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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
 FORM 10-QSB [X]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE PERIOD ENDED JUNE 30, 2004
 [   ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO _________.
 Commission file number: 0-26680 NICHOLAS FINANCIAL, INC. (Exact name of registrant as specified in its Charter)
 British Columbia, Canada
(State or Other Jurisdiction of
Incorporation or Organization)
    
    8736-3354
(I.R.S. Employer
Identification No.)
 2454 McMullen Booth Road, Building C
Clearwater, Florida
(Address of Principal Executive Offices)
    
    33759
(Zip Code)
 (727) 726-0763  (Registrants telephone number, including area code)
 Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 and 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter periods that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X]
            No
[   ]. As of July 31, 2004,
there were 6,487,288 shares of common stock outstanding.




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NICHOLAS FINANCIAL,
INC. FORM 10-QSB TABLE OF CONTENTS PagePart I. Financial InformationItem 1. Financial Statements (Unaudited)Condensed Consolidated Balance Sheet as of June 30, 2004
    
    
    2Condensed Consolidated Statements of Income for the three months ended June 30, 2004 and 2003
    
    
    3Condensed Consolidated Statements of Cash Flows for the three months ended June 30, 2004 and 2003
    
    
    4Notes to the Condensed Consolidated Financial Statements
    
    
    5Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    11Item 3. Controls and Procedures
    
    
    22Part II. Other InformationItem 6. Exhibits and Reports on Form 8-K
    
    
    23Amendment No.4 to Loan AgreementSection 302 Certification of the President & CEOSection 302 Certification of the CFOSection 906 Certification of the President & CEOSection 906 Certification of the CFO
  1




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PART I. FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL
STATEMENTS Nicholas Financial, Inc. 
 Condensed Consolidated Balance Sheet (Unaudited) June 30,2004AssetsCash
    
    $
    1,781,256Finance receivables, net
    
    
    102,031,237Accounts receivable
    
    
    14,487Assets held for resale
    
    
    629,539Prepaid expenses and other assets
    
    
    429,981Property and equipment, net
    
    
    584,676Derivatives
    
    
    3,848Deferred income taxes
    
    
    3,125,271Total assets
    
    $
    108,600,295LiabilitiesLine of credit
    
    $
    60,060,290Drafts payable
    
    
    630,263Notes payable  related party
    
    
    1,000,530Accounts payable
    
    
    4,344,272Income taxes payable
    
    
    1,390,544Deferred revenues
    
    
    1,150,575Total liabilities
    
    
    68,576,474Shareholders equityPreferred stock, no par: 5,000,000 shares authorized;
none issued and outstanding
    
    
    Common stock, no par: 50,000,000 shares authorized;
6,487,288 shares issued and outstanding
    
    
    14,644,249Accumulated other comprehensive income
    
    
    2,395Retained earnings
    
    
    25,377,177Total shareholders equity
    
    
    40,023,821Total liabilities and shareholders equity
    
    $
    108,600,295
 See accompanying notes. 2




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Nicholas Financial, Inc. 
 Condensed Consolidated Statements of Income (Unaudited) Three months endedJune 302004
    
    2003Revenue:Interest income on finance receivables
    
    $
    7,214,258
    
    
    $
    5,988,473Sales
    
    
    62,397
    
    
    
    71,5587,276,655
    
    
    
    6,060,031Expenses:Cost of sales
    
    
    14,811
    
    
    
    17,074Marketing
    
    
    196,626
    
    
    
    211,232Administrative
    
    
    2,894,708
    
    
    
    2,315,877Provision for credit losses
    
    
    580,846
    
    
    
    579,999Depreciation
    
    
    49,538
    
    
    
    69,718Interest expense
    
    
    915,320
    
    
    
    987,3284,651,849
    
    
    
    4,181,228Operating income before income taxes
    
    
    2,624,806
    
    
    
    1,878,803Income tax expense:Current
    
    
    1,410,987
    
    
    
    1,452,031Deferred
    
    
    (418,573
    )
    
    
    (739,203
    )992,414
    
    
    
    712,828Net income
    
    $
    1,632,392
    
    
    $
    1,165,975Earnings per share  basic
    
    $
    0.29
    
    
    $
    0.23Earnings per share  diluted
    
    $
    0.27
    
    
    $
    0.22
 See accompanying notes. 3




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Nicholas Financial, Inc. 
 Condensed Consolidated Statements of Cash Flows (Unaudited) Three months ended June 302004
    
    2003Operating activitiesNet income
    
    $
    1,632,392
    
    
    $
    1,165,975Adjustments to reconcile net income to net cash provided
by operating activities:Depreciation
    
    
    49,538
    
    
    
    69,718Provision for credit losses
    
    
    580,846
    
    
    
    579,999Deferred income taxes
    
    
    (418,573
    )
    
    
    (739,203
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    (2,564
    )
    
    
    3,078Prepaid expenses, other assets and assets held for resale
    
    
    (96,155
    )
    
    
    (123,750
    )Accounts payable and other liabilities
    
    
    579,228
    
    
    
    240,776Income taxes payable
    
    
    1,264,926
    
    
    
    1,406,031Deferred revenues
    
    
    77,692
    
    
    
    (7,721
    )Net cash provided by operating activities
    
    
    3,667,330
    
    
    
    2,594,903Investing activitiesPurchase and origination of finance contracts
    
    
    (21,004,123
    )
    
    
    (17,619,385
    )Principal payments received
    
    
    15,628,556
    
    
    
    13,555,378Purchase of property and equipment, net of disposals
    
    
    (68,652
    )
    
    
    (112,200
    )Net cash used in investing activities
    
    
    (5,444,219
    )
    
    
    (4,176,207
    )Financing activitiesIssuance (repayment) of notes payable  related party
    
    
    319,000
    
    
    
    (1,142
    )Net (repayment) proceeds from line of credit
    
    
    (7,450,000
    )
    
    
    1,800,000(Decrease) increase in drafts payable
    
    
    (280,838
    )
    
    
    27,040Sale of common stock, net of offering costs
    
    
    10,012,299
    
    
    
