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Advance America, Cash Advance Centers 10-Q 2005

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2005

OR

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

For the transition period from             to           

COMMISSION FILE NUMBER 001-32363

ADVANCE AMERICA, CASH ADVANCE CENTERS, INC.

(Exact name of registrant as specified in its charter)

Delaware

 

58-2332639

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

135 North Church Street
Spartanburg, South Carolina 29306

(Address of principal executive offices)
(Zip Code)

864-342-5600
(Registrant’s telephone number, including area code)

None
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class

 

Outstanding as of November 4, 2005

Common Stock, par value $.01 per share

 

82,243,972 shares

 

 




ADVANCE AMERICA, CASH ADVANCE CENTERS, INC.
Form 10-Q
For the three months and nine months ended September 30, 2005

 

 

 

Page

FORWARD-LOOKING STATEMENTS

 

3

 

PART I.   FINANCIAL INFORMATION

 

4

 

Item 1.

 

Financial Statements

 

4

 

 

 

Unaudited Consolidated Balance Sheets December 31, 2004 and
September 30, 2005

 

4

 

 

 

Interim Unaudited Consolidated Statements of Income Three Months and Nine Months Ended September 30, 2004 and 2005

 

5

 

 

 

Interim Unaudited Consolidated Statement of Stockholders’ Equity Nine Months Ended September 30, 2005

 

6

 

 

 

Interim Unaudited Consolidated Statements of Cash Flows Nine Months Ended September 30, 2004 and 2005

 

7

 

 

 

Notes to Interim Unaudited Consolidated Financial Statements

 

8

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

20

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

66

 

Item 4.

 

Controls and Procedures

 

66

 

PART II.   OTHER INFORMATION

 

67

 

Item 1.

 

Legal Proceedings

 

67

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

67

 

Item 6.

 

Exhibits

 

67

 

SIGNATURES

 

 

 

INDEX TO EXHIBITS

 

 

 

 

2




FORWARD-LOOKING STATEMENTS

The matters discussed in this Quarterly Report on Form 10-Q that are forward-looking statements are based on current management expectations that involve substantial risks and uncertainties, which could cause actual results to differ materially from the results expressed in, or implied by these forward-looking statements. These statements can be identified by the fact that they do not relate strictly to historical or current facts. They use words such as “expect,” “intend,” “plan,” “believe,” “project,” “anticipate,” “may,” “will,” “should,” “would,” “could,” “estimate,” “continue,” and other words and terms of similar meaning in conjunction with a discussion of future operating or financial performance. You should read statements that contain these words carefully because they discuss our future expectations, contain projections of our future results of operations or of our financial position or state other “forward-looking” information.

The factors listed in “Part I. Financial Information—Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Factors,” as well as any cautionary language in this Quarterly Report, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. Although we believe that our expectations are based on reasonable assumptions, actual results may differ materially from those in the forward-looking statements as a result of various factors, including, but not limited to, those described under the heading “Risk Factors” in “Part I. Financial Information—Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Quarterly Report.

Forward-looking statements speak only as of the date of this Quarterly Report. Except as required under federal securities laws and the rules and regulations of the U.S. Securities and Exchange Commission, we do not have any intention, and do not undertake, to update any forward-looking statements to reflect events or circumstances arising after the date of this Quarterly Report, whether as a result of new information, future events or otherwise. As a result of these risks and uncertainties, readers are cautioned not to place undue reliance on the forward-looking statements included in this Quarterly Report or that may be made elsewhere from time to time by, or on behalf of, us. All forward-looking statements attributable to us are expressly qualified by these cautionary statements.

3




PART I. FINANCIAL INFORMATION

ITEM 1.                FINANCIAL STATEMENTS.

Advance America, Cash Advance Centers, Inc.
Unaudited Consolidated Balance Sheets
December 31, 2004 and September 30, 2005
(in thousands, except per share data)

 

 

December 31,
2004

 

September 30,
2005

 

Assets

 

 

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

 

$

18,224

 

 

 

$

25,714

 

 

Advances and fees receivable, net

 

 

155,009

 

 

 

181,800

 

 

Deferred income taxes

 

 

3,141

 

 

 

4,688

 

 

Other current assets

 

 

9,887

 

 

 

10,254

 

 

Total current assets

 

 

186,261

 

 

 

222,456

 

 

Restricted cash

 

 

9,110

 

 

 

9,474

 

 

Property and equipment, net

 

 

72,247

 

 

 

64,053

 

 

Goodwill

 

 

122,324

 

 

 

122,573

 

 

Other assets

 

 

7,597

 

 

 

6,877

 

 

Total assets

 

 

$

397,539

 

 

 

$

425,433

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

 

 

Accounts payable

 

 

$

13,911

 

 

 

$

7,937

 

 

Accrued liabilities

 

 

23,027

 

 

 

24,656

 

 

Income taxes payable

 

 

2,169

 

 

 

3,128

 

 

Accrual for excess bank losses

 

 

3,219

 

 

 

1,949

 

 

Current portion of long-term debt

 

 

471

 

 

 

466

 

 

Total current liabilities

 

 

42,797

 

 

 

38,136

 

 

Revolving credit facility

 

 

39,506

 

 

 

43,661

 

 

Long-term debt

 

 

6,660

 

 

 

6,306

 

 

Deferred income taxes

 

 

12,286

 

 

 

14,124

 

 

Other liabilities

 

 

 

 

 

39

 

 

Total liabilities

 

 

101,249

 

 

 

102,266

 

 

Non-controlling interest in variable interest entity

 

 

 

 

 

13,906

 

 

Commitments and contingencies (Note 7)

 

 

 

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

 

 

 

 

Preferred stock, par value $.01 per share, 25,000 shares authorized; no shares issued and outstanding

 

 

 

 

 

 

 

Common stock, par value $.01 per share, 250,000 shares authorized; 96,821 shares issued and 83,958 outstanding as of December 31, 2004 and 96,821 shares issued and 83,053 outstanding at September 30, 2005

 

 

968

 

 

 

968

 

 

Paid in capital

 

 

284,004

 

 

 

283,858

 

 

Paid in capital—unearned compensation

 

 

(3,451

)

 

 

(2,392

)

 

Retained earnings

 

 

52,492

 

 

 

76,218

 

 

Common stock in treasury (12,863 and 13,768 shares at cost at December 31, 2004 and September 30, 2005, respectively)

 

 

(37,723

)

 

 

(49,391

)

 

Total stockholders’ equity

 

 

296,290

 

 

 

309,261

 

 

Total liabilities and stockholders’ equity

 

 

$

397,539

 

 

 

$

425,433

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

4




Advance America, Cash Advance Centers, Inc.
Interim Unaudited Consolidated Statements of Income
Three Months and Nine Months Ended September 30, 2004 and 2005
(in thousands, except per share data)

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2004

 

2005

 

2004

 

2005

 

Revenues:

 

 

 

 

 

 

 

 

 

Fees and interest charged to customers

 

$

115,656

 

$

153,161

 

$

311,408

 

$

373,010

 

Marketing, processing and servicing fees

 

36,208

 

19,476

 

99,091

 

88,327

 

Total revenues

 

151,864

 

172,637

 

410,499

 

461,337

 

Provision for doubtful accounts and agency bank losses

 

(29,064

)

(36,340

)

(59,117

)

(76,998

)

Net revenues

 

122,800

 

136,297

 

351,382

 

384,339

 

Center Expenses:

 

 

 

 

 

 

 

 

 

Salaries and related payroll costs

 

39,175

 

44,359

 

117,702

 

128,948

 

Occupancy costs

 

17,765

 

20,455

 

49,145

 

58,735

 

Center depreciation expense

 

3,539

 

3,841

 

10,150

 

10,973

 

Advertising expense

 

5,117

 

7,952

 

19,318

 

20,808

 

Other center expenses

 

11,485

 

13,991

 

34,150

 

39,040

 

Total center expenses

 

77,081

 

90,598

 

230,465

 

258,504

 

Center gross profit

 

45,719

 

45,699

 

120,917

 

125,835

 

Corporate and Other Expenses (Income):

 

 

 

 

 

 

 

 

 

General and administrative expenses

 

10,009

 

13,236

 

30,534

 

38,218

 

General and administrative expenses with related parties

 

516

 

58

 

1,646

 

222

 

Corporate depreciation expense

 

974

 

1,241

 

2,975

 

3,390

 

Interest expense

 

2,075

 

1,356

 

4,899

 

2,914

 

Interest expense with related parties

 

2,629

 

 

7,830

 

 

Interest income

 

(26

)

(50

)

(116

)

(208

)

Loss on disposal of property and equipment

 

197

 

325

 

466

 

448

 

