to acceleration of dealers’ spiffs expenses, bank/custody fees, professional/consulting fees, and repossessions/collection expenses. Operating expenses as a percentage of average finance receivables increased to 15.0% for the nine months ended December 31, 2019 from 11.8% for the nine months ended December 31, 2018. These increased percentages were attributed to the decrease in the average finance receivables balance. During the quarter, the Company completed bulk sales of charge-off accounts, which included $1.5 million of bankruptcy accounts and $0.1 million of non-performing accounts. These bulk sales impacted the provision for credit losses, net

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charge-off, and allowance percentages for December 31, 2019. The Company’s allowance for credit losses also incorporates recent trends such as delinquency, non-performing assets, and bankruptcy. The Company believes that this approach reflects the current trends of incurred losses within the portfolio and better aligns the allowance for credit losses with the portfolio’s performance indicators.

 

 

Provision Expense

The provision for credit losses decreased to $13.0 million for the nine months ended December 31, 2019 from $21.7 million for the nine months ended December 31, 2018, largely due to a 17.4% decrease in the average finance receivables and decrease in the net charge-off percentage to 9.6% for the nine months ended December 31, 2019 from 10.5% for the nine months ended December 31, 2018. For the three months ended December 31, 2019, the Company completed bulk sales of charge-off accounts, which included $1.5 million of bankruptcy accounts and $0.1 million of non-performing accounts. These bulk sales impacted the provision for credit losses, net charge-off, and allowance percentages for December 31, 2019. The Company’s allowance for credit losses also incorporates recent trends such as delinquency, non-performing assets, and bankruptcy. The Company believes that this approach reflects the current trends of incurred losses within the portfolio and better aligns the allowance for credit losses with the portfolio’s performance indicators.

 

Interest Expense

Interest expense was $6.7 million for the nine months ended December 31, 2019 and $7.3 million for the nine months ended December 31, 2018. The following table summarizes the Company’s average cost of borrowed funds:

 

 

LIBOR rates have decreased (1.93%, which represents three-month LIBOR rate, as of December 31, 2019 compared to 2.46%, which represents one-month LIBOR rate, as of December 31, 2018). For further discussions regarding interest rates see “Note 6—Credit Facility”.

Income Taxes

The Company recorded an income tax expense of approximately $527,000 for the nine months ended December 31, 2019 compared to income tax expense of approximately $293,000 for the nine months ended December 31, 2018. The Company’s effective tax rate increased to 31.1% for the nine months ended December 31, 2019 from 21.1% for the nine months ended December 31, 2018. The changes in the effective tax rate was attributed to discrete items, primarily related to state apportionment rates.

Contract Procurement

The Company purchases Contracts in the 15 states for fiscal year 2020 listed in the table below. The Contracts purchased by the Company are predominantly for used vehicles; for the three and nine-month periods ended December 31, 2019 and 2018, less than 1% were for new vehicles.

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The following tables present selected information on Contracts purchased by the Company.

 

 

 

 

Direct Loan Origination

The following table presents selected information on Direct Loans originated by the Company.

 

 

 

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Liquidity and Capital Resources

The Company’s cash flows are summarized as follows:

 

 

The Company’s primary use of working capital for the quarter ended December 31, 2019 was funding the purchase of Contracts and bulk asset purchases, which are financed substantially through cash from principal and interest payments received, and the Credit Facility (as defined below).

On March 29, 2019, NF Funding I, a special purpose financing subsidiary of Nicholas Financial, entered into a senior secured credit facility (the “Credit Facility”) pursuant to a credit agreement with Ares Agent Services, L.P., as administrative agent and collateral agent, and the lenders that are party thereto (the “Credit Agreement”). The Company’s prior line of credit was paid off in connection with this Credit Facility.

Pursuant to the Credit Agreement, the lenders agreed to extend to the  NF Funding I a line of credit of up to $175,000,000, which will be used to purchase Contracts from Nicholas Financial on a revolving basis pursuant to a related receivables purchase agreement between NF Funding I and Nicholas Financial (the “Receivables Purchase Agreement”). Under the terms of the Receivables Purchase Agreement, Nicholas Financial sells to NF Funding I the receivables under Contracts. Nicholas Financial continues to service the Contracts transferred to NF Funding I pursuant to a related servicing agreement (the “Servicing Agreement”).

The availability of funds under the Credit Facility is generally limited to 82.5% of the value of non-delinquent receivables, and outstanding advances under the Credit Facility will accrue interest at a rate of LIBOR plus 3.75%. The commitment period for advances under the Credit Facility is three years. At the end of the commitment period, the outstanding balance would be paid off over a four-year amortization period.

As required under the Credit Facility, the Company is required to maintain at least $3.5 million of unrestricted cash.  Collections are remitted to restricted cash collection accounts, which totaled $8.3 million as of December 31, 2019.