    7,480Net cash provided by financing activities
    
    
    2,600,461
    
    
    
    1,833,378Net increase in cash
    
    
    823,572
    
    
    
    252,074Cash, beginning of period
    
    
    957,684
    
    
    
    481,211Cash, end of period
    
    $
    1,781,256
    
    
    $
    733,285
 See accompanying notes. 4




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Nicholas Financial, Inc. 
 Notes to the Condensed Consolidated Financial Statements (Unaudited) June 30, 2004 1. Basis of Presentation The accompanying unaudited condensed consolidated financial statements of
Nicholas Financial, Inc. (including its subsidiaries, the Company) have been prepared in accordance with
accounting principles generally accepted in the United States for interim
financial information and with the instructions to Form 10-QSB pursuant to the
Securities and Exchange Act of 1934, as amended in Article 10 of Regulation SB.
Accordingly, they do not include all of the information and footnotes required
by accounting principles generally accepted in the United States for complete
financial statements. 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 fiscal year ending March
31, 2005. For further information, refer to the condensed consolidated
financial statements and footnotes thereto included in the Companys Annual
Report on Form 10-KSB for the year ended March 31, 2004, as filed with the
Securities and Exchange Commission on June 29, 2004. 2. Revenue Recognition 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 60 days or more or the collateral is repossessed,
whichever is earlier. The Company attributes all of its dealer discount and a portion of unearned
income to a reserve for credit losses. Such amounts reduce the interest
recognized over the life of the contract. The Company receives a commission for
selling add-on services to consumer borrowers and amortizes the commission, net
of the related costs, over the term of the loan using the interest method. The
Companys net fees charged for processing a loan are recognized as an
adjustment to the yield and are amortized over the life of the loan using the
interest method. The amount of future unearned income represents the amount of finance charges
the Company expects to fully earn over the life of the current portfolio, and
is computed as the product of the contract rate, the contract term, and the
contract amount. The Company aggregates the contracts purchased during a
three-month period for all of its branch locations. After the analysis of
purchase date accounting is complete, any uncollectable amounts would be
contemplated in the allowance for credit losses. 5




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Nicholas Financial, Inc. Notes to the Condensed Consolidated Financial Statements (Unaudited) 3. Earnings Per Share Basic earnings per share excludes any dilutive effects of common stock
equivalents such as options, warrants, and convertible securities. Diluted
earnings per share includes the effects of dilutive options, warrants, and
convertible securities. Basic and diluted earnings per share have been computed
as follows: Three months endedJune 30,2004
    
    2003Numerator for earnings per share  net income
    
    $
    1,632,392
    
    
    $
    1,165,975Denominator:Denominator for basic earnings per share 
weighted average shares
    
    
    5,669,552
    
    
    
    5,006,926Effect of dilutive securities:Employee stock options
    
    
    394,070
    
    
    
    293,532Denominator for diluted earnings per share
    
    
    6,063,622
    
    
    
    5,300,458Earnings per share  basic
    
    $
    0.29
    
    
    $
    0.23Earnings per share  diluted
    
    $
    0.27
    
    
    $
    0.22
 6




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Nicholas Financial, Inc. Notes to the Condensed Consolidated Financial Statements (Unaudited) 4. Finance Receivables Finance receivables consist of automobile finance installment
contracts (Contracts) and
direct consumer loans and are detailed as follows: Finance
receivables, gross Contracts
    
    $
    164,713,489Less: Unearned interest
    
    
    (39,450,090
    )Finance receivables, net of unearned interest
    
    
    125,263,399Dealer discounts
    
    
    (16,817,392
    )Allowance for credit losses
    
    
    (6,414,770
    )Finance receivables, net
    
    $
    102,031,237
 The terms of the receivables range from 12 to 66 months and bear a weighted
average effective interest rate of approximately 24%. 5. Line of Credit The Company has a $85 million Line of Credit facility (the Line) which expires
on November 30, 2006. The Company may borrow the lesser of $85 million or
amounts based upon formulas principally related to a percentage of eligible
finance receivables, as defined. Borrowings under the Line may be under various
LIBOR pricing options or at the prime rate plus twenty-five basis points. Prime
rate based borrowings are generally less than $5 million. Pledged as collateral
for this credit facility are all of the assets of the Companys
Nicholas Financial, Inc. subsidiary. As
of June 30, 2004 the amount outstanding under the line was
approximately $60.1 million and the amount available under the
Line was
approximately $24.9 million. As of June 30, 2004 the Company was in full
compliance with all debt covenants thereunder. 6. Notes Payable - Related Party The Companys notes payable consist of unsecured notes bearing interest at
5.90% with principal and interest due within 30-days upon demand. The notes
totaled $1,000,530 at June 30, 2004 and are payable to a related party. 7




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Nicholas Financial, Inc. Notes to the Condensed Consolidated Financial Statements (Unaudited) 7. Derivatives and Hedging The Company is party to interest rate swap agreements which are derivative
instruments. For derivative instruments that are designated and qualify as a
cash flow hedge (i.e., hedging the exposure to variability in expected future
cash flows that is attributable to a particular risk, such as interest rate
risk), the effective portion of the gain or loss on the derivative instrument
is reported as a component of comprehensive income and reclassified into
earnings in the same period or periods during which the hedged transaction
affects earnings. The remaining gain or loss on the derivative instrument in
excess of the cumulative change in the present value of the future cash flows
of the hedged item, if any, is recognized in current earnings during the period
of change. The Company has entered into interest rate swap agreements that effectively
convert a portion of its floating-rate debt to a fixed-rate basis, thus
reducing the impact of interest rate changes on future interest expense. At
June 30, 2004 $50 million of the Companys borrowings were designated as
hedged items to interest rate swap agreements. Under the swap and
dept agreements,
the Company received an average variable rate of 3.51% and 3.56% and paid an
average fixed rate of 5.75% and 6.35% during the three months ended June 30,
2004 and 2003, respectively. A gain of $3,848 related to the fair value of the
swaps at June 30, 2004 has been recorded in the caption derivatives on the
balance sheet. Accumulated other comprehensive income at June 30, 2004 in the
amount of $2,395 represents the after-tax effect of the derivative income.
Amounts of net income or losses on derivative instruments expected to be
reclassified from comprehensive income to earnings in the next 12 months are
not expected to be material. The Company has also entered into one forward
locking swap included in the table below. The Company has entered into the following cash-flow hedges: Fixed RateDate Entered
    