Loss on impairment of assets

 

 

1,852

 

 

1,852

 

Transaction related expense

 

1,592

 

 

1,592

 

 

Income before income taxes

 

27,753

 

27,681

 

71,091

 

78,999

 

Income tax expense

 

792

 

11,352

 

2,314

 

32,187

 

Income before income of consolidated variable interest entity

 

26,961

 

16,329

 

68,777

 

46,812

 

Income of consolidated variable interest entity

 

 

(476

)

 

(476

)

Net income

 

$

26,961

 

$

15,853

 

$

68,777

 

$

46,336

 

Net income per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.39

 

$

0.19

 

$

1.00

 

$

0.55

 

Diluted

 

$

0.39

 

$

0.19

 

$

1.00

 

$

0.55

 

Dividends declared per common share

 

$

0.84

 

$

0.09

 

$

1.15

 

$

0.27

 

Weighted average number of shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

68,667

 

83,220

 

68,667

 

83,528

 

Diluted

 

68,667

 

83,449

 

68,667

 

83,760

 

Pro Forma Data:

 

 

 

 

 

 

 

 

 

Historical income before taxes

 

$

27,753

 

 

 

$

71,091

 

 

 

Pro forma income tax expense

 

11,295

 

 

 

28,934

 

 

 

Net income adjusted for pro forma income tax expense

 

$

16,458

 

 

 

$

42,157

 

 

 

Pro forma net income per common share—basic and diluted

 

$

0.24

 

 

 

$

0.61

 

 

 

Weighted average pro forma number of shares outstanding—basic and diluted

 

68,667

 

 

 

68,667

 

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

5




Advance America, Cash Advance Centers, Inc.
Interim Unaudited Consolidated Statement of Stockholders’ Equity
Nine Months Ended September 30, 2005
(in thousands, except per share data)

 

 

Common Stock

 

 

 

Paid-In
Capital—

 

 

 

Common Stock

 

 

 

 

 

 

 

Par

 

Paid-In

 

Unearned

 

Retained

 

In Treasury

 

 

 

 

 

Shares

 

Value

 

Capital

 

Compensation

 

Earnings

 

Shares

 

Amount

 

Total

 

Balances, December 31, 2004

 

96,821

 

 

$

968

 

 

$

284,004

 

 

$

(3,451

)

 

$

52,492

 

(12,863

)

$

(37,723

)

$

296,290

 

Amortization of restricted stock 

 

 

 

 

 

 

 

809

 

 

 

 

 

809

 

Forfeitures of restricted stock 

 

 

 

 

 

 

 

250

 

 

 

(17

)

(250

)

 

Stock option expense

 

 

 

 

 

23

 

 

 

 

 

 

 

23

 

Dividends paid ($0.27 per share)

 

 

 

 

 

 

 

 

 

(22,552

)

 

 

(22,552

)

Dividends payable

 

 

 

 

 

 

 

 

 

(58

)

 

 

(58

)

Common stock issuance costs 

 

 

 

 

 

(169

)

 

 

 

 

 

 

(169

)

Purchases of treasury stock

 

 

 

 

 

 

 

 

 

 

(888

)

(11,418

)

(11,418

)

Net Income

 

 

 

 

 

 

 

 

 

46,336

 

 

 

46,336

 

Balances, September 30, 2005

 

96,821

 

 

$

968

 

 

$

283,858

 

 

$

(2,392

)

 

$

76,218

 

(13,768

)

$

(49,391

)

$

309,261

 

 

The accompanying notes are an integral part of these consolidated financial statements.

6




Advance America, Cash Advance Centers, Inc.
Interim Unaudited Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2004 and 2005
(in thousands)

 

 

2004

 

2005

 

Cash flows from operating activities

 

 

 

 

 

Net income

 

$

68,777

 

$

46,336

 

Adjustments to reconcile net income to net cash provided by operating activities, net of acquisition

 

 

 

 

 

Depreciation

 

13,125

 

14,363

 

Non-cash interest expense

 

654

 

735

 

Provisions for doubtful accounts and agency bank losses

 

59,117

 

76,998

 

Deferred income taxes

 

550

 

291

 

Loss on disposal of property and equipment

 

499

 

448

 

Loss on impairment of assets

 

 

1,768

 

Amortization of restricted stock

 

 

809

 

Stock option expense

 

 

23

 

Changes in operating assets and liabilities

 

 

 

 

 

Other current assets

 

(311

)

5,940

 

Other assets

 

(4,379

)

 

Accounts payable

 

4,227

 

(4,911

)

Accrued liabilities

 

1,802

 

(320

)

Income taxes payable

 

284

 

959

 

Accrual for excess bank losses

 

(14,425

)

(13,698

)

Net cash provided by operating activities

 

129,920

 

129,741

 

Cash flows from investing activities

 

 

 

 

 

Changes in advances and fees receivable, net

 

(58,597

)

(80,258

)

Changes in restricted cash

 

1,188

 

(364

)

Cash from consolidated variable interest entity

 

 

2,931

 

Acquisition of business, net of cash acquired

 

 

(332

)

Proceeds from sale of property and equipment

 

18

 

230

 

Purchases of property and equipment

 

(22,376

)

(13,039

)

Net cash used in investing activities

 

(79,767

)

(90,832

)

Cash flows from financing activities

 

 

 

 

 

Proceeds from revolving credit facility, net

 

31,657

 

4,156

 

Common stock issuance costs

 

 

(169

)

Payments on mortgage payable

 

(229

)

(249

)

Payments on note payable

 

 

(110

)

Payments of financing costs

 

(3,055

)

(15

)

Purchases of treasury stock

 

 

(11,418

)

Payments of dividends

 

(79,250

)

(22,552

)

Changes in book overdrafts

 

(1,624

)

(1,062

)

Net cash used in financing activities

 

(52,501

)

(31,419

)

Net (decrease)/increase in cash and cash equivalents

 

(2,348

)

7,490

 

Cash and cash equivalents, beginning of period

 

10,484

 

18,224

 

Cash and cash equivalents, end of period

 

$

8,136

 

$

25,714

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest, net of amounts capitalized

 

$

12,248

 

$

2,089

 

Income taxes

 

1,473

 

30,992

 

Supplemental schedule of non-cash investing and financing activity:

 

 

 

 

 

Property and equipment purchases included in accounts payable and accrued expenses

 

1,495

 

1,426

 

Restricted stock dividends payable

 

 

58

 

Reclassification of property and equipment to other assets held for sale (included in other current assets)

 

 

6,300

 

Net assets assumed in consolidation of variable interest entity

 

 

13,906

 

Net assets acquired through acquisition of business

 

 

229

 

 

The accompanying notes are an integral part of these consolidated financial statements.

7




Advance America, Cash Advance Centers, Inc.
Notes to Interim Unaudited Consolidated Financial Statements

1.   Summary of Significant Accounting Policies

Basis of Presentation

The accompanying interim unaudited consolidated financial statements of Advance America, Cash Advance Centers, Inc. (“AACACI”) and its wholly owned subsidiaries (collectively, the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”). They do not include all information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. Although management believes that the disclosures are adequate to prevent the information from being misleading, the interim unaudited consolidated financial statements should be read in conjunction with the Company’s audited financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 filed with the SEC. In the opinion of the Company’s management, all adjustments, consisting of normal recurring accruals considered necessary for a fair statement, have been included. The results of operations for the three and nine months ended September 30, 2005 are not necessarily indicative of the results that may be expected for future interim periods or the entire year ended December 31, 2005.

In January 2003, Financial Accounting Standards Board Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), was issued. In December 2003, a revised version of FIN 46 (“FIN 46R”) was issued. FIN 46R addresses reporting and disclosure requirements for Variable Interest Entities (“VIE”). It defines a VIE as an entity that either does not have equity investors with voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN 46R requires consolidation of a VIE by the enterprise that has the majority of the risks and rewards of ownership, referred to as the primary beneficiary. It also requires additional disclosures for an enterprise that holds a significant variable interest in a VIE, but is not the primary beneficiary. See Note 9 for the impact of adopting FIN 46R on the Company’s results of operations and financial condition as well as other disclosures required by FIN 46R.

In May 2005, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard No. 154, “Accounting Changes and Error Corrections–A Replacement of APB Opinion No. 20 and FASB Statement No. 3’’ (“SFAS No. 154”). SFAS No. 154 applies to all voluntary changes in accounting principle and changes the requirements for accounting for and reporting of a change in accounting principle. SFAS No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless it is impracticable. In addition, SFAS No. 154 carries forward without change the guidance contained in APB Opinion No. 20, “Accounting Changes,” for reporting a correction of an error in previously issued financial statements and a change in accounting estimate. The Company will adopt SFAS No. 154 on January 1, 2006, as required. The Company does not expect the adoption of SFAS No. 154 to have a material impact on its financial condition or results of operations.