The Company will continue to depend on the availability the Credit Facility, together with cash from operations, to finance future operations. The availability of funds under the Credit Facility generally depends on availability calculations as defined in the Credit Agreement. In addition, the Credit Agreement and the other loan documents contain customary events of default and negative covenants, including but not limited to those governing indebtedness, liens, fundamental changes, investments, and sales of receivables. See also “ Our Credit Facility is subject to certain defaults and negative covenants” in “1A. Risk Factors” in our Annual Report on Form 10-K, as well as the disclosure in Note 6. Credit Facility in this Form 10-Q, both of which are incorporated herein by reference.

 

 

Contractual Obligations

The following table summarizes the Company’s material obligations as of December 31, 2019.

 

 

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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

We are subject to market risk exposure related to changes in interest rates on our debt. Derivative financial instruments, such as interest rate swap agreements, may be used to manage fluctuating interest rate exposures that exist from ongoing business operations. The Company does not use interest rate swap agreements for speculative purposes. During the three-months ended June 30, 2018 the Company’s then remaining interest rate swap expired.

As of December 31, 2019, $119.5 million, or 100.00% of our total debt, was subject to floating interest rates. As a result, a hypothetical increase in LIBOR of 1% or 100 basis points (based on LIBOR rate of 1.93%, which represents three-month LIBOR rate, as of December 31, 2019) would have resulted in an annual increase of interest expense of approximately $1.2 million.

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 Chief Financial Officer, the effectiveness 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 Chief Financial Officer have concluded that the disclosure controls and procedures were not effective as of the end of the period covered by this Quarterly Report on Form 10-Q.

Changes in internal control over financial reporting.

As disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2019, the Company reported that its internal control over financial reporting was not effective as of March 31, 2019, as a result of a material weakness. A material weakness is a deficiency or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the registrant’s annual or interim financial statements will not be prevented or detected on a timely basis. Specifically, management identified the following internal control deficiencies that in combination are considered to be a material weakness.

The Company experienced significant management turnover in the year ended March 31, 2018, and during fiscal year 2019.  The turnover included the Chief Executive Officer, the Chief Financial Officer, and the Controller, which all have significant roles in the structure of the Company’s internal control over financial reporting.  In addition to this, the Company hired an Assistant Controller during fiscal 2019, which has a significant impact on the day-to-day operation of the accounting function. With the implementation of new management, there was an acclimation period, in which management had to familiarize themselves with the systems and processes of the Company.  The new management team implemented certain policies and procedures that changed the way the Company was previously operating, particularly surrounding the loans receivable portfolio, and the underwriting standards, by tightening the underwriting standards and lessening payment deferrals.  These policy and procedure changes changed the design of the internal controls, and some of the previous controls were no longer applicable to the Company.  

On February 1, 2019, the new management team implemented a conversion of the Company’s in-house loan operating system to a third-party loan operating system.  The new loan system has improved internal controls since it is serviced by a third-party and not managed in-house.  

Due to the turnover and system conversion, the Company was unable to maintain consistent internal control processes, testing and documentation at a level necessary to enable management to assess the effectiveness of internal control over financial reporting as of March 31, 2019.  

Due to the limited number of employees with accounting experience at the Company, many of the schedules prepared, including schedules surrounding critical accounting areas, were performed without proper review, therefore, segregation of duties did not exist at the Company.  

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Remedial Actions

The Company has taken the following remedial actions to address the material weakness:

 

 

 

 

Management believes the foregoing efforts will effectively remediate the material weakness.  As management continues to evaluate and work to improve internal control over financial reporting, management may determine to take additional measures to address control deficiencies or determine to modify or supplement the remediation plan described above.  Management cannot assure you, however, when the Company will remediate such weakness, nor can management be certain of whether additional actions will be required or the costs of any such actions.

Notwithstanding the material weakness, which still exists as of December 31, 2019, the Company’s management, including its Chief Executive Officer and Chief Financial Officer, have concluded that the consolidated financial statements included in this Quarterly Report present fairly, in all material respects, our financial position, results of operations and cash flows as of the dates, and for the periods presented, in conformity with accounting principles generally accepted in the United States.

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PART II—OTHER INFORMATION

The Company currently is not a party to any pending legal proceedings other than ordinary routine litigation incidental to its business, that, 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.

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, 2019, 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.

The table below sets forth the information with respect to purchase made by or on behalf of the Company or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Exchange Act) of our shares of common stock during the three months ended December 31, 2019.

 

In May 2019, the Company’s Board of Directors (“Board”) authorized a new stock repurchase program allowing for the repurchase of up to $8.0 million of the Company’s outstanding shares of common stock in open market purchases, privately negotiated transactions, or through other structures in accordance with applicable federal securities laws. The authorization was effective immediately.

 

The timing and actual number of sharers will depend on a variety of factors, including stock price, corporate and regulatory requirements and other market and economic conditions. The Company’s stock repurchase program may be suspended or discontinued at any time.

 

In August 2019, the Company’s Board authorized additional repurchase of up to $1.0 million of the Company’s outstanding shares.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.

NICHOLAS FINANCIAL, INC.

(Registrant)

 

 

 

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