    Effective Date
    
    Notional Amount
    
    Of Interest
    
    Maturity DateOctober 5, 2001
    
    October 5, 2001
    
    $
    10,000,000
    
    
    
    3.85
    %
    
    October 5, 2004June 28, 2002
    
    June 28, 2002
    
    $
    10,000,000
    
    
    
    3.83
    %
    
    July 2, 2005January 6, 2003
    
    April 2, 2003
    
    $
    10,000,000
    
    
    
    3.35
    %
    
    April 2, 2007January 31, 2003
    
    August 1, 2003
    
    $
    10,000,000
    
    
    
    3.20
    %
    
    August 2, 2006February 26, 2003
    
    May 17, 2004
    
    $
    10,000,000
    
    
    
    3.91
    %
    
    May 19, 2008March 11, 2004
    
    October 5, 2004
    
    $
    10,000,000
    
    
    
    3.64
    %
    
    October 5, 2009
 The Company utilizes the above noted interest rate swaps to manage its interest
rate exposure. The swaps effectively convert a portion of the Companys
floating rate debt to a fixed rate, more closely matching the interest rate
characteristics of the Companys finance receivables. There has historically
been no ineffectiveness associated with the Companys hedges. 8




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Nicholas Financial, Inc. Notes to the Condensed Consolidated Financial Statements (Unaudited) 7. Derivatives and Hedging (continued) The following table reconciles net income with comprehensive income. Three months ended June 30,2004
    
    2003Net Income
    
    $
    1,632,392
    
    
    $
    1,165,975Mark to market
interest rate
swaps (net of tax)
    
    
    1,067,737
    
    
    
    (264,269
    )Comprehensive income
    
    $
    2,700,129
    
    
    $
    901,706
 8. Stock Options The Company has an employee stock incentive plans (the SIP) for officers,
directors and key employees. The Company is authorized to grant options for up
to 940,000 common shares under the SIP, of which 200,766 shares were
remaining available
for future grants as of June 30, 2004. Options currently granted by the Company
generally vest over a five-year period. As permitted under Statement of Financial Accounting Standards (SFAS) No. 148,
Accounting for Stock-Based Compensation - Transaction and
Disclosure, which
amended SFAS 123, Accounting for Stock-Based Compensation, the Company has
elected to continue to follow the intrinsic value method in accounting for its
stock-based employee compensation arrangements as defined by Accounting
Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to
Employees, and related interpretations including FASB Interpretation No. 44,
Accounting for Certain Transactions Involving Stock Compensation, an
interpretation of APB. 25. No stock-based employee compensation cost is
reflected in operations, as all options granted under those plans have an
exercise price equal to or above the market value of the underlying common
stock on the date of grant. The fair value method uses the Black-Scholes option-pricing model to determine
compensation expense associated with the Companys options. The
following table
illustrates the effect on net income and net income per share if the Company
had applied the fair value recognition provisions of SFAS 123 to stock-based
employee compensation: Three Months Ended June
30,2004
    
    2003Net income
    
    $
    1,632,392
    
    
    $
    1,165,975Basic earnings per share
    
    $
    0.29
    
    
    $
    0.23Fully diluted earnings per share
    
    $
    0.27
    
    
    $
    0.22Stock based employee compensation cost
under the Fair Value Method
    
    $
    12,037
    
    
    $
    12,012Pro forma net income
    
    $
    1,620,355
    
    
    $
    1,153,963Pro forma basic earnings per share
    
    $
    .29
    
    
    $
    .23Pro forma fully diluted earnings per share
    
    $
    .27
    
    
    $
    .22
 9




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Nicholas Financial, Inc. Notes to the Condensed Consolidated Financial Statements (Unaudited) 9. Contingencies For discussion of certain legal proceedings to which the Company is a party,
see Item 3 in the Companys Annual Report on Form 10-KSB for the fiscal year
ended March 31, 2004, as filed with the Securities and Exchange
Commission on June 29, 2004. 10. Subsequent events On August 11, 2004 the Companys Board of Directors approved the payment of a cash
dividend of $0.10 per share, payable semi-annually. The first cash
dividend of $0.05 per share will be payable
to shareholders of record as of August 28, 2004, with a payment date of September 30, 2004. The second cash dividend of $0.05 per share of
common stock will be payable when and as determined by the Board of Directors, provided that the Companys future earnings meet expectations and written
approval can be obtained from the Companys consortium of lenders. 10




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward-Looking Information This Form 10-QSB contains
various statements, other than those concerning historical
information,
that are based on managements beliefs and assumptions, as well as information
currently available to management, and should be considered
forward-looking statements. This notice is intended to take advantage
of the safe harbor provided by the Private Securities Litigation
Reform Act of 1995 with respect to such forward-looking statements. When used in this document, the words
anticipate, estimate, expect, and similar expressions are intended to
identify forward-looking statements. Although the Company believes that the
expectations reflected in such forward-looking statements are reasonable, it
can give no assurance that such expectations will prove to be correct. Such
statements are subject to certain risks, uncertainties and assumptions. Should
one or more of these risks or uncertainties materialize, or should underlying
assumptions prove incorrect, actual results may vary materially from those
anticipated, estimated or expected. Among the key factors that may have a
direct bearing on the Companys operating results are fluctuations in the
economy, the degree and nature of competition, demand for consumer financing in
the markets served by the Company, the Companys products and services,
increases in the default rates experienced on Contracts, adverse regulatory
changes in the Companys existing and future markets, the Companys ability to
expand its business, including its ability to complete acquisitions and
integrate the operations of acquired businesses, to recruit and retain
qualified employees, to expand into new markets and to maintain profit margins
in the face of increased pricing competition. Introduction Consolidated net income
increased to $1,632,392 for the three-month period ended June
30, 2004 as compared to $1,165,975 for the three-month period ended
June 30, 2003. Earnings were favorably impacted by an increase in the
outstanding loan portfolio, a reduction in the average cost of borrowed funds
and a reduction in the charge-off rate. The Companys software subsidiary,
Nicholas Data Services (NDS), did not contribute significantly to consolidated
operations in the three month periods ended June 30, 2004 or 2003. 11