Certain prior period balances have been reclassified to conform to the current period’s presentation.

Revenue Recognition

Revenues on payday cash advances (and as of July 2005, installment loans under the agency business model) can be characterized as fees and/or interest depending upon various state laws. Revenue is recognized on payday cash advances made by the Company under the standard business model on a

8




constant-yield basis ratably over the term of each payday cash advance. Under the agency business model, all charges of fees and/or interest paid by the lending banks’ customers are deposited directly to the respective lending bank’s bank account, and the Company’s revenues consist of the marketing, processing and servicing fees payable to the Company by the lending banks. Prior to July 2005, these fees included the losses for which the lending banks were contractually obligated in each of the states where the Company operated its agency business model. As of July 2005, these fees include only the losses for which the lending bank operating in Pennsylvania is contractually obligated. The Company recognizes revenue under the agency business model on a constant-yield basis ratably over the term of each payday cash advance and installment loan.

Concentration of Risk

The Company marketed, processed and serviced payday cash advances, and, beginning in July 2005, installment loans under either the standard or agency business model, to a broad base of individuals in 37 states in the United States. For the three months ended September 30, 2004 and 2005, total revenues within five states accounted for approximately 41.6% and 40.1%, respectively, of the Company’s total revenues. For the nine months ended September 30, 2004 and 2005, total revenues within five states accounted for approximately 42.0% and 40.5%, respectively, of the Company’s total revenues.

Income Taxes

Effective October 1, 2001, AACACI filed an election to convert to Subchapter S status. Certain subsidiaries also converted to Subchapter S status as part of this election. The Company terminated these elections on December 21, 2004. For the three and nine months ended September 30, 2004, approximately 93% and 95%, respectively, of total revenues were attributable to companies that had elected Subchapter S status.

Income taxes have been accounted for under the asset and liability method since the Company terminated its S corporation election on December 21, 2004 and prior thereto for those subsidiaries that remained C corporations during the period the Company was an S corporation. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying value of existing assets and liabilities and their respective tax bases and for operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the related temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date.

Earnings Per Share

Basic earnings per share are computed by dividing net income by the weighted average number of shares outstanding for the period excluding unvested restricted stock. Diluted earnings per share are computed by dividing net income by the weighted average number of shares outstanding for the period, after adjusting for the dilutive effect of restricted stock and stock options. Options to purchase 250,000 shares of common stock that were outstanding at September 30, 2005 were not included in the computation of diluted earnings per share since the effect of including these options would be anti-dilutive.

9




The following table presents the reconciliation of the denominator used in the calculation of basic and diluted earnings per share (in thousands):

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,
2005

 

September 30,
2005

 

Reconciliation of denominator:

 

 

 

 

 

 

 

 

 

Weighted average number of common shares outstanding—basic

 

 

83,220

 

 

 

83,528

 

 

Effect of unvested restricted stock

 

 

229

 

 

 

232

 

 

Weighted average number of common and dilutive shares outstanding—diluted

 

 

83,449

 

 

 

83,760

 

 

 

2.   Marketing, Processing and Servicing Arrangements

As part of the agency business model, the Company is party to marketing, processing and servicing agreements (“MP&S Agreements”) with lending banks that offer payday cash advances and, as of July 2005, installment loans. The Company’s marketing, processing and servicing duties typically include the following:

a)               taking in applications from prospective customers of the lending bank;

b)              submitting the applications for approval or denial to the lending bank’s independent, third-party credit scoring agent;

c)               depending on whether the application is approved or denied, providing the customer with a lending bank contractual agreement or an adverse action letter;

d)              collecting repayments from the lending bank’s customers and depositing them in the lending bank’s bank accounts;

e)               if repayment is not received from a customer, commencing collection activities to collect on the amount owed to the lending bank; and

f)                 undertaking various marketing efforts on behalf of the lending bank.

In Pennsylvania, North Carolina and Arkansas, the Company is compensated under these MP&S Agreements by the lending banks for marketing, processing and servicing the payday cash advances and, as of July 2005, installment loans the lending banks make to their customers. The Company was previously a party to MP&S Agreements with lending banks offering payday cash advances in Texas and Michigan, which agreements were terminated in June and/or July 2005, and the Company no longer operates in Texas or Michigan under the agency business model. Although the Company markets, processes and services payday cash advances and, now, installment loans made by the lending banks under the agency business model, each lending bank is responsible for evaluating each of its customers’ applications and determining whether the payday cash advance or installment loan is approved. The Company is not involved in the lending banks’ payday cash advance or installment loan approval process or the determination of their approval procedures or criteria, and the Company does not fund or acquire any payday cash advances or installment loans from the lending banks. The payday cash advances and installment loans are repayable solely to the lending banks and are assets of the lending banks; accordingly, they are not included in the Company’s balance sheet. On September 15, 2005, the lending bank for which the Company markets, processes and services payday cash advances and installment loans in its 117 centers in North Carolina temporarily suspended its payday cash advance and installment loan originations. The Company continues to service all payday cash advances and installment loans that are currently outstanding in North Carolina.

10




Prior to July 2005, each lending bank was contractually obligated for the losses on payday cash advances in an amount established as a percentage of the interest and/or fees charged by the banks to their customers. The Company’s marketing, processing and servicing fee increased by the lending bank’s contractual obligation for losses. If the amount of the lending bank’s uncollected payday cash advances and installment loans exceeded the lending bank’s contractual obligations, the Company was potentially obligated to pay the lending bank the outstanding amount of the advances and loans plus the lending bank’s fees and/or interest receivable on the advances, less the lending bank’s contractually obligated portion of the losses. The outstanding balances of the lending banks’ advances, installment loans and fees receivable serviced by the Company were approximately $61.8 million and $30.2 million at December 31, 2004 and September 30, 2005, respectively. Beginning in July 2005, the lending bank offering payday cash advances and installment loans in North Carolina and Arkansas is responsible for any and all losses associated with its payday cash advances and installment loans, while the lending bank offering payday cash advances and installment loans in Pennsylvania continues to be contractually obligated only for losses in an amount established as a percentage of the interest and/or fees charged by the bank to its customers.

3.   Advances and Fees Receivable, Net

Advances and fees receivable, net, consisted of (in thousands):

 

 

December 31,
2004

 

September 30,
2005

 

Payday advances receivable

 

 

$

137,309

 

 

 

$

149,515

 

 

Fees and interest receivable

 

 

21,942

 

 

 

25,144

 

 

Returned items receivable

 

 

25,705

 

 

 

42,597

 

 

Loans and fees receivable of consolidated variable interest entity, net of unearned revenues

 

 

 

 

 

13,411

 

 

Lending bank receivable

 

 

10,762

 

 

 

4,196

 

 

Other

 

 

1,833

 

 

 

2,512

 

 

Allowance for doubtful accounts

 

 

(29,221

)

 

 

(41,811

)

 

Unearned revenues

 

 

(13,321

)

 

 

(13,764

)

 

Advances and fees receivable, net

 

 

$

155,009

 

 

 

$

181,800

 

 

 

4.   Allowance for Doubtful Accounts and Accrual for Excess Bank Losses

Changes in the allowance for doubtful accounts for the three and nine months ended September 30, 2004 and 2005 were as follows (in thousands):

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2004

 

2005

 

2004

 

2005

 

Beginning balance

 

$

24,910

 

$

33,875

 

$

23,021

 

$

29,221

 

Provision for doubtful accounts

 

22,915

 

34,704

 

45,408

 

64,570

 

Charge-offs

 

(21,779

)

(30,097

)

(50,008

)

(65,618

)

Recoveries

 

2,131

 

3,329

 

9,756

 

13,638

 

Ending balance

 

$

28,177

 

$

41,811

 

$

28,177

 

$

41,811

 

 

11




Changes in the accrual for excess bank losses for the three and nine months ended September 30, 2004 and 2005 were as follows (in thousands):

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2004

 

2005

 

2004

 

2005

 

Beginning balance

 

$

3,977

 

$

5,337

 

$

3,623

 

$

3,219

 

Provision for agency bank losses

 

6,149

 

1,636

 

13,709

 

12,428

 

Charge-offs

 

(8,416

)

(5,785

)

(19,697

)

(19,158

)

Recoveries

 

1,197

 

761

 

5,272

 

5,460

 

Ending balance

 

$

2,907

 

$

1,949

 

$

2,907

 

$

1,949

 

 

The provision for agency bank losses consists of those losses for which the lending banks under the agency business model are contractually obligated and an estimate by which actual losses will differ from the lending banks’ contractual obligation (which is referred to as provision for excess bank losses).