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Three months ended June 30,Select Portfolio Information
    
    2004
    
    2003Average finance receivables, net of
unearned interest (1)
    
    $
    123,025,445
    
    
    $
    107,212,467Average indebtedness (2)
    
    
    63,714,820
    
    
    
    62,239,301Finance revenue (3)
    
    
    7,214,258
    
    
    
    5,988,473Interest expense
    
    
    915,320
    
    
    
    987,328Net finance revenue
    
    
    6,298,938
    
    
    
    5,001,145Weighted average contractual rate (4)
    
    
    24.29
    %
    
    
    24.10
    %Average cost of borrowed funds (2)
    
    
    5.75
    %
    
    
    6.35
    %Gross portfolio yield (5)
    
    
    23.46
    %
    
    
    22.34
    %Interest expense as a percentage of
average finance receivables, net of
unearned interest
    
    
    2.98
    %
    
    
    3.68
    %Provision for credit losses as a
percentage of average finance
receivables, net of unearned interest
    
    
    1.89
    %
    
    
    2.16
    %Net portfolio yield (5)
    
    
    18.59
    %
    
    
    16.50
    %Operating expenses as a percentage of
average finance receivables, net of
unearned interest (6)
    
    
    10.04
    %
    
    
    9.43
    %Pre-tax yield as a percentage of average
finance receivables, net of unearned
interest (7)
    
    
    8.55
    %
    
    
    7.07
    %Write-off to liquidation (8)
    
    
    5.46
    %
    
    
    7.76
    %Net charge-off percentage (9)
    
    
    4.65
    %
    
    
    6.64
    %
 12




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(1)
    
    Average finance receivables, net of unearned interest, represents the
average of gross finance receivables, less unearned interest throughout
the period.  (2)
    
    Average indebtedness represents the average outstanding borrowings under
the Line and notes payable-related party. Average cost of borrowed funds
represents interest expense as a percentage of average indebtedness.  (3)
    
    Finance revenue does not include revenue generated by NDS.
See page 14 for
detail on NDS revenue for the three months ended June 30, 2004 and 2003,
respectively.  (4)
    
    Weighted average contractual rate represents the weighted average annual
percentage rate (APR) of all Contracts purchased and direct loans
originated during the three months ended June 30, 2004 and 2003,
respectively.  (5)
    
    Gross portfolio yield represents finance revenues as a percentage of
average finance receivables, net of unearned interest. Net portfolio yield
represents finance revenue minus (a) interest expense and (b) the
provision for credit losses as a percentage of average finance
receivables, net of unearned interest.  (6)
    
    Operating expenses represent total expenses, less interest expense, the
provision for credit losses and operating costs associated with NDS. See
page 14 for detail on NDS operating expenses for the three months ended
June 30, 2004 and 2003, respectively.  (7)
    
    Pre-tax yield represents net portfolio yield minus operating expenses as
a percentage of average finance receivables, net of unearned interest.  (8)
    
    Write-off to liquidation percentage is defined as net charge-offs divided
by liquidation. Liquidation is defined as beginning receivable balance
plus current period purchases minus voids and refinances minus ending
receivable balance.  (9)
    
    Net charge-off percentage represents net charge-offs divided by average
finance receivables, net of unearned interest, outstanding during the
period. Note:All three month key performance indicators expressed as percentages have
been annualized. 13




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Three months ended June 30, 2004 compared to three months ended June 30, 2003 Finance Revenue and Loan Portfolio Finance revenue increased 20%
to $7.2 million for the three-month period ended June 30,
2004, from $6.0 million for the corresponding period ended June 30, 2003. Average finance
receivables, net of unearned interest equaled $123.0 million for the three-month period
ended June 30, 2004, an increase of 15% from $107.2 million
for the corresponding period
ended June 30, 2003. The primary reason average finance receivables, net of
unearned interest increased was the increase in the receivable base of several
existing branches and the opening of three additional branch locations. The
gross finance receivable balance increased 15% to $164.7 million at June 30,
2004 from $143.2 million at June 30, 2003. The primary reason interest income
increased was the increase in the outstanding loan portfolio. The gross
portfolio yield increased from 22.34% for the period ended June 30, 2003 to
23.46% for the three-month period ended June 30, 2004. The net portfolio yield increased
from 16.50% for the three-month period ended June 30, 2003 to
18.59% for the corresponding period ended
June 30, 2004. The primary reasons for the increase in the net portfolio yield
was a decrease in charge-offs and a reduction in the cost of borrowed funds for
the period ended June 30, 2004. The net charge-off percentage for the three-month period
ended June 30, 2004 was 4.65% as compared to 6.64% for the
corresponding period ended June 30,
2003. Computer Software Business Sales for the three-month period ended June 30, 2004 were $62,397 compared to $71,558
for the corresponding period ended June 30, 2003, a decrease of 13%. This decrease was
primarily due to lower revenue from the existing customer base during the
period ended June 30, 2004. Cost of sales and operating expenses decreased from
$86,555 for the three-month period ended June 30, 2003 to
$69,123 for the corresponding period ended June
30, 2004. Operating Expenses Operating expenses, excluding provision for credit losses and interest
expense and costs associated with NDS, increased to $3.1 million
for the three month period
ended June 30, 2004 from $2.5 million for the corresponding period ended June 30, 2003. This
increase of 22% was primarily attributable to the additional staffing of
several existing branches, increased general operating expenses and the opening
of three additional branch offices. Operating expenses as a percentage of
finance receivables, net of unearned interest increased from 9.43% for the
three-month period ended June 30, 2003 to 10.04% for the
corresponding period ended June 30, 2004. Interest Expense Interest expense decreased to $915,320 for the three-month period ended June 30, 2004
as compared to $987,328 for the corresponding period ended June 30, 2003. The average
indebtedness for the three-month period ended June 30, 2004 increased to $63.7 million
as compared to $62.2 million for the corresponding period ended June 30, 2003.
The effect of this in crease on the Companys interest expense
was more than
offset by a decrease in the average cost of borrowed funds from 6.35% during
the three months ended June 30, 2003 to 5.75% during the three months ended
June 30, 2004. 14