5.   Accrued Liabilities

Accrued liabilities were as follows (in thousands):

 

 

December 31,
2004

 

September 30,
2005

 

Employee compensation

 

 

$

9,678

 

 

 

$

7,484

 

 

Workers’ compensation

 

 

3,521

 

 

 

4,571

 

 

Health and dental insurance

 

 

3,364

 

 

 

3,455

 

 

Accrued construction in progress

 

 

1,818

 

 

 

1,426

 

 

Accrued branch closing costs

 

 

55

 

 

 

1,344

 

 

Accrued property tax

 

 

447

 

 

 

1,211

 

 

Legal

 

 

827

 

 

 

778

 

 

Other

 

 

3,317

 

 

 

4,387

 

 

Total

 

 

$

23,027

 

 

 

$

24,656

 

 

 

6.   Income Taxes

Income tax expense for the three and nine months ended September 30, 2004 and 2005 consisted of the following (in thousands):

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

  2004  

 

2005

 

2004

 

2005

 

Current

 

 

 

 

 

 

 

 

 

 

 

Federal

 

 

$

 

 

$

11,021

 

$

 

$

26,610

 

State

 

 

517

 

 

2,189

 

1,763

 

5,286

 

 

 

 

517

 

 

13,210

 

1,763

 

31,896

 

Deferred

 

 

275

 

 

(1,858

)

551

 

291

 

Total

 

 

$

792

 

 

$

11,352

 

$

2,314

 

$

32,187

 

 

12




A reconciliation of the statutory federal income tax rate and the Company’s effective income tax rate for the three and nine months ended September 30, 2004 and 2005 follows:

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

    2004    

 

    2005    

 

    2004    

 

    2005    

 

 

Statutory income tax rate

 

 

35.0

%

 

 

35.0

%

 

 

35.0

%

 

 

35.0

%

 

 

S corporation income not subject to tax

 

 

(31.6

)

 

 

 

 

 

(33.0

)

 

 

 

 

 

State income taxes, net

 

 

2.0

 

 

 

4.4

 

 

 

2.0

 

 

 

4.4

 

 

 

Other

 

 

(2.5

)

 

 

1.6

 

 

 

(0.7

)

 

 

1.3

 

 

 

Effective income tax rate

 

 

2.9

%

 

 

41.0

%

 

 

3.3

%

 

 

40.7

%

 

 

 

The tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities are (in thousands):

 

 

December 31,
2004

 

September 30,
2005

 

Deferred tax assets

 

 

 

 

 

 

 

 

 

Accrued expenses

 

 

$

2,762

 

 

 

$

4,400

 

 

Bad debts

 

 

1,819

 

 

 

2,363

 

 

Net operating loss carryforwards

 

 

845

 

 

 

40

 

 

Other

 

 

35

 

 

 

 

 

Total deferred tax assets

 

 

5,461

 

 

 

6,803

 

 

Deferred tax liabilities

 

 

 

 

 

 

 

 

 

Goodwill

 

 

(7,877

)

 

 

(10,027

)

 

Depreciation

 

 

(1,882

)

 

 

(1,780

)

 

Prepaid expenses

 

 

(1,590

)

 

 

(1,732

)

 

Book versus tax basis difference for aircraft

 

 

(3,257

)

 

 

(2,700

)

 

Total deferred tax liabilities

 

 

(14,606

)

 

 

(16,239

)

 

Net deferred tax liability

 

 

$

(9,145

)

 

 

$

(9,436

)

 

 

From October 1, 2001 through December 20, 2004, AACACI and substantially all of its subsidiaries (the “Subchapter S Companies”) were treated for federal and most state income tax purposes as an S Corporation under the Internal Revenue Code and comparable state laws. As a result, the Subchapter S Companies’ earnings were taxed for federal and most state income tax purposes directly to AACACI’s stockholders rather than to the Subchapter S Companies. On December 21, 2004, the Subchapter S Companies terminated their status as S Corporations and are now taxed as C corporations. As a result of the termination of the Subchapter S Companies’ S corporation status, the Company recorded a net deferred tax liability and corresponding income tax expense on the termination date of $8.4 million.

As of December 31, 2004 and September 30, 2005, the Company had net operating loss carryforwards for federal and state income tax purposes totaling approximately $3.4 million and $0.7 million, respectively, which will begin to expire in 2014.

7.   Commitments and Contingencies

The Company is involved in several active lawsuits, including lawsuits arising out of actions taken by state regulatory authorities, and is involved in various other legal proceedings with state and federal regulators.

In July 2002, the Industrial Loan Commissioner for Georgia issued an examination certificate to the Company seeking to investigate whether the Company had complied with the Georgia Industrial Loan Act.

13




On August 2, 2002, the Company and BankWest, Inc. (“BankWest”), the lending bank for whom the Company acted as marketing, processing and servicing agent in Georgia, filed suit against the Commissioner in the Superior Court for Fulton County, Georgia seeking to enjoin him from enforcing the examination certificate and proceeding with an examination. In October 2005, the parties submitted a proposed order to seal certain documents and dismiss all of the actions, and are awaiting the court’s approval.

In the Spring of 2004, Georgia adopted a statute, which became effective in May 2004, that effectively prohibits payday cash advance services in that state and effectively restricts the Company’s ability to act as a marketing, processing and servicing agent for a lending bank in that state. In April 2004, the Company, along with a lending bank, BankWest, and other banks and agents involved in providing payday cash advances in Georgia, filed an action in the U.S. District Court for the Northern District of Georgia against the Attorney General of Georgia and the Georgia Secretary of State (BankWest, et al. vs. Baker, et al. or “BankWest vs. Baker”), seeking a declaration that the recently passed Georgia anti-payday cash advance law is unconstitutional and is preempted by federal law and should not be enforced. The District Court denied BankWest and the Company’s request, and BankWest and the Company subsequently suspended operations at the Company’s centers in Georgia. BankWest and the Company appealed the District Court’s order to the U.S. Court of Appeals for the Eleventh Circuit, which affirmed the District Court’s order in June 2005. BankWest and the Company and other parties filed a petition for rehearing en banc with the Eleventh Circuit in July 2005, and are awaiting a response to this petition. Net revenues from the Company’s Georgia operations were approximately $5.1 million, or 1.4% of the Company’s net revenues, for the nine months ended September 30, 2004. The Georgia centers have not generated revenue since operations were ceased in May 2004. During the three months ended September 30, 2005, the Company permanently closed all 86 remaining centers in Georgia. The lease cancellation and other closing costs were approximately $0.4 million.

Currently, the Company and certain of its officers, directors, owners and “stakeholders” are defending two putative class action lawsuits, one in North Carolina (filed in July 2004) and one in Georgia (filed August 2004), where the plaintiffs are alleging, among other things, that the Company, and not the lending bank, is the “true lender” and is therefore offering usurious payday cash advances in violation of numerous consumer protection statutes.

·       On July 27, 2004, John Kucan, Welsie Torrence and Terry Coates, each of whom was a customer of Republic Bank & Trust Company (“Republic”), the lending bank for whom the Company marketed, processed and serviced payday cash advances in North Carolina, filed a putative class action lawsuit in the General Court of Justice for the Superior Court Division for New Hanover County, North Carolina against the Company, its subsidiary that operates in North Carolina and William M. Webster, IV, the Company’s former Chief Executive Officer, alleging, among other things, that the relationship between the Company’s subsidiary that operates in North Carolina and Republic was a “rent a charter” relationship and therefore the bank was not the “true lender” on the payday cash advances. The lawsuit also claims that the payday cash advances were made, administered and collected in violation of numerous North Carolina consumer protection laws. The lawsuit seeks an injunction barring the Company from continuing to do business in North Carolina, the return of the principal amount of the payday cash advances made to the plaintiff class since August 2001, the return of any interest or fees associated with those advances, treble damages, attorneys’ fees and other unspecified costs. Thus far the only substantive motions the Company has filed are motions to (1) have the case designated as a complex business case, (2) dismiss or stay proceedings and (3) compel arbitration. In November 2004, plaintiffs filed a motion seeking class certification. Also in November 2004, the North Carolina Superior Court denied the Company’s motion to have the case designated as a complex business case and assigned to the North Carolina Business Court and instead granted the plaintiffs’ motion to designate the case as exceptional and

14




assigned to a special Superior Court judge. That ruling did not express any opinion on the merits of the case. Plaintiffs’ counsel indicated at the hearing held prior to that ruling, and in papers filed in support of their motion for class certification, that the distributions to the Company’s stockholders of substantially all of the net income earned by the Company in the form of cash dividends may be the subject of a fraudulent conveyance claim. At that hearing, plaintiffs’ counsel indicated that they might seek injunctive relief to return such payments or to hold them in escrow pending a judgment in this lawsuit. Plaintiffs’ complaint also contains a fraudulent conveyance claim but seeks no specific relief with respect to that claim. In May 2005, the judge assigned to the case issued a ruling allowing limited discovery on the issues of arbitration, personal jurisdiction and class certification. Arguments on defendants’ motions to dismiss and/or compel arbitration and plaintiff’s motion for class certification were held in October and November 2005, and the parties are waiting for a ruling on these motions. An adverse ruling in this case could have a material adverse effect on the Company’s results of operations and financial condition, including possibly forcing the Company to cease its operations in North Carolina. In addition, in September 2004, Republic filed an action in federal court in North Carolina against the three plaintiffs who have sued the Company, seeking a declaratory judgment that all disputes their customers have should be submitted to arbitration and an injunction preventing the plaintiffs from pursuing disputes in a non-arbitral forum. A motion to dismiss Republic’s lawsuit was granted in February 2005, on the grounds that Republic lacks standing. Republic subsequently filed a motion to alter or amend that decision and for reconsideration, which was denied. Republic has filed an appeal of these decisions to the U.S. Court of Appeals for the Fourth Circuit.

·       On August 6, 2004, Tahisha King and James E. Strong, who were customers of BankWest, the lending bank for whom the Company marketed, processed and serviced payday cash advances in Georgia, filed a putative class action lawsuit in the State Court of Cobb County, Georgia against the Company, its subsidiary in Georgia, William M. Webster, IV and several of the Company’s unnamed officers, directors, owners and “stakeholders,” alleging many different causes of action, most notably that the Company made illegal payday loans in Georgia in violation of Georgia’s usury law, the Georgia Industrial Loan Act and Georgia’s Racketeer Influenced and Corrupt Organizations Act. The complaint alleges that BankWest was not the “true lender” on the loans that the Company marketed, processed and serviced for BankWest in Georgia and that the Company was the “de facto” lender. The complaint seeks compensatory damages, attorneys’ fees, punitive damages and the trebling of any compensatory damages. The Company has removed the case to the U.S. District Court for the Northern District of Georgia, and filed an answer denying the allegations and asserting the defense of arbitration as well as other defenses. The plaintiffs filed a motion in September 2004 to remand the case to Georgia state court to which the Company responded. Also in September 2004, the Company filed an action in the U.S. District Court for the Northern District of Georgia against the Georgia class action plaintiffs seeking a declaratory judgment that all disputes relating to the loans by BankWest should be submitted to arbitration and that plaintiffs should be prohibited from pursuing loan related disputes in a non-arbitral forum. In December 2004, the court indicated its intention to place the Georgia cases on hold until the Eleventh Circuit issued its ruling in BankWest vs. Baker, which challenged the constitutionality of Georgia’s payday cash advance law, and Jenkins vs. First American, which involved the enforceability of an arbitration clause similar to the one at issue in the Company’s Georgia case. In February 2005, the Eleventh Circuit held in the Jenkins case that the arbitration clause was enforceable and binding on the plaintiffs. In March 2005, the court in the King and Strong case issued a formal opinion indicating that it was staying that case until the Eleventh Circuit issued its decision in BankWest vs. Baker. After the Eleventh Circuit issued its ruling upholding the District Court’s order in BankWest vs. Baker, the court in the King and Strong case issued a scheduling order and the

15




parties filed briefs regarding the Eleventh Circuit’s opinion. The Court has yet to schedule a hearing with respect to those briefs or issue a subsequent order.

The Company is involved in another case in Georgia that, although not a class action lawsuit, contains essentially the same allegations as the Tahisha King and James Strong case. On March 10, 2003, Angela Glasscock, a customer of BankWest, filed an adversary proceeding in the U.S. Bankruptcy Court for the Southern District of Georgia alleging that the Company’s subsidiary in Georgia was making payday cash advances in Georgia in violation of the Georgia Industrial Loan Act. The Company and BankWest filed a motion for summary judgment, which was granted in September 2005. In its holding, the court ruled that BankWest, not the Company, was the “true lender.” Plaintiffs have filed a notice of appeal of this ruling. Although the amount in controversy in the case is only $350, the underlying claims of Ms. Glasscock, if validated by the appellate court, could serve as a basis for future claims against the Company in Georgia.

The Company and certain of its officers, directors and employees are also defendants in two putative class-action lawsuits commenced by three of the Company’s former customers, Gerald and Wendy Betts and Donna Reuter, in Florida. The first putative class action was filed by Ms. Betts and Ms. Reuter in February 2001 in the Circuit Court of Palm Beach County against the Company’s subsidiary, McKenzie Check Advance of Florida, LLC and certain other parties. This lawsuit alleges that the Company engaged in unfair and deceptive trade practices and violated the Florida criminal usury statute, the Florida Consumer Finance Act, and Florida’s Racketeer Influenced and Corrupt Organizations Act. The suit seeks unspecified damages, and the Company could be required to refund fees and/or interest collected, refund the principal amount of payday cash advances, pay multiple damages and pay other monetary penalties. The Company successfully moved to have Ms. Reuter’s case sent to arbitration and was awarded summary judgment as to Ms. Betts’s claims. The arbitration order in Ms. Reuter’s case is currently on appeal to the Florida Supreme Court and the summary judgment order in Ms. Betts’s case was reversed in August 2004 by Florida’s Fourth District Court of Appeals. The Company is appealing to the Florida Supreme Court the Fourth District Court of Appeals’ ruling, and the parties are awaiting a ruling from the Florida Supreme Court. In May 2005, the Florida Supreme Court issued an order requesting briefing as to whether the Florida Supreme Court should summarily quash the decision ordering arbitration in light of another Florida Supreme Court decision on arbitration entitled Cardegna v. Buckeye Check Cashing, Inc., which held that a substantially similar arbitration agreement was unenforceable. In June 2005, the U.S. Supreme Court granted a writ of certiorari in the Cardegna case, and will review the case in its 2005-06 term. Consequently, this case against the Company has been stayed pending the U.S. Supreme Court review of the Florida Supreme Court’s decision in the Cardegna case.

A second Florida lawsuit was filed in August 2004 in the Circuit Court of Palm Beach County by Mr. Betts and Ms. Reuter against the Company, its subsidiary in Florida and officers and directors of the subsidiary. The allegations are nearly identical to those alleged in the lawsuit discussed in the preceding paragraph. The Company has filed motions to dismiss, to stay the proceedings pending determination of dispositive actions by the Florida Supreme Court in the original Betts and Reuter case, and to compel arbitration. Proceedings in this case have been stayed pending the disposition of the original Betts and Reuter case.

In August 2004, the North Carolina Attorney General’s Office in conjunction with the Commissioner of Banks for North Carolina issued a subpoena to the Company to produce documents, respond to written questions and have a corporate representative appear for a deposition regarding the relationship between the Company’s North Carolina subsidiary and Republic. The Company believes the primary purpose of the investigation is to determine whether the Company’s operations in North Carolina are in compliance with North Carolina law. The Company has cooperated with the investigation. The Attorney General for North Carolina as well as the class action plaintiffs in the North Carolina class action case have moved to intervene and participate in this matter. The Attorney General was granted the right to intervene and participate, and the class action plaintiffs were granted the right to submit an amicus brief. The parties

16




have submitted their briefs and evidence and are awaiting the Commissioner’s findings. During the course of the proceeding, the Commissioner issued several pre-hearing orders that clarified the scope of discovery and eliminated the possibility of retrospective relief. However, it is possible that the North Carolina Attorney General or the Commissioner of Banks for North Carolina may make a determination or finding that is adverse to the Company’s business operations in the state. Specifically, the North Carolina Attorney General and Commissioner of Banks potentially could issue an injunction or issue a cease and desist order based on the Consumer Finance Act. This could result in the imposition of fines and the alteration or cessation of the Company’s use of the agency business model in North Carolina. All North Carolina centers currently operate under the agency business model. On September 15, 2005, the lending bank for which the Company markets, processes and services payday cash advances and installment loans in its 117 centers in North Carolina temporarily suspended its payday cash advance and installment loan originations. Net revenues from the Company’s North Carolina operations were $6.5 million, or 5.3% of the Company’s net revenues, and $4.1 million, or 3.0% of the Company’s net revenues, for the three months ended September 30, 2004 and 2005, respectively. Net revenues from the Company’s North Carolina operations were $19.2 million, or 5.5% of the Company’s net revenues, and $17.4 million, or 4.5% of the Company’s net revenues, for the nine months ended September 30, 2004 and 2005, respectively. The Company estimates that it would cost, as of September 30, 2005, approximately $3.1 million (including lease cancellation costs of approximately $0.6 million, the charge-off of undepreciated cost of assets of approximately $1.2 million and other shut-down costs of approximately $1.3 million) if the Company is required to shut down its North Carolina operations completely.