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##### Table of Contents



Contract Procurement The Company purchases Contracts in the seven states listed in the table below. The Company
has been expanding its Contract procurement in South Carolina, Michigan and
Virginia. See  Future Expansion below. The Contracts purchased by the Company
are predominately for used vehicles; for the three-months periods ended June 30, 2004 and 2003, respectively,  less than 3% were new. As of June 30, 2004, the average model
year collateralizing the portfolio was a 1999 vehicle. The amounts shown in the tables below represent information on finance
receivables, net of unearned interest of Contracts purchased. Three Months Ended June 30,State
    
    2004
    
    2003Florida
    
    $
    11,020,839
    
    
    $
    10,148,495Georgia
    
    
    2,510,543
    
    
    
    2,331,056North Carolina
    
    
    2,153,230
    
    
    
    1,998,035South Carolina
    
    
    1,134,618
    
    
    
    760,698Ohio
    
    
    3,251,208
    
    
    
    3,125,301Michigan
    
    
    951,131
    
    
    
    455,534Virginia
    
    
    1,377,750
    
    
    
    17,040Total
    
    $
    22,399,319
    
    
    $
    18,836,159
 Indirect Contracts
    
    Three Months Ended June 30,Purchased
    
    2004
    
    2003Purchases
    
    $
    22,399,319
    
    
    $
    18,836,159Weighted APR
    
    
    24.11
    %
    
    
    23.90
    %Average Discount
    
    
    8.76
    %
    
    
    8.96
    %Weighted average
Term (months)
    
    
    44
    
    
    
    44Average Loan
    
    $
    8,275
    
    
    $
    8,186Number of Contracts
    
    
    2,707
    
    
    
    2,301
 Loan Origination The following table presents information on direct loans originated by
the Company, net of unearned interest. Direct Loans
    
    Three Months Ended June 30,Originated
    
    2004
    
    2003Originations
    
    $
    1,155,523
    
    
    $
    941,223Weighted APR
    
    
    26.13
    %
    
    
    26.50
    %Weighted average
Term (months)
    
    
    26
    
    
    
    27Average Loan
    
    $
    3,001
    
    
    $
    2,878Number of Loans
    
    
    385
    
    
    
    327
 15




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##### Table of Contents



Analysis of Credit Losses Because of the nature of the customers under the Companys Contracts, the
Company considers the establishment of adequate reserves for credit losses to
be imperative. The Company segregates its Contracts into static pools for
purposes of establishing reserves for losses. All Contracts purchased by a
branch during a fiscal quarter comprise a static pool. The Company pools
Contracts according to branch location because the branches purchase Contracts
in different geographic markets. This method of pooling by branch and quarter
allows the Company to evaluate the different markets where the branches
operate. The pools also allow the Company to evaluate the different levels of
customer income, stability, credit history, and the types of vehicles purchased
in each market. Each such static pool consists of the Contracts purchased by a
Company branch office during a fiscal quarter. As of June 30, 2004, the Company had 517 active static pools. The average pool consisted of 71
Contracts with aggregate finance receivables, net of unearned interest, of
approximately $574,000. 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 or the maximum interest rate at which the customer will
accept. In certain markets, competitive forces will drive down Contract rates
from the maximum allowable rate to a level where an individual competitor is willing to
buy an individual Contract. The Company only buys Contracts on an individual
basis and never purchases Contracts in batches, although the Company does
consider portfolio acquisitions as part of its growth strategy. A dealer discount represents the difference between the finance
receivable, net of unearned interest, of a Contract, and the amount of money
the Company actually pays for the Contract. The discount negotiated by the
Company is a function of the credit quality of the customer and the wholesale
value of the vehicle. The automotive dealer accepts these terms by executing a
dealer agreement with the Company. The entire amount of discount is related to
credit quality and is considered to be part of the credit loss reserve. The
Company utilizes a static pool approach to track portfolio performance. A
static pool retains an amount equal to 100% of the discount as a reserve for
credit losses. In situations where, at the date of purchase, the discount is
determined to be insufficient to absorb all potential losses associated with
the static pool, a portion of future unearned income associated with that
specific static pool will be added to the reserves for credit losses until
total reserves have reached the appropriate level. Subsequent to the purchase,
if the reserve for credit losses is determined to be inadequate for a static
pool which is not fully liquidated, then a charge to income through the
provision is used to reestablish adequate reserves. If a static pool is fully
liquidated and has any remaining reserves, the excess reserves are immediately
recognized into income. For static pools not fully liquidated, that are
determined to have excess reserves, such excess amounts are accreted into
income over the remaining life of the static pool. Reserves accreted into
income for the three months ended June 30, 2004 were approximately $885,000 as
compared to $525,000 for the three months ended June 30, 2003. The primary
reason for this increase in the three months ended June 30, 2004 as compared to
the three months ended June 30, 2003 was a decrease in the net charge-off
percentage from 6.64% to 4.65%. The Company has detailed underwriting guidelines it utilizes to determine
which Contracts to purchase. These guidelines are specific and are designed to
cause all of the Contracts that the Company purchases to have common risk
characteristics. The Company utilizes its District Managers to evaluate their
respective branch locations for adherence to these underwriting guidelines. The
Company also utilizes an internal audit department to assure adherence to its
underwriting guidelines. The Company utilizes the branch model, which allows
for Contract purchasing to be done on the branch level. Each Branch Manager may
interpret the guidelines differently and as a result, the common risk
characteristics tend to be the same on an individual branch level but not
necessarily compared to another branch. In analyzing a static pool, the Company considers the performance of prior
static pools originated by the branch office, the performance of prior
Contracts purchased from the dealers whose Contracts are included in the
current static pool, the credit rating of the customers under the Contracts in
the static pool, and current market and economic conditions. Each static pool
is analyzed monthly to determine if the loss reserves are adequate and
adjustments are made if they are determined to be necessary. 16