In addition to the cases discussed above, the Company is also involved in other litigation and administrative proceedings. This litigation includes employee claims for workers’ compensation, wrongful termination, harassment, discrimination, payment of wages due and customer claims relating to collection practices and violations of state and/or federal consumer protection laws. The consequences of an adverse ruling in any current or future litigation or proceeding could have a material adverse effect on the Company’s results of operations and financial condition. The amount of loss, if any, cannot be reasonably estimated.

8.   Capital Stock

On May 4, 2005, the Company announced that its Board of Directors had approved a program authorizing the repurchase by the Company of up to $50 million of its currently outstanding common stock. During the three and nine months ended September 30, 2005, the Company repurchased, pursuant to its stock repurchase program, 520,958 and 888,158 shares of its common stock, respectively, at a cost of approximately $7.0 million and $11.4 million, respectively.

During the three and nine months ended September 30, 2005, the Company cancelled 13,333 and 16,666 shares, respectively, of unvested restricted stock.

In 2004, the Company adopted Statement of Financial Accounting Standards No. 123 (Revised), Share-Based Payment (“SFAS 123(R)”). Accordingly, the Company measures the cost of its share-based employee compensation at fair value and recognizes such cost in the financial statements over the requisite service period.

In August 2005, the Company granted to its new President and Chief Executive Officer options to purchase 250,000 shares of common stock in the Company. The stock options granted vest ratably over a five-year period and expire ten years from the date of grant. The stock options were granted with an exercise price equal to the market value of the Company’s common stock on the date of grant.

17




A summary of the Company’s stock option activity and weighted average exercise prices follows:

 

 

Options

 

Exercise Price

 

Outstanding, beginning of period

 

 

 

 

 

Granted

 

250,000

 

 

$

13.83

 

 

Purchased

 

 

 

 

 

Forfeited

 

 

 

 

 

Outstanding, end of period

 

250,000

 

 

$

13.83

 

 

Options exercisable

 

 

 

 

 

Shares of stock outstanding

 

83,053,446

 

 

 

 

 

 

The weighted-average fair value of the options granted was $5.53 per option and was estimated on the date of grant using the Black-Scholes option pricing model using the following assumptions: dividend yield of 2.6%, risk free interest rate of 3.94%, expected volatility of 51% and an expected life of 5.41 years. Compensation expense for the three months and nine months ended September 30, 2005 for these stock options was approximately $23,000.

9.   Transactions with Variable Interest Entity

Beginning in July 2005, the Company ceased conducting business under the agency business model in its 208 centers in Texas, and began conducting business in those centers through a wholly owned subsidiary registered as a Credit Services Organization (“CSO”) under Texas law. As a CSO, the Company offers a fee-based credit services package to assist customers in trying to improve their credit and in obtaining an extension of consumer credit through an unaffiliated third-party lender. In connection with commencing operations as a CSO in Texas, the Company has entered into a credit services agreement (“CSO Agreement”) with an unaffiliated third-party lender. The CSO Agreement governs the terms by which the Company refers customers in Texas to that lender, on a non-exclusive basis, for a possible extension of credit, processes loan applications and commits to reimburse the lender for any loans or related fees that are not collected from such customers.

Under the CSO model, the third-party lender determines whether to approve the loan and establishes all of the loan underwriting criteria. All of the terms, conditions and features of the loan agreements between the lender and the customers are determined by the lender. The customer writes a personal check payable to the lender in the amount of the loan, including interest for the anticipated duration of the loan and the CSO fee, which the Company holds on behalf of the lender pending repayment of the loan. Under the CSO Agreement, the Company agrees to reimburse the lender for the full amount of the loan and all related fees that are not paid by the customers.

When the loan becomes due, the customer returns to the CSO center to repay the loan, the Company returns the customer’s check, and the Company deposits the loan payment in the lender’s account. If the customer does not return to the CSO center to repay the loan, the Company may then begin collection efforts to obtain from the customer payment of the loan and any applicable late and non-sufficient funds (“NSF”) fees. If the Company is unsuccessful in collecting any payments for the lender, the Company will reimburse the lender, and then may continue its collection efforts with respect to all amounts due by the customer. Under the CSO Agreement, the Company is contractually obligated for all losses incurred by the lender with respect to loans it makes to customers referred by the Company.

The Company has determined that the third-party lender’s subsidiary is a variable interest entity (“VIE”) under FIN 46R. The Company has neither an equity interest nor voting rights in the lender’s subsidiary and has no input into the management of the lender’s subsidiary. However, the Company was determined to be the primary beneficiary of the VIE, due primarily to the fact that the third-party lender

18




was created for the exclusive purpose of offering loans to qualified customers referred by the Company, and the Company has committed to reimburse the lender for the full amount of the loans and all related fees that are not paid by the customers. As a result, the Company has consolidated the lender’s subsidiary as of September 30, 2005.

The impact of the consolidation of this VIE on the Company’s September 30, 2005 consolidated balance sheet was to increase cash and cash equivalents by approximately $2.9 million, increase advances and fees receivable, net by approximately $11.0 million, increase accrued liabilities by approximately $15,000 and increase non-controlling interest in variable interest entity by $13.9 million. The impact of the consolidation of this VIE on the Company’s consolidated statements of income for the three months and nine months ended September 30, 2005 was to increase net revenues by approximately $0.6 million and increase other center expenses by approximately $0.1 million, the net effect of which was an increase in income of consolidated variable interest entity of approximately $0.5 million.

10.   Subsequent Events

Subsequent to September 30, 2005, the Company repurchased 1,039,475 shares of its common stock pursuant to its stock repurchase program at a cost of approximately $13.8 million.

On October 27, 2005, the Company’s Board of Directors declared a cash dividend of $0.11 per share of common stock, payable on December 9, 2005 to shareholders of record on November 28, 2005.

On October 27, 2005, the Company granted to its new President and Chief Executive Officer, a nonqualified stock option to purchase 700,000 shares of the Company’s common stock at an exercise price of $12.11 per share, and granted him 250,000 shares of restricted common stock. The options and the restricted shares vest in eight equal annual installments beginning on the first anniversary of the grant and are subject to various terms and restrictions as specified in the related Nonqualified Stock Option Agreement and Restricted Stock Agreement. These stock options and restricted shares are outside the terms of the Company’s existing 2004 Omnibus Stock Plan (“Stock Plan”).

Additionally, on October 27, 2005, the Company granted to its Executive Vice President and Chief Financial Officer, a nonqualified stock option to purchase 250,000 shares of the Company’s common stock at an exercise price of $12.11 per share. The options vest in eight equal annual installments beginning on the first anniversary of the grant and are within the Company’s Stock Plan.

The weighted-average fair value of the 950,000 options granted on October 27, 2005 was $4.73 per option. The fair value was estimated on the date of grant using the Black-Scholes option pricing model using the following assumptions: dividend yield of 3.6%, risk-free interest rate of 4.48%, expected volatility of 50% and an expected life of 6.86 years. These options expire ten years from the date of grant.

On October 31, 2005, the Company completed the sale of one of its aircraft. As a result of this transaction, the Company recorded an impairment of the carrying value of the aircraft for approximately $1.5 million during the quarter ended September 30, 2005. For tax purposes, the Company will recognize a gain of approximately $5.8 million in the fourth quarter of 2005.

19




ITEM 2.                MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes in “Item 1. Financial Statements.” This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated by these forward-looking statements. Please see “—Risk Factors” and “—Forward-Looking Statements” for discussions of the uncertainties, risks and assumptions associated with these statements.

Overview

Headquartered in Spartanburg, South Carolina, we are the largest provider of payday cash advance services in the United States as measured by the number of centers operated. Our centers provide, directly or on behalf of a lending bank, small-denomination, short-term, unsecured cash advances that are typically due on the customers’ next payday. As of September 30, 2005, we operated 2,598 centers in 37 states.

In most states in which we conduct business, we make payday cash advances directly to our customers (which we refer to as the standard business model). In other states in which we conduct business, we act as a marketing, processing and servicing agent through our centers for FDIC insured, state-chartered banks that make payday cash advances and installment loans to their customers pursuant to the authority of the laws of the states in which they are located and federal interstate banking laws, regulations and guidelines (which we refer to as the agency business model). In the agency business model, we refer to the banks for which we act as agent as the lending banks.

We ceased conducting business under the agency business model in our 208 centers in Texas in the beginning of July 2005 and our 86 centers in Michigan at the end of June 2005, and began conducting business in our Texas centers as a Credit Services Organization (“CSO”), and in our Michigan centers as a provider of check-cashing and deferred presentment services. As a CSO, we offer a fee-based credit services package to assist customers in trying to improve their credit and in obtaining an extension of consumer credit through an unaffiliated third-party lender. Our operations in Michigan of check-cashing services are similar to our operations under our standard business model. The amount of the fee charged by us varies based on whether the check cashed is a government check, a payroll check or a personal check, and for a personal check we charge interest for the period of time that we agree with the customer to hold the check before presenting it to the bank. Beginning in late June 2005, we have included our Michigan centers, in which we now offer check-cashing services, in our standard business model. As of July 2005, we have also included our Texas centers, in which we now operate as a CSO, in our standard business model.

As of September 30, 2005, we were making payday cash advances directly to customers under the standard business model in 2,350 of our 2,598 centers in 34 states, including our now 87 centers in Michigan, and serving as agent for the lending banks under the agency business model in our 248 centers located in Arkansas, North Carolina and Pennsylvania. On September 15, 2005, the lending bank for which we market, process and service payday cash advances and installment loans in our 117 centers in North Carolina temporarily suspended its payday cash advance and installment loan originations. We continue to service all payday cash advances and installment loans that are currently outstanding in North Carolina.

20




We have historically derived our revenues from (1) fees and/or interest paid to us directly by our customers under the standard business model, including, beginning in July 2005, in our capacity as a CSO, and (2) marketing, processing and servicing fees paid to us by the lending banks under the agency business model. For the payday cash advances and installment loans made and funded by the lending banks from their own bank accounts and marketed, processed and serviced by us under the agency business model, all payments of principal and fees and/or interest paid by customers are deposited directly to the account of the respective lending bank. We in turn are paid a marketing, processing and servicing fee by the lending bank after we send it an invoice. Our total revenues for the three and nine month periods ended September 30, 2004 and 2005 consisted of (in millions):

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2004

 

2005

 

2004

 

2005

 

 

 

Dollars

 

%

 

Dollars

 

%

 

Dollars

 

%

 

Dollars

 

%

 

Fees and interest charged to customers

 

$

115.7

 

76.2

 

$

153.1

 

88.7

 

$

311.4

 

75.9

 

$

373.0

 

80.9

 

Marketing, processing and servicing fees

 

36.2

 

23.8

 

19.5

 

11.3

 

99.1

 

24.1

 

88.3

 

19.1

 

Total revenues

 

$

151.9

 

100.0

 

$

172.6

 

100.0

 

$

410.5

 

100.0

 

$

461.3

 

100.0

 

 

Our expenses relate primarily to the operation of our centers. These expenses include salaries and related payroll costs, occupancy expense related to our leased centers, center depreciation expense, advertising expense and other center expenses that consist principally of costs related to center openings and closings, communications, delivery, supplies, travel, bank charges, various compliance and collection costs and costs associated with theft.

21




Centers.   The following table lists the number of centers by state at December 31, 2004 and September 30, 2005:

State

 

 

 

December 31,
2004

 

September 30,
2005

 

Alabama

 

 

127

 

 

 

139

 

 

Arizona

 

 

49

 

 

 

51

 

 

Arkansas(1)

 

 

30

 

 

 

30

 

 

California

 

 

290

 

 

 

293

 

 

Colorado

 

 

56

 

 

 

60

 

 

Delaware

 

 

10

 

 

 

13

 

 

Florida

 

 

173

 

 

 

187

 

 

Idaho

 

 

8

 

 

 

12

 

 

Illinois

 

 

61

 

 

 

61

 

 

Indiana

 

 

91

 

 

 

111

 

 

Iowa

 

 

21

 

 

 

30

 

 

Kansas

 

 

 

 

 

31

 

 

Kentucky

 

 

33

 

 

 

38

 

 

Louisiana

 

 

64

 

 

 

71

 

 

Michigan(1)

 

 

87

 

 

 

87

 

 

Mississippi

 

 

51

 

 

 

53

 

 

Missouri

 

 

62

 

 

 

67

 

 

Montana

 

 

8

 

 

 

8

 

 

Nebraska

 

 

25

 

 

 

27

 

 

Nevada

 

 

10

 

 

 

10

 

 

New Hampshire

 

 

15

 

 

 

16

 

 

New Mexico

 

 

12

 

 

 

12

 

 

North Carolina(1)(2)

 

 

118

 

 

 

117

 

 

North Dakota

 

 

 

 

 

4

 

 

Ohio

 

 

178

 

 

 

196

 

 

Oklahoma

 

 

68

 

 

 

67

 

 

Oregon

 

 

42

 

 

 

50

 

 

Pennsylvania(1)

 

 

101

 

 

 

101

 

 

Rhode Island

 

 

 

 

 

3

 

 

South Carolina

 

 

105

 

 

 

109

 

 

South Dakota

 

 

10

 

 

 

10

 

 

Tennessee

 

 

59

 

 

 

58

 

 

Texas(1)

 

 

204

 

 

 

208

 

 

Virginia

 

 

109

 

 

 

115

 

 

Washington

 

 

90

 

 

 

106

 

 

Wisconsin

 

 

37

 

 

 

43

 

 

Wyoming

 

 

4

 

 

 

4

 

 

Total

 

 

2,408

 

 

 

2,598

 

 


(1)          We have operated under the agency business model in Arkansas and North Carolina since April 14, 2001 and September 12, 2001, respectively. Prior to these dates, we operated in Arkansas and North Carolina under the standard business model. We have operated in Pennsylvania only under the agency business model. We operated in Texas under the agency business model until July 2005, when we started operating as a CSO. We have operated in Michigan under the standard business model since June 27, 2005. Prior to this date, we operated in Michigan under the agency business model.

22




(2)          We are currently facing certain litigation and regulatory proceedings in North Carolina that may ultimately cause us to stop acting as marketing, processing and servicing agent for a lending bank in that state. On September 15, 2005, the lending bank for which we market, process and service payday cash advances and installment loans in our 117 centers in North Carolina temporarily suspended its payday cash advance and installment loan originations. We continue to service all payday cash advances and installment loans that are currently outstanding in North Carolina.

New               centers.   We opened 87 and 82 new centers during the three months ended September 30, 2004 and 2005, respectively. We opened 346 and 208 new centers during the nine months ended September 30, 2004 and 2005, respectively.

Closed centers.   We closed 7 (including 2 in Georgia) and 93 (including 86 in Georgia) centers during the three months ended September 30, 2004 and 2005, respectively. We closed 8 (including 2 in Georgia) and 107 (including 86 in Georgia) centers during the nine months ended September 30, 2004 and 2005, respectively. The expenses related to closing centers typically include the undepreciated costs of fixtures and signage that cannot be moved and reused at another center, moving costs, severance payments and any lease cancellation costs. We recorded expenses related to closed centers of approximately $0.1 million and $0.7 million in the three months ended September 30, 2004 and 2005, respectively, and approximately $0.1 million and $1.0 million in the nine months ended September 30, 2004 and 2005, respectively.

In May 2004, a Georgia law became effective that prohibits payday cash advance services in the state and restricts our ability to act as marketing, processing and servicing agent for a lending bank in the state. See “Item 1. Financial Statements—Notes to Interim Unaudited Consolidated Financial Statements—Note 7. Commitments and Contingencies.” Accordingly, we suspended operations at our 89 (all of which were subsequently closed) centers in Georgia. Net revenues from our Georgia operations were approximately $5.1 million, or 1.4% of the Company’s net revenues, for the nine months ended September 30, 2004. Our Georgia operations have not generated revenue since operations were ceased in May 2004. During the three months ended September 30, 2005, we permanently closed 86 centers in Georgia. The lease cancellation and other closing costs were approximately $0.4 million.