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##### Table of Contents



The Company experienced lower losses during the three months ended June
30, 2004 as compared to the three months ended June 30, 2003. This resulted in
static pools having reserves in excess of estimates currently needed to
liquidate these pools. The Company is in the process of accreting these excess
reserves from these more mature static pools over their remaining life. Static
pools originated during the fiscal year ended March 31, 2004 have seen losses
lower than their most recent predecessors; however, there can be no assurances
that this trend will continue. The Companys overall reserve percentage has
increased from 13.48% of gross finance receivables as of June 30, 2003 to
14.10% of gross finance receivables as of June 30, 2004. The following table sets forth a reconciliation of the changes in dealer
discount on Contracts. Three months ended June 30,2004
    
    2003Balance at beginning of period
    
    $
    15,377,582
    
    
    $
    12,394,089Discounts acquired on new volume
    
    
    3,680,806
    
    
    
    3,067,849Losses absorbed
    
    
    (1,673,850
    )
    
    
    (1,856,531
    )Recoveries
    
    
    317,829
    
    
    
    277,063Discounts accreted
    
    
    (884,974
    )
    
    
    (524,125
    )Balance at end of period
    
    $
    16,817,393
    
    
    $
    13,358,345Dealer discounts as a percent of gross
indirect contracts
    
    
    10.51
    %
    
    
    9.62
    %
 The following table sets forth a reconciliation of the changes in the
allowance for credit losses on Contracts. Three months ended June 30,2004
    
    2003Balance at beginning of period
    
    $
    5,787,764
    
    
    $
    5,428,681Current period provision
    
    
    547,701
    
    
    
    519,454Losses absorbed
    
    
    (110,533
    )
    
    
    (212,015
    )Balance at end of period
    
    $
    6,224,932
    
    
    $
    5,736,120Allowance as a percent of gross
indirect contracts
    
    
    3.89
    %
    
    
    4.13
    %
 The following table sets forth a reconciliation of the changes in the
allowance for credit losses on direct loans. Three months ended June 30,2004
    
    2003Balance at beginning of period
    
    $
    184,334
    
    
    $
    176,126Current period provision
    
    
    26,644
    
    
    
    60,545Losses absorbed
    
    
    (27,760
    )
    
    
    (41,250
    )Recoveries
    
    
    6,619
    
    
    
    5,595Balance at end of period
    
    $
    189,837
    
    
    $
    201,016Allowance as a percent of gross
direct loan receivables
    
    
    4.02
    %
    
    
    4.62
    %
 17




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##### Table of Contents



The following table summarizes the total amounts of Discounts and
Allowances for both Contracts and direct loans. Three months ended June 30,2004
    
    2003Total Discounts and Allowances at end of
period
    
    $
    23,232,162
    
    
    $
    19,295,481Discounts and Allowances as a percent of
gross receivables
    
    
    14.10
    %
    
    
    13.48
    %
 The average dealer discount associated with new volume for the three
months ended June 30, 2004 and 2003 were 8.76% and 8.96%, respectively. The
Company does not consider this change to be material, and such changes were not
the result of any change in buying philosophy or competition. The provision for credit losses increased to approximately $580,000 for
the three months ended June 30, 2004 as compared to approximately $547,000 for
the three months ended June 30, 2003. The Companys losses as a percentage of
liquidation decreased from 7.76% for the three months ended June 30, 2003 to
5.46% for the three months ended June 30, 2004. The Company anticipates losses
as a percentage of liquidation will be in the 8-10% range during the
remainder of the
current fiscal year. The longer term outlook for portfolio performance will
depend on the overall economic conditions, the unemployment rate and the
Companys ability to monitor, manage and implement its underwriting philosophy
in additional geographic areas as it strives to continue its expansion. The
Company does not believe there have been any significant changes in loan
concentrations, terms or quality of Contracts purchased during the three months
ended June 30, 2004 that would have contributed to the decrease in losses. Recoveries as a percentage of charge-offs were 17.9% and 13.4% for the
three months ended June 30, 2004 and 2003, respectively. The Company believes
that as it continues to expand its operations, it will become more difficult to
implement its loss recovery model in geographic areas further away from its
Corporate headquarters, and as a result, the Company will likely experience
declining recovery rates over the long term. Reserves accreted into income for the three months ended June 30, 2004 and
2003 were approximately $885,000 and $524,000, respectively. The amount and
timing of reserves accreted into income is a function of individual static pool
performance. The Company has seen improvement in the performance of its Contract
portfolio, more specifically, newer static pools have seen a slight decrease in
the default rate when compared to the preceding year pool performance during their same
liquidation cycle. The Company attributes this decrease to an improvement in
overall general economic conditions. The U.S. unemployment rate has dropped slightly over the past year. The
Company believes there is a correlation between the unemployment rate and
future portfolio performance. The Company does not expect the U.S. unemployment
rate to rise or fall significantly in the foreseeable future. Therefore the
Company does not plan on increasing or decreasing reserves based on the current
U.S. unemployment rate. The number of voluntary repossessions decreased
slightly for the three months ended June 30, 2004 as compared to the three
months ended June 30, 2003. The Company believes its percentage of voluntary
repossessions will stabilize in the current fiscal year, and as a result,
management believes that the Companys current reserve levels are adequate for
the foreseeable future. The number of bankruptcy filings
by Company customers decreased slightly
during the three months ended June 30, 2004 as compared to the three months
ended June 30, 2003. The Company believes the percentage of bankruptcy filings
 as a percentage of active receivables will stabilize in the current fiscal
year, and as a result, management believes that the Companys current reserve
levels are adequate for the foreseeable future. 18




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##### Table of Contents



The amount of future unearned income represents the amount of finance
charges the Company expects to fully earn over the life of its current Contract
portfolio, and is computed as the product of the Contract rate, the Contract
term, and the Contract amount. After the analysis of purchase date accounting
with respect to static pools is complete, any uncollectable amounts would be
contemplated in the allowance for credit losses. The following tables present certain information regarding the delinquency
rates experienced by the Company with respect to Contracts and under its direct
consumer loan program: At June 30, 2004
    
    At June 30, 2003ContractsGross Balance Outstanding
    
    $
    159,986,743
    
    
    $
    138,823,707
 Dollar
    
    
    
    
    
    DollarDelinquencies
    
    Amount
    
    Percent
    
    Amount
    
    Percent30 to 59 days
    
    $
    2,704,294
    
    
    
    1.68
    %
    
    $
    2,647,022
    
    
    
    1.91
    %60 to 89 days
    
    
    539,691
    
    
    
    0.34
    %
    
    
    736,415
    
    
    
    0.53
    %90 + days
    
    
    219,687
    
    
    
    0.14
    %
    
    
    307,405
    
    
    
    0.22
    %Total Delinquencies
    
    $
    3,463,672
    
    
    
    2.16
    %
    
    $
    3,690,842
    
    
    
    2.66
    %Direct LoansGross Balance Outstanding
    
    $
    4,726,746
    
    
    
    
    
    
    $
    4,346,709Delinquencies30 to 59 days
    
    $
    26,903
    
    
    
    0.57
    %
    
    $
    49,582
    
    
    
    1.14
    %60 to 89 days
    
    
    20,089
    
    
    
    0.43
    %
    
    
    12,760
    
    
    
    0.29
    %90 + days
    
    
    26,998
    
    
    
    0.57
    %
    
    
    38,609
    
    
    
    0.89
    %Total Delinquencies
    
    $
    73,990
    
    
    
    1.57
    %
    
    $
    100,951
    
    
    
    2.32
    %
 The delinquency percentage for contracts more than thirty days past due
for the three months ended June 30, 2004 was 2.17% as compared to 2.66% for the
three months ended June 30, 2003. The delinquency percentage for direct loans
more than thirty days past due for the three months ended June 30, 2004 was
1.57% as compared to 2.32% for the three months ended June 30, 2003. The
Company does not give significant consideration to short-term trends in
delinquency percentages when evaluating reserve levels. Delinquency percentages
tend to be very volatile and often are not necessarily an indication of future
losses. The Company estimates future portfolio performance by considering
various factors, the most significant of which are described as follows. The
Company analyzes historical static pool performance for each branch location
when determining appropriate reserve levels. The Company utilizes internal
branch audits as an indication to future static pool performance. The Company also considers such things
as the current unemployment rate in markets the Company operates in, the
percentage of voluntary repossessions as compared to prior periods, the
percentage of bankruptcy filings as compared to prior periods and other leading
economic indicators. 19




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##### Table of Contents



Income Taxes The provision for income taxes increased 24% to $992,414 for the three
months ended June 30, 2004 from $712,828 for the three months ended June 30,
2003, primarily as a result of higher pre-tax income. The Companys effective
tax rate decreased from 37.94% for the three months ended June 30, 2003 to
37.81% for the three months ended June 30, 2004. Liquidity and Capital Resources The Companys cash flows for the three months ended June 30, 2004 and June 30,
2003 are summarized as follows: Three months ended
    
    Three months endedJune 30,
    
    June 30,2004
    
    2003Cash provided by (used in):Operating Activities -
    
    $
    3,667,330
    
    
    $
    2,594,903Investing Activities - (primarily purchase of Contracts)
    
    
    (5,444,219
    )
    
    
    (4,176,207
    )Financing Activities
    
    
    2,600,461
    
    
    
    1,833,378Net increase in cash
    
    
    823,572
    
    
    
    252,074
 The Companys primary use of working capital for the three months ended
June 30, 2004 was the funding of the purchase of Contracts. The Contracts were
financed substantially through borrowings under the Companys $85.0 million
Line. The Line is secured by all of the assets of the Companys Nicholas Financial, Inc. subsidiary. The
Company may borrow the lesser of $85.0 million or amounts based upon formulas
principally related to a percentage of eligible finance receivables, as
defined. Borrowings under the Line may be under various LIBOR pricing options
or at the prime rate plus twenty-five basis points. Prime rate based borrowings
are generally less than $5.0 million. As of June 30, 2004, the amount
outstanding under the Line was approximately $60.1 million and the amount
available under the Line was approximately $24.9 million. As of June 30, 2004,
the Company was in full compliance with all debt covenants thereunder. The Company has entered into interest rate swap agreements, each of which
effectively converts a portion of the Companys floating-rate debt to a
fixed-rate, thus reducing the impact of interest rate change on the Companys
interest expense. At June 30, 2004, approximately 83% of the Companys
borrowings under the Line were subject to interest rate swap agreements. These
swap agreements have maturities ranging from October 5, 2004 through October 5,
2009. The self-liquidating nature of Contracts and other loans enables the
Company to assume a higher debt-to-equity ratio than in most businesses. The
amount of debt the Company incurs from time to time under these financing
mechanisms depends on the Companys need for cash and ability to borrow under
the terms of the Line. The Company believes that borrowings available under the
Line as well as cash flow from operations will be sufficient to meet its short
term funding needs. In late May and early June 2004, the Company closed the sale of an
aggregate of 1,400,000 shares of its common stock at a public offering price of
$8.00 per share. The net proceeds of the offering, approximately $9.9 million,
was used to pay down the Companys Line. In addition, approximately 900,000
shares of common stock were sold in the offering by a group of selling
shareholders. Ferris, Baker Watts, Incorporated served as the underwriter for
the offering. 20




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##### Table of Contents



The Company completed Amendment No. 4 to its Line on June 30, 2004. This
amendment increased the amount of the Line from $75.0 million to $85.0 million
and extends the maturity date from November 30, 2004 to November 30, 2006. Future Expansion The Company currently operates
in seven states through a total of thirty-two branch locations, including sixteen in
Florida, five in Ohio, four in North Carolina, three in Georgia, two in South Carolina,
 and one in each Michigan and Virginia. Each office is budgeted (size of
branch, number of employees and location) to handle up to 1,000 accounts and up
to $7.5 million in outstanding receivables. To date none of our branches has
reached this capacity. The Company currently intends to continue its expansion through the
purchase of additional Contracts and the expansion of its direct consumer loan
program. In order to increase the size of the Companys portfolio of
Contracts, it will be necessary for the Company to open additional branch
offices and increase the size of its Line, either with its current
lender or another lender. The Company, from time to time, has and will meet
with investment bankers and financial institutions discussing various
strategies to meet the future needs of the Company. The Company believes that
opportunity for growth continues to exist in Ohio, Michigan, and Virginia and
intends to continue its expansion activities in those states. The Company is
currently expanding its automobile financing program in the State of Virginia.
The Company has targeted additional locations within the State of Virginia
where it believes there is a sufficient market for its automobile financing
program. The Company is currently purchasing Contracts in the State of
Virginia utilizing employees who resides in the State of Virginia. These
employees are developing their respective markets in Virginia and the Company
is utilizing its Central Buying Office at its Corporate Headquarters to
purchase, process and service these Contracts. The Companys strategy is to
monitor these new markets and ultimately decide where and when to open actual
branch locations. No assurances can be given, however,
that the Company will be able to continue to expand, or if it does continue to expand,
that it will be able to do so profitably. The Company is also analyzing other markets in states
the Company does not currently operate in, however no assurance can be given
that any expansion will occur in these new markets. Recently Issued Accounting Standards In October 2003, the AICPA issued SOP 03-3, Accounting for Loans or
Certain Debt Securities Acquired in a Transfer. SOP 03-3 applies to a loan
with evidence of deterioration in credit quality subsequent to its origination
that is acquired by completion of a transfer (as defined in SOP 03-3), for
which it is probable at acquisition of such loan, that the acquirer will be
unable to collect all contractually required payments receivable. SOP 03-3
requires that the acquirer recognize the excess of all cash flows expected at
acquisition over the investors initial investment in the loan as interest
income on a level-yield basis over the life of the loan as the accretable
yield. The loans contractual required payments receivable in excess of the
amount of its cash flows expected at acquisition (nonaccretable difference)
should not be recognized as an adjustment to yield, a loss accrual or a
valuation allowance for credit risk. Subsequent increases in cash flows
expected to be collected generally would be recognized prospectively through
adjustment of the loans yield over its remaining life. Decreases in cash flows
expected to be collected would be recognized as impairment. SOP 03-3 is
effective for loans acquired in fiscal years beginning after December 31, 2004.
Management is currently evaluating the provisions of SOP 03-3. 21




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##### Table of Contents



Item 3. Controls and Procedures Evaluation of disclosure controls and procedures. In accordance with Rule 13a-15(b) of the Securities Exchange Act
of 1934 (the Exchange Act), as of the end of the period covered by this Quarterly Report on Form 10-QSB, the
Companys management evaluated, with the participation of the Companys President and Chief Executive Officer
and Senior Vice President - Finance and Chief Financial Officer, the effectiveness of the design and operation of the
Companys disclosure controls and procedures (as defined in rule 13a-15(e) under the Exchange Act). Based upon
their evaluation of these disclosure controls and procedures, the President and Chief Executive Officer and the
Senior Vice President-finance and Chief Financial Officer have concluded that the disclosure controls and
procedures were effective as of the date of such evaluation to ensure that material information relating to the
Company, including its consolidated subsidiaries, was made known to them by others within those entities,
particularly during the period in which this Quarterly Report on Form
10-QSB was being prepared. Changes in internal controls. There was no change in the Companys internal control over financial reporting that
occurred during the Companys first quarter that has materially affected, or is reasonably likely to materially affect, the Companys internal control
over financial reporting 22




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##### Table of Contents



PART II  OTHER INFORMATION 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit No.
    
    Description10.1
    
    Amendment No. 4 to Loan Agreement, dated June 30, 200431.1
    
    Certification of President and Chief Executive Officer Pursuant of Section 302 of the Sarbanes-Oxley Act of 200231.2
    
    Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 200232.1
    
    Written Statement of the Chief Executive Officer Pursuant to 18 U.S.C. § 135032.2
    
    Written Statement of the Chief Financial Officer Pursuant to 18 U.S.C. § 1350
 (b) Reports on Form 8-K. On April 9, 2004, the Company
filed a current report on Form 8-K reporting that it planned to offer approximately
1,500,000 shares of common stock in a public offering. In addition,
approximately 900,000 shares of common stock would be offered by a group of
selling shareholders. On April 27, 2004, the
Company filed a current report on Form 8-K reporting that the defendant in a deficiency
action brought by the Company has filed a counterclaim in Cleveland Municipal
Court. On May 6, 2004, the
Company filed a current report on Form 8-K including a press release
reporting the Companys financial results for the
fourth quarter and full year ended March 31, 2004. On May 14, 2004, the
Company filed a current report on Form 8-K reporting the pricing of its public offering of common
stock at $8.00 per share. On June 9, 2004, the
Company filed a current report on Form 8-K reporting that it had closed the sale of an
additional 300,000 shares of its common stock in connection with the exercise
of the over-allotment option granted to the underwriter of the Companys recent
common stock offering. 23




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##### Table of Contents



SIGNATURES In accordance with the requirements of the Securities Act of 1934, the
Registrant
caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. NICHOLAS FINANCIAL, INC.
(Registrant) Date: August 14, 2004
    
    /s/ Peter L. VosotasPeter L. VosotasChairman of the Board, President,Chief Executive Officer and DirectorDate: August 14, 2004
    
    /s/ Ralph T. FinkenbrinkRalph T. FinkenbrinkSr. Vice President  Finance,Chief Financial Officer and Director
 24




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##### Table of Contents



EXHIBIT INDEX Exhibit No.
    
    Description10.1
    
    Amendment No. 4 to Loan Agreement, dated June 30, 200431.1
    
    Certification of President and Chief Executive Officer Pursuant of Section 302 of the Sarbanes-Oxley Act of 200231.2
    
    Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 200232.1
    
    Written Statement of the Chief Executive Officer Pursuant to 18 U.S.C. § 135032.2
    
    Written Statement of the Chief Financial Officer Pursuant to 18 U.S.C. § 1350
 E-1