The following is a summary of the financial information for our operations in Georgia for the three and nine months ended September 30, 2004 and 2005 (in thousands):

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2004

 

2005

 

2004

 

2005

 

Georgia Revenues:

 

 

 

 

 

 

 

 

 

Marketing, processing and servicing fees

 

$

 

$

 

$

7,102

 

$

 

Provision for agency bank losses

 

(545

)

 

(2,008

)

 

Net revenues

 

(545

)

 

5,094

 

 

Georgia Center Expenses:

 

 

 

 

 

 

 

 

 

Salaries and related payroll costs

 

763

 

43

 

3,855

 

216

 

Occupancy costs

 

603

 

470

 

1,802

 

1,543

 

Center depreciation expense

 

159

 

 

483

 

 

Advertising expense

 

 

 

523

 

 

Other center expenses

 

233

 

652

 

1,028

 

871

 

Total center expenses

 

1,758

 

1,165

 

7,691

 

2,630

 

Georgia Center Gross Profit/(Loss)

 

$

(2,303

)

$

(1,165

)

$

(2,597

)

$

(2,630

)

 

On August 26, 2004, the North Carolina Attorney General’s office, in conjunction with the Commissioner of Banks for North Carolina, issued us a subpoena to produce documents, respond to written questions and have a corporate representative appear for testimony regarding the relationship

23




between our North Carolina subsidiary and Republic, the lending bank for whom we acted as marketing, processing and servicing agent in North Carolina, and has since commenced a Notice of Hearing to determine if our activities in North Carolina are in contravention to North Carolina law. See “Item 1. Financial Statements—Notes to Interim Unaudited Consolidated Financial Statements—Note 7. Commitments and Contingencies.” All North Carolina centers currently operate under the agency business model. However, on September 15, 2005, the lending bank for which we market, process and service payday cash advances and installment loans in our 117 centers in North Carolina temporarily suspended its payday cash advance and installment loan originations. We continue to service all payday cash advances and installment loans that are currently outstanding in North Carolina.

Net revenues from our North Carolina operations were $6.5 million, or 5.3% of our net revenues, and $4.1 million, or 3.0% of our net revenues, for the three months ended September 30, 2004 and 2005, respectively. Net revenues from our North Carolina operations were $19.2 million, or 5.5% of our net revenues, and $17.4 million, or 4.5% of our net revenues, for the nine months ended September 30, 2004 and 2005, respectively. We estimate that it would cost, as of September 30, 2005, approximately $3.1 million (including lease cancellation costs of approximately $0.6 million, the charge-off of undepreciated cost of assets of approximately $1.2 million and other shut-down costs of approximately $1.3 million) if we are required to shut down our North Carolina operations completely as a result of this investigation.

The following is a summary of financial information for our operations in North Carolina for the three and nine months ended September 30, 2004 and 2005 (in thousands):

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2004

 

2005

 

2004

 

2005

 

North Carolina Revenues:

 

 

 

 

 

 

 

 

 

Marketing, processing and servicing fees

 

$

8,176

 

$

6,096

 

$

22,305

 

$

20,976

 

Provision for agency bank losses

 

(1,694

)

(2,036

)

(3,146

)

(3,548

)

Net revenues

 

6,482

 

4,060

 

19,159

 

17,428

 

North Carolina Center Expenses:

 

 

 

 

 

 

 

 

 

Salaries and related payroll costs

 

2,042

 

2,615

 

6,529

 

7,084

 

Occupancy costs

 

865

 

851

 

2,558

 

2,531

 

Center depreciation expense

 

115

 

125

 

364

 

359

 

Advertising expense

 

312

 

344

 

898

 

917

 

Other center expenses

 

476

 

530

 

1,390

 

1,378

 

Total center expenses

 

3,810

 

4,465

 

11,739

 

12,269

 

North Carolina Center Gross Profit

 

$

2,672

 

$

(405

)

$

7,420

 

$

5,159

 

 

Revised FDIC Guidance

On March 1, 2005, the FDIC issued Revised Guidance (“Revised Guidance”) to FDIC insured institutions that offer payday cash advances, including the lending banks for which we then acted as an agent. The Revised Guidance limits the frequency of customer usage of payday cash advances and limits the period that a customer may have payday cash advances outstanding from any lender to an aggregate of three months during the previous 12-month period. Based on an average term of approximately 15 days, this effectively limits the number of payday cash advances that may be made to any customer to six advances during any 12-month period. All payday cash advances made from any lender would count against this limit. In response to the Revised Guidance, lending banks are offering alternative longer-term credit products, which have generally taken the form of installment loans.

24




In late June and early July 2005, we underwent several operational changes in the five states where we conducted business under the agency business model as a result of the Revised Guidance. These changes affected our operations in Arkansas, Michigan, North Carolina, Pennsylvania and Texas.

We historically operated in Pennsylvania as a marketing, processing and servicing agent for BankWest, Inc., a South Dakota bank (“BankWest”), in Arkansas as a marketing, processing and servicing agent for Venture Bank, a Washington bank (“Venture”), and in North Carolina as a marketing, processing, and servicing agent for Republic Bank & Trust, a Kentucky bank (“Republic”). Effective July 1, 2005, we amended our marketing, processing and servicing agreement (‘MP&S Agreement”) with BankWest with respect to Pennsylvania, primarily to allow us to also act as a marketing, processing and servicing agent for a new installment loan product offered by BankWest in our 101 centers in Pennsylvania. On June 30, 2005, we terminated our MP&S Agreement with Venture and we entered into a new MP&S Agreement with First Fidelity Bank, a South Dakota bank (“First Fidelity Bank”), to operate as a marketing, processing and servicing agent for payday cash advances and installment loans made by First Fidelity Bank in our 30 centers in Arkansas. Effective July 6, 2005, we terminated our MP&S Agreement with Republic and entered into a new MP&S Agreement with First Fidelity Bank to operate as a marketing, processing and servicing agent for payday cash advances and installment loans made by First Fidelity Bank in our 117 centers in North Carolina. On September 15, 2005, First Fidelity Bank temporarily suspended its payday cash advance and installment loan originations in North Carolina. We continue to service all payday cash advances and installment loans that are currently outstanding in North Carolina.

Pursuant to our MP&S Agreements with First Fidelity Bank, First Fidelity Bank is contractually obligated for all losses on payday cash advances and installment loans to its customers in Arkansas and North Carolina. Under our terminated MP&S Agreements with Venture and Republic, those lending banks were contractually obligated for the losses on their payday cash advances in an amount established as a percentage of the fees and interest charged by the lending banks to their customers. Therefore, under the terminated agreements with Venture and Republic, we were obligated if actual payday cash advance losses exceeded the respective lending bank’s contractual obligations. We remain obligated in North Carolina and Arkansas for the existing advances and fees receivable in excess of the prior lending bank’s contractual obligations.

Under the terms of the new MP&S Agreements with BankWest and First Fidelity Bank, payday cash advances are offered in Pennsylvania, Arkansas and North Carolina (prior to the suspension) by the lending banks within the limits of the Revised Guidance. In response to the Revised Guidance, the lending banks also offer installment loans to their customers for which we also act as marketing, processing and servicing agent. The installment loans generally have bi-weekly payments amortized over a three- or four-month period. The lending banks establish all of the underwriting criteria and utilize third-party credit scores to determine whether to approve an installment loan for a customer. All of the terms, conditions and features of the installment loan agreements between the lending banks and their customers are determined by the lending banks. The lending banks fund all loans, and we do not expect to purchase or participate in the loans. We deposit, on behalf of the lending banks, all repayments of installment loans, interest and fees in the lending banks’ accounts, and the lending banks pay to us our marketing, processing and servicing fees for the installment loans.

Depending on the lending bank, fees charged to the customer for the installment loan product range from $55 to $65 per $100 advance plus an additional origination fee of $25 to $30 per transaction. Although the total fee is higher than for a payday cash advance, total revenues are reduced because of the longer duration of the installment product. The Revised Guidance limits the number of payday cash advances that may be made and requires more stringent underwriting standards to qualify for the installment loan. Accordingly, we generally expect our marketing, processing and servicing fee to decrease by approximately 20% to 40% in the states where we continue to operate under the agency business model. It is difficult for us to predict, however, what those revenues may be given the numerous uncertainties

25




associated with predicting consumer demand for a new product; with anticipating the effect of new underwriting standards for that product by the lending banks; and with marketing, processing and servicing a new product. Arkansas, North Carolina and Pennsylvania, the states in which we operated under the agency business model during the quarter ended September 30, 2005, represented an aggregate of approximately 11% and 13% of our total revenues for the three and nine-month periods ended September 30, 2005, respectively. Going forward, we expect that less than 10% of our revenues will be derived from the agency business model in these three states.

Information for our centers operating under the agency business model for the three and nine months ended, and as of, September 30, 2004 and 2005 was as follows (in thousands, except centers):

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2004(1)(2)

 

2005(2)

 

2004(1)(2)

 

2005(2)

 

Agency Business Model Revenues:

 

 

 

 

 

 

 

 

 

 

 

Marketing, processing and servicing fees

 

 

$

36,208

 

 

$

19,476

 

$

99,091

 

$

88,327

 

Provision for agency bank losses

 

 

(6,149

)

 

(1,636

)

(13,709

)

(10,732

)

Net revenues

 

 

30,059

 

 

17,840

 

85,382

 

77,595

 

Agency Business Model Center Expenses: