ITEM 1. BUSINESS
General
We originate and service consumer loans, and provide other financial products and services on a worldwide basis, exclusively to active duty or retired career U.S. military personnel or U.S. Department of Defense employees. We make direct loans to our customers through our network of retail sales offices and via the Internet. We also purchase retail installment contracts from retail merchants that sell consumer goods to active duty or retired career U.S. military personnel or U.S. Department of Defense employees. We are not associated with, nor are we endorsed by, the U.S. military or U.S. Department of Defense. However, we do seek to maintain a positive, supportive relationship with the military community. In fact, in July 2005, we were named one of only 15 organizations nationwide to earn the prestigious Secretary of Defense Employer Support Freedom Award, which recognizes companies that show "extraordinary support" for employees who serve in the National Guard Reserves. In addition, we were one of three non-Fortune 500 companies who earned the honor of being a top "military friendly employer" in the Veteran's Day edition of the G.I. Jobs magazine. We also champion various pieces of legislature in support of military families such as those that set a ceiling on interest rates that can be charged to military service members and those that oppose predatory lending practices. Through sponsorship and underwriting of U.S. military programs and educational efforts, we actively support initiatives aimed at improving the quality of life for U.S. military personnel and their families. Our operations and financial products are also designed to meet the needs of these military service personnel. We also offer credit life and credit accident and health insurance to our loan customers, to be purchased at their discretion. This insurance is issued by a non-affiliated insurance company. Furthermore, we sell roadside assistance packages and discount healthcare cards to our loan customers, to be purchased at their discretion. These products are issued by an non-affiliated third party.
Generally, all managers and a majority of associates in our retail offices have earned a CCRR certification, Certified Credit Report Reviewer, by the Institute of Consumer Financial Education, a third party non-profit organization. In addition some of our managers have received, or are working towards becoming Accredited Financial Counselors "AFC" as designated by the Association for Financial Counseling and Planning Education, which is also a third party non-profit organization that is created to promote the education and training of professionals in financial management. Through this certification, an AFC is endorsed as a financial counselor who has certified skills to assist individuals and families through the process of financial decision making, while maintaining the highest ethical standards as written in the AFC Code of Ethics, and seeking up-to-date knowledge through continuing education in the fields of personal finance and financial counseling.
Our lending subsidiaries originate and service direct consumer loans made to customers referred by our retail office network and our unaffiliated strategic partners. Some subsidiaries also purchase retail installment contracts generated by merchants when active duty or retired career U.S. military personnel or U.S. Department of Defense employees purchase consumer goods. As of September 30, 2005:
o We have three full service lending subsidiaries strategically located throughout the United States. Our lending subsidiaries are responsible for all direct lending activity. They receive applications from customers, make all underwriting decisions, generate loan documents and necessary disclosures, prepare loan disbursements, maintain loan documentation and service outstanding direct loans. If a customer is approved for a loan, in addition to loan disclosures, he or she receives information regarding credit insurance. If the customer chooses to purchase this insurance, licensed insurance agent employees of the lending subsidiary sell this protection on behalf of an unaffiliated insurance company.
o We have another lending subsidiary that also originates and services loans to customers primarily via the Internet. It also originates loans to customers referred by a German subsidiary. Our Internet lending capability allows customers to apply online via the Internet and receive loan proceeds electronically. If a customer is approved and accepts the loan offer, loan proceeds are generally deposited into the customer's bank account within 24 hours. This lending subsidiary also sells credit life insurance and credit accident and health insurance products over the Internet to customers who choose this option. The lending activities of this subsidiary have increased in the past year because we entered into third party marketing agreements in October 2003 with companies who market and sell products over the Internet to military service members. These agreements have expanded our ability to help additional military customers who need financing to effectuate Internet purchases as well as other needs. Either party may terminate these agreements after 30 days written notice.
o We have another subsidiary that operates our retail network of 24 offices located in 14 states. Our retail network offices are located in close proximity to, but not on, U.S. military installations. They are typically located in retail strip shopping centers. We continually review our retail network to determine how to best deploy our resources and look for opportunities for expansion. Our locations were strategically selected based on several criteria including market size of military installation, convenience and growth and profitability opportunities. The retail network refers loans to our lending subsidiaries and sells various financial products and services, which are designed for military personnel to purchase at their option. These products include referrals for installment loans and mortgages, roadside assistance packages and discount healthcare cards. At no charge to our customers, our retail offices also provide credit bureau analysis, child fingerprinting cards, tax services discounts, video e-mail, military email.com, copying, fax, notary, voter registration and financial education courses. These courses include a program called Break the Debt Cycle training that we developed to help military families move toward financial independence. To further support our education initiatives, we offer discounted tuition rates for service members and their families from an accredited university to assist in completion of a college degree on-line. Our retail network refers customers to our lending subsidiaries and expedites the loan application process. None of our retail offices will expedite a loan application process for residents of the state in which the office is located, unless we have a lending license in that state.
o We also have subsidiaries that purchase individual, and portfolios of, retail installment contracts, which meet our quality standards and return on investment objectives from approximately 77 retail merchants. Retail installment contracts are finance receivable notes generated by a single purchase of consumer goods by active duty or retired career U.S. military personnel or U.S. Department of Defense employees. We generally acquire these contracts without recourse to the originating merchant. However, most retail merchant reserve agreements allow us to withhold funds from the merchant's proceeds to create reserves to be used in the event a customer defaults and the loan is deemed uncollectable. Retail installment contracts generally have maximum terms of 48 months.
o Our day-to-day collection activities are generally performed by our lending subsidiaries. Once an account reaches a certain delinquency level or the customer becomes a civilian or declares bankruptcy, the account is serviced by our collection subsidiary.
As discussed under "Insurance Operations" below, we have a subsidiary that reinsures a portion of the accident and health credit insurance issued by an unaffiliated insurance company in connection with loans we make.
Our subsidiaries' activities are supported by a centralized support services subsidiary that provides the following services:
o Finance and accounting services o Human resources and recruiting services
o Information technology services o Marketing and solicitation services
Customers
We exclusively market and sell financial services and products to persons who are, at the time the loan or sale is made, active duty or retired career U.S. military personnel or U.S. Department of Defense employees. In general, our customers are unable to obtain traditional financing from banks, credit unions or savings and loan associations due to factors such as their age, likelihood of relocation and lack of credit history.
In general, customers use our direct loans for purchases of appliances, furniture, household electronics and other durable goods, emergency expenses, vacations, auto purchases and debt consolidation. These borrowers are attracted to our loan products as a result of being referred to us by an existing customer or by our marketing efforts. Retail installment contracts are another source of loan customers. These customers have demonstrated an apparent need to finance a retail purchase and a willingness to use credit. After we purchase a retail installment contract, we often contact the customer using various solicitation methods. We invite the customer to visit one of our retail network offices to discuss their overall financial needs and consider our other products and services.
Seasonality
Our highest finance receivable demand occurs generally from October through December, our first fiscal quarter. From January to March, our second fiscal quarter, demand is generally lower and repayments higher. Demand is generally stable in the third and fourth quarters. Consequently, we experience mild seasonal fluctuations in our cash requirements during our first and second quarters.
Lending Activities
In general, our loans are under $10,000, repayable in equal monthly installments and have terms no longer than 48 months. In evaluating the creditworthiness of potential customers, we primarily examine the individual's debt to income ratio, discretionary income, military rank, time served in the military and prior credit experience. Loans are limited to amounts that the customer can reasonably be expected to repay from that discretionary income. Loan repayment terms are generally structured to repay the entire loan prior to the customer's estimated separation from the military. However, because we cannot predict when or whether a customer may unexpectedly leave the military or when or whether other events could occur which result in us not being repaid prior to a customer's departure from the military, we cannot implement any policy or procedure to ensure that we are repaid prior to the time our customers leave the military.
A risk in all consumer lending and retail sales financing transactions is the customer's unwillingness or inability to repay obligations. Unwillingness to repay is usually evidenced by a consumer's historical credit repayment record. An inability to repay occurs after our initial credit evaluation and funding and usually results from lower income due to early separation from the military or reduction in rank, major medical expenses, or divorce. Occasionally, these types of events are so economically severe that the customer files for protection under the bankruptcy laws. We use standard underwriting guidelines at the time the customer applies for a loan to help minimize the risk of unwillingness or inability to repay. These guidelines are developed from past customer credit repayment experience and are periodically revalidated based on current portfolio performance. We use these guidelines to predict the relative likelihood of credit applicants repaying their obligation to us. We extend credit to those consumers who fit our underwriting guidelines. The amount and interest rate of the loan or retail sales finance transaction are based upon the estimated credit risk assumed.
All of our customers are required to complete standardized credit applications in person at one of our retail network offices or to complete an online application via the Internet. All of our retail network offices are staffed and equipped to expedite loan applications electronically to one of the lending subsidiaries for loan underwriting. Promptly, our lending subsidiary employees verify the applicant's military service history and status including rank, review credit histories using major credit reporting agencies and conduct other review procedures as deemed necessary.
We believe that the development and continual reinforcement of personal relationships with customers improves our ability to monitor their creditworthiness, reduce credit risk and generate loyal repeat customers. It is not unusual for us to have made a number of loans to the same customer over the course of several years, many of which were refinanced with a new loan after approximately one third of the scheduled payments were made. In determining whether to refinance existing loans, we typically require loans to be current on a recency basis, and
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customers are required to complete a new credit application. Rarely do we grant extensions or deferments, or allow account revisions, rewriting renewal or rescheduling to bring an otherwise delinquent account current. Our policy is that we do not refinance loans to cure a default in principal or interest. Generally, we refinance existing loans when a portion of the new loan proceeds is used to repay the balance of the existing loan and the remaining portion is advanced to the customer. We market the opportunity to refinance existing loans prior to maturity, thereby increasing the amount borrowed and increasing the fees and other income we realize. In fiscal 2005, approximately 45.8% of the number and 30.2% of the amount of our loan originations were refinancings of outstanding loans.
To reduce our credit risk and provide better service, we encourage our customers to employ the convenience of making their monthly loan payments electronically through payroll deduction via the Government Allotment System or through an automatic debit of their bank account through the National Automated Clearinghouse Association. As of September 30, 2005, approximately 94% of our customers were utilizing these options.
Credit Loss Experience
We closely monitor portfolio delinquency and loss rates in measuring the quality of our portfolio and the potential for ultimate credit losses. We attempt to control customer delinquency through careful evaluation of each application and credit history at the time the loan is originated or purchased and through appropriate collection activity. Collection efforts continue after an account has been charged-off until it is determined that the cost of collection efforts outweighs the benefits received.
Insurance Operations
Generally, where applicable laws permit, we sell credit insurance products offered by third party insurance companies to our customers. We earn a pre-negotiated commission on the sale of credit insurance. The customer's premiums for insurance coverage are financed as part of the customer's loan.
Credit life insurance policies typically cover the life of the customer and provide for the full payment of the outstanding loan balance in the event of the customer's death, including war-related deaths. Credit accident and health insurance policies provide for the payment of loan installments as they become due while a customer is disabled due to illness or injury, including war-related injuries. Purchases of credit life insurance and credit accident and health insurance are entirely voluntary and at the customer's discretion.
We have a wholly-owned insurance subsidiary that reinsures a portion of the credit accident and health insurance that we sell on behalf of an unaffiliated insurance carrier, providing us with an additional source of income from the earned reinsurance premiums. If these customers are injured or become ill, including during war, this subsidiary will have payment obligations. The liability we establish for possible losses related to our reinsurance operations and the corresponding charges to our income to maintain this amount are immaterial to our overall business.
The laws of the states in which we operate regulate our sale of insurance to our customers by prescribing, among other things, the maximum amount of coverage and term of policy and by fixing the permissible premium rates or authorizing a state official to fix the maximum premium rates.
Regulation
Our consumer lending business is subject to extensive regulation, supervision and licensing by various state departments of banking and other state and federal agencies. We are also subject to various judicial and administrative decisions of general applicability that also set requirements and restrictions applicable to our lending activities. Failure to comply with these requirements can lead to, among other sanctions, termination or suspension of licenses, consumer litigation and administrative enforcement actions. In addition, state and federal agencies have the authority to require a lender that has violated existing laws to reimburse customers for fees or other charges.
Our lending subsidiaries are subject to detailed supervision by authorities in the states where they are located. Legislation and regulations generally require licensing, limit loan amounts, duration and charges for various categories of loans, require adequate disclosure of certain contract terms and limit collection practices and creditor remedies. Licenses are renewable and may be subject to revocation for violation of these laws and regulations. In addition, these states have usury laws, which limit the interest rates we may charge.
State and federal regulatory agencies, state attorneys general, the Federal Trade Commission, and the U.S. Department of Justice have increased their focus on certain types of lending practices by some companies in the subprime lending industry, sometimes referred to as "predatory lending" practices. State and federal governmental agencies have imposed sanctions for certain lending practices, including, but not limited to, charging borrowers excessive fees, making loans to refinance existing loans when there is no tangible benefit to the borrower, imposing higher interest rates than a borrower's credit risk warrants and failing to adequately disclose the material terms of loans to borrowers. We are subject to the Truth-in-Lending Act and Regulation Z promulgated thereunder. This act requires us, among other things, to disclose pertinent terms of our consumer loans, including the finance charge and the comparative costs of credit expressed in terms of an annual percentage rate. These disclosure requirements are designed to provide consumers with uniform, understandable information with respect to the terms and conditions of loans and credit transactions in order to enable them to compare credit terms.
In addition, we are subject to the Equal Credit Opportunity Act which, in part, prohibits credit discrimination on the basis of race, color, religion, sex, marital status, national origin or age. Regulation B, promulgated under this act, restricts the type of information that we may ask for or obtain in connection with a credit application. It also requires us to make certain disclosures regarding consumer rights and requires us to advise applicants who are denied credit the reasons for the denial. In instances where a loan application is denied or the rate or charge on a loan is increased as a result of information obtained from a consumer credit agency, the act requires us to supply the applicant with the name and address of the reporting agency.
Our insurance activities are also regulated by state and federal law, and are subject to supervision by agencies having jurisdiction over consumer credit and insurance. These regulations cover such matters as solicitation practices, disclosure, policy terms, claims payment, premiums, premium financing and permitted commissions. In addition, our reinsurance subsidiary is subject to laws and regulations of the insurance authorities in the state of Arizona. These regulations cover such matters as its capitalization, reserve requirements, affiliate transactions, permitted investments and limitations on the amount of dividends payable.
The Gramm-Leach-Bliley Act, which was signed into law at the end of 1999, contains comprehensive consumer financial privacy restrictions. Various federal enforcement agencies, including the Federal Trade Commission, have issued final regulations to implement this act. These restrictions fall into two basic categories. First, we must provide various notices to our customers about our privacy policies and practices. Second, this act restricts us from disclosing non-public personal information about the customer to non-affiliated third parties, with certain exceptions. If we violate this law, regulators may require us to discontinue disclosing information improperly and in certain circumstances customers may have a private right of action if such disclosure is made without the consent of the customer. We believe we have prepared the appropriate consumer disclosures and internal procedures to address these requirements.
We have procedures and controls to monitor compliance with numerous federal and state laws and regulations. However, because these laws and regulations are complex and often subject to interpretation, or because of a result of inadvertent errors, we may, from time to time, inadvertently violate these laws and regulations. If more restrictive laws, rules and regulations are enacted or more restrictive judicial and administrative interpretations of those laws are issued, compliance with the laws could become more expensive or difficult.
The merchants who originate retail installment contracts purchased by us also must comply with both state and federal credit and trade practice statutes and regulations. If the merchants fail to comply with these statutes and regulations, consumers may have rights of rescission and other remedies. In such cases, we have a right under our agreement with the merchant to require the merchant to repurchase the related retail installment contracts and to pay us for any damages we incur or litigation costs, including attorney's fees and costs. However, if we are unable to enforce our agreement with the merchant, resulting consumer recession rights and remedies could have an adverse effect on us.
The Soldier's and Sailor's Civil Relief Act, in part, requires lenders to reduce the interest rate charged on loans to customers who subsequently join the military or are called to active duty. Generally, we only originate loans with active duty and retired career military personnel. Therefore, this act does not have a material affect on our business. Furthermore, our customers waive their right to enforce this act at time of loan closing.
Although we believe our operations comply with current regulatory requirements, we are unable to predict whether state or federal authorities will require changes in our lending practices in the future, or the impact of those changes on our profitability.
Competition
The markets in which we operate are competitive. Traditional competitors in the consumer finance industry include independent finance companies, banks and thrift institutions, credit unions, credit card issuers, leasing companies, manufacturers and vendors. Some of these competitors are large companies that have greater capital and technological and marketing resources than we do. These competitors also have access to capital at a lower cost.
Competition varies by delivery system and geographic region. For example, some competitors deliver their services exclusively via the Internet while others exclusively through a branch network. We distribute our products using both delivery channels. In addition, we compete with other consumer finance companies on the basis of overall pricing of loans, including interest rates and fees, and general convenience of obtaining the loan, including the location of our retail offices to the military base.
We maintain product delivery flexibility and convenience, which we believe offers us a competitive advantage. In addition, we believe that innovation is necessary to compete in the industry, including enhanced customer service, products designed for military personnel and use of the Internet for loan processing and funding. While some of our customers can qualify for loans from traditional lending sources, we believe they are attracted to our products and services as a result of our exclusive commitment to the military market, an understanding of the military culture, our products and services and our expedited loan processing and funding. In addition, we provide a fifteen-day, no costs, 100% satisfaction guarantee on all loans, in an effort to be a disciplined and financially responsible alternative for service members to obtain funds for unforeseen expenses.
Employee Relations
At September 30, 2005, we employed approximately 290 persons, none of whom were represented by labor unions. We believe that our employee relations are good.
Factors That May Affect Future Results of Operations, Financial Condition or Business
We have identified important risks and uncertainties that could affect our results of operations, financial position, cash flow or business and that could cause them to differ materially from our historical results of operations, financial position, cash flow or business, or those contemplated by forward-looking statements made herein or elsewhere, by, or on behalf of, us. Factors that could cause or contribute to such differences include, but are not limited to, those factors described below.
Lending exclusively to the military market may result in higher delinquencies in our loan portfolio, which could result in a reduction in profitability and impair our ability to pay interest and principal on the investment notes.
A large portion of our customers are unable to obtain financing from traditional sources, due to factors such as their age, frequent relocations and lack of credit history, which may not allow them to build relationships with sources such as commercial banks. Historically, we have experienced higher delinquency rates than traditional financial institutions. While we use underwriting standards and collection procedures designed to mitigate the higher credit risk associated with lending to these borrowers, our standards and procedures may not offer adequate protection against risks of default. Higher than anticipated delinquencies, foreclosures or losses on the loans we originate or purchase would reduce our profitability, which could restrict our ability to pay interest and principal on the investment notes.
An increase in market interest rates may result in a reduction in our profitability and impair our ability to pay interest and principal on the notes.
Sustained, significant increases in interest rates could unfavorably impact our liquidity and profitability by reducing the interest rate spread between the rate of interest we receive on loans and interest rates we must pay under our outstanding bank debt and debentures. Any significant reduction in our profitability would diminish our ability to pay interest and principal on the notes.
Acts of war or terrorist attacks in the United States may cause disruption in our business and may adversely affect the markets in which we operate, which could affect our profitability and our ability to pay interest and principal on the investment notes.
Terrorist attacks in the United States in September 2001 caused major instability in the U.S. financial markets. Additional attacks and the response of the U.S. government may lead to additional armed hostilities or to further acts of terrorism in the U.S. which may cause a further decline in the financial markets and may contribute to a further decline in economic conditions. In addition, the involvement of military personnel in armed hostilities may reduce the demand for our products and services or increase payment delinquencies and therefore reduce our revenues, possibly without immediate comparable reductions in overhead. To the extent these events occur, our profitability and cash flow could be reduced and our ability to pay interest and principal on the investment notes could be impaired.
If a large number of our borrowers are wounded in combat, our profits may be adversely affected.
Our wholly-owned subsidiary reinsures a portion of the credit accident and health insurance policies issued on the borrowers for the loans we originate. These policies pay the loan payments as they become due during a customer's disability due to illness or injury, including war-related injuries. Therefore, if a large number of our borrowers are injured and disabled in combat, the profitability of our insurance subsidiary would be impaired, which could impair our ability to pay interest and principal on the investment notes.
We are subject to many laws and governmental regulations, and any changes in these laws or regulations may materially adversely affect our financial condition and business operations.
Our operations are subject to regulation by federal authorities and state banking, finance, consumer protection and insurance authorities and are subject to various laws and judicial and administrative decisions imposing various requirements and restrictions on our operations which, among other things, require that we obtain and maintain certain licenses and qualifications, and limit the interest rates, fees and other charges we may impose. Although we believe we are in compliance in all material respects with applicable laws, rules and regulations, there can be no assurance that we are or that any change in such laws, or in the interpretations thereof, will not make our compliance therewith more difficult or expensive or otherwise adversely affect our financial condition or business operations.
We are subject to regulation by states where our lending subsidiaries are located. At this time, we are not subject to consumer lending regulation in the states in which we only have retail offices. If this were to change in the future, any resulting regulation by the states in which we only have retail offices could adversely impact our operating costs and our ability to repay the investment notes.
Almost all of our borrowers are active duty military or federal government employees who could be instructed not to do business with us, or their access to the Government Allotment System could be denied.
When they deem it to be in the best interest of their personnel, military commanders and supervisors of federal employees may instruct their personnel, formally or informally, not to patronize a business. If military commanders or federal employee supervisors at any given level determine one or more of our retail offices or our Internet site to be off limits, we would be unable to do new business with the potential customers they command or supervise. Additionally, approximately 62.0% of our borrowers make their monthly loan payments through the Government Allotment System. Military commanders or federal employee supervisors could deny those they command or supervise access to these programs, increasing our credit risk. Without access to sufficient new customers or to the Government Allotment System, we may be forced to discontinue lending and liquidate our portfolio of consumer loans and retail installment contracts.
Our profitability and future growth depend on our continued access to bank debt.
The profitability and growth of our business currently depends on our ability to access bank debt at competitive rates, and we cannot guarantee that such financing will be available in the future. Our bank debt is comprised of individual loans from banks, which are party to our senior lending agreement. This senior lending agreement is an uncommitted facility which provides common terms and conditions pursuant to which individual banks that are a party to this agreement may choose to make loans to us in the future. No bank has an obligation to make any additional future loans to us. As of September 30, 2005, we could request up to $18.2 million in additional funds pursuant to the terms of the senior lending agreement signed October 1, 2003 and remain in compliance with the terms of our senior lending agreement. No bank, however, has any contractual obligation to lend us these additional funds. If we are unable to renew or replace our bank debt or find alternative financing at
reasonable rates, we may be forced to liquidate. If we are forced to liquidate, there can be no assurance that we will be able to pay the interest and principal on the investment notes.
If a customer leaves the military prior to repaying our loan, there is an increased risk that our loan will not be repaid.
The terms of repayment on the loans we make are generally structured so the entire loan amount is repaid prior to the customer's estimated separation from the military. If, however, a customer unexpectedly leaves the military or other events occur which result in the loan not being repaid prior to our customer's departure from the military, there is an increased chance that our loan will not be repaid. Because we do not know whether or when a customer will leave the military early, we cannot institute policies or procedures to ensure that the entire loan is repaid before the customer leaves the military. As of September 30, 2005, we had approximately 5,300 customers who separated from the military prior to repaying our loan and who in the aggregate owed us approximately $9.9 million. Based on historical charge-off models, management believes this could result in approximately $5.6 million in charge-offs. If that amount increases or the number of our customers who separate from the military prior to their scheduled separation date materially increases, our charge-offs may increase.
Additional competition may decrease our profitability, which would adversely affect our ability to repay the investment notes.
We compete for business with a number of large national companies and banks that have substantially greater resources, lower cost of funds, and a more established market presence than we have. If these companies increase their marketing efforts to include our market niche of borrowers, or if additional competitors enter our markets, we may be forced to reduce our interest rates and fees in order to maintain or expand our market share. Any reduction in our interest rates or fees could have an adverse impact on our profitability and our ability to repay our notes.
The laws and regulations of the Arizona insurance authorities may restrict our reinsurance subsidiary's ability to distribute available cash to us.
The operations of our wholly-owned reinsurance subsidiary are subject to the laws and regulations of the insurance authorities in the state of Arizona. Among other things, these laws and regulations place restrictions on the amount of dividends that our reinsurance subsidiary can pay to us and require us to maintain a certain capital structure. As of September 30, 2005, our reinsurance subsidiary had the ability to pay us up to $1,195,827 in dividends pursuant to these laws and regulations. If our reinsurance subsidiary does not continue to satisfy these requirements, it may be prohibited from distributing available cash to us, which may in turn impair our ability to pay interest and principal on the notes.
We are controlled by a single shareholder.
As of September 30, 2005, our sole shareholder, Pioneer Financial Industries, Inc., owned all of the outstanding shares of our capital stock. Various trusts controlled by William D. Sullivan control Pioneer Financial Industries, Inc. Accordingly, Mr. Sullivan will be able to exercise significant control over our affairs including, but not limited to, the election of directors, operational decisions and decisions regarding the debentures. Our senior lending agreement limits the amounts that we can pay to our parent each year. In fiscal 2005, the senior lending agreement prohibits us from paying our parent more than $713,300 for strategic planning services, professional services, product identification and branding and service charges. Other than the covenants contained in our senior lending agreement, there are no other contractual or regulatory limits on the amounts we can pay to our parent or other affiliates.
Loss of key personnel could have an adverse effect on our operations.
The loss of certain key personnel could adversely affect our operations. Our success depends in large part on the retention of a limited number of key persons, including: William D. Sullivan, our Chief Executive Officer, and Thomas H. Holcom, Jr., our President. We will likely undergo a difficult transition period if we lose the services of either or both of these individuals.
Risk of loss of material vendor.
Portions of our marketing efforts are dependent on the services provided by certain vendors. If those marketing efforts are unsuccessful or if we lose the relationship with these third party vendors, we may experience a
reduction in our originations of loans. Such reduction may have an adverse impact on our results of operation and financial condition. See "--General".
ITEM 2.
ITEM 2. PROPERTIES
Our operations are generally conducted on leased premises under operating leases with terms not normally exceeding five years. At September 30, 2005, we had 31 leased operating facilities in the United States. Please see Note 7 to our Consolidated Financial Statements for information concerning our lease obligations. The furniture, equipment and other personal property that we own represents less than 4% of our total assets at September 30, 2005 and is therefore not significant in relation to our total assets.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We became aware, in the second quarter of fiscal year 2005, that the Florida Attorney General was planning to file a lawsuit against a subsidiary of ours accusing it of violating Florida lending laws and requiring it to comply with such laws in connection with 216 loans that were made by our subsidiary during the period December 2001 to March 2003. We have relied upon the case of Pioneer Military Lending v. Manning, 2 F.3d 280 (8th Cir. 1993), the Eighth Circuit Court of Appeals held that the Commerce Clause of the U.S. Constitution prevents the lending laws of the State in which a non-resident military borrower is stationed from regulating such loan transactions. In the eleven years since the Manning decision, more than 25 states have accepted the rationale in that decision and allowed us to utilize the aforementioned business model without local state regulation. While not obligated to do so, we have been cooperating fully with an inquiry conducted during the past two and a half years by the Florida Attorney General regarding the loans made from our subsidiary in Georgia to non-resident U.S. military personnel stationed in Florida. In March 2005, our subsidiary received another subpoena from the Attorney General's Office, that we interpreted as indicating that the Florida Attorney General was planning to file a lawsuit. We believe we cannot continue to meet the borrowing needs of U.S. military personnel if we are required to comply with the lending laws of each of the significant number of states that have military installations. On April 29, 2005, Pioneer Military Lending of Georgia, Inc., a Georgia corporation and wholly-owned subsidiary of ours, filed a Complaint for Declaratory Judgment, Injunctive Relief and Damages against Charlie Crist, the Attorney General of Florida, in the United States District Court for the Northern District of Florida. The complaint seeks a determination that, among other things, we and our affiliates are not subject to Florida lending laws and licensing requirements. See "Risk Factors- We are subject to many laws and governmental regulations and any changes in these laws and regulations may materially adversely affect its financial condition and business operations."
We are currently involved in various litigation matters in the ordinary course of our business. We are not currently involved in any other litigation or proceeding that we expect, either individually or in the aggregate, will have a material adverse effect on our financial condition, results of operations and cash flows.
PART II.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction with our audited consolidated financial statements and the related notes, with other financial data included in this report and with "Item 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
Overview
We originate and service consumer loans and provide other financial products and services on a worldwide basis, exclusively to active duty or retired career U.S. military personnel or U.S. Department of Defense employees. We make direct loans to our customers through our network of retail sales offices and over the Internet. We also purchase retail installment sales contracts from retail merchants who sell consumer goods to active duty or retired career U.S. military personnel or U.S. Department of Defense employees. We refer to these consumer loans and retail installment contracts as finance receivables.
Our finance receivables are effectively unsecured. See "Item 1. Business--Lending Activities." Our finance receivables have fixed interest rates and typically have a maturity of less than 48 months. During fiscal 2005, the size of our average finance receivable at origination was approximately $3,400. A large portion of our customers are unable to obtain financing from traditional sources, due to factors such as their age, frequent relocations and lack of credit history, which may not allow them to build relationships with sources such as commercial banks.
Further improvement of our profitability is dependent upon the growth in our finance receivables, the maintenance of loan quality, acceptable levels of borrowing costs and operating expenses and the ongoing introduction of innovative new products and services to our customer base. Since September 30, 2000, finance receivables have increased at a 14.1% annual compounded rate from $127.7 million to $247.2 million at September 30, 2005. The aggregate finance receivable increase of 24.6% for fiscal year 2005 is attributable in part to the presence of third party marketing agreements entered into in October 2003 with companies that market and sell products over the Internet to military service members. These agreements have expanded our ability to help additional military customers who need financing to effectuate Internet purchases as well as other needs. We plan to continue to pursue innovative and efficient methods to distribute our loans, including looking for opportunities to expand the Internet portion of our business and adding new retail offices as we evaluate new military markets and possible products. See "--Results of Operations" and "--Loan Origination".
Sources of Income
We derive revenues and resulting income from finance income derived from direct consumer lending and retail installment contracts, commissions earned on the sale of credit insurance products, credit reinsurance premiums, and commissions earned on the sale of ancillary products and services. For purposes of the following discussion, "revenues" means the sum of our finance income, insurance premiums and commissions and other income.
Direct Lending. Our finance income from direct loans to customers consists of interest and fees paid by the customer. Our interest income is based on the risk adjusted interest rates we charge customers for loans. Interest rates vary from loan to loan based on many factors, including the overall degree of credit risk assumed and the interest rates allowed in the state where the loan is originated. Substantially all of the fee income we derive from these loans consists of origination, prepayment and late fees. Finance income from our direct lending business comprised approximately 83.9% of our total revenues in fiscal 2005, 81.6% of our revenues in fiscal 2004 and 80.9% of our revenues in fiscal 2003. See "Item 1. Business--Lending Activities".
Retail Installment Contracts. We purchase retail installment contracts from approximately 77 retail merchants. Retail installment contracts are notes receivable generated by a single purchase of consumer goods. Our revenue from retail installment contracts consists of interest and fees. Like our direct loans, interest rates charged on retail sales contracts vary from contract to contract based on many factors, including the overall degree of credit risk assumed and the interest rates allowed in the state where the loan is originated. Substantially all of the fee income we derive from retail installment contracts consists of prepayment and late fees. Interest and fee income from retail installment contracts comprised approximately 7.2% of our total revenues in fiscal 2005. See "Item 1. Business--Lending Activities".
Credit Insurance Commissions. We sell credit life and credit accident and health insurance to be purchased at our customers' discretion. Our income from the sale of these products consists of commissions paid to us by an unaffiliated insurance company that issues the policies. The commission rates are based on a pre-negotiated schedule. Commissions are recognized ratably over the life of the policy. Credit insurance commissions comprised approximately 5.5% of our total revenues in fiscal 2005. See "Item 1. Business--Insurance Operations."
The sale of credit property insurance was discontinued in the fourth quarter of fiscal year 2005 as management determined that we should refine the installment loan program in order to continue as a responsible alternative in an increasingly competitive military lending market. Secured lending is now limited to loans that are secured by real property and/or titled vehicles. The majority of loans will continue to be unsecured and we no longer accept other personal property as security for secured loans. We will continue to earn commission revenue throughout the term of the property insurance policies sold prior to the fourth quarter.
Credit Reinsurance Premiums. We have a wholly-owned insurance subsidiary that reinsures a portion of the credit accident and health insurance sold at the customer's option in connection with loans we make. A portion of the premiums for policies that we sell for the unaffiliated insurance company are ceded to one of our subsidiaries, providing us with an additional source of revenue. Net credit reinsurance premiums comprised approximately 1.6% of our total revenues in fiscal 2005. The liability we establish for possible losses related to our reinsurance operations and the corresponding charges to our income to maintain this amount are immaterial to our overall business. See "Item 1. Business--Insurance Operations."
Ancillary Products and Services. We also sell non-loan related products and services including roadside assistance programs and discount healthcare cards. Our revenues from the sale of these products and services consists of commissions paid by an unaffiliated company. These sales commissions comprised approximately 1.7% of our total revenues in fiscal 2005.
Finance Receivables
Our finance receivables are comprised of direct loans and retail installment contracts. The following table sets forth the five-year history of certain information about the components of our finance receivables as of the ends of the periods presented:
As of, and For the Years Ended September 30 --------------------------------------------------- 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- (dollars in thousands, except average note balance)
Finance Receivables: Finance receivables balance.. $247,190 $198,407 $165,895 $159,011 $137,314 Average note balance......... $ 2,523 $ 2,403 $ 2,117 $ 1,946 $ 1,753 Total finance income......... $ 63,182 $ 54,059 $ 50,003 $ 45,884 $ 38,965 Total number of notes........ 97,958 82,565 78,364 81,726 78,316
Direct Loans: Finance receivables balance.. $223,927 $176,691 $147,095 $139,664 $117,098 Percent of finance receivables................ 90.59% 89.05% 88.67% 87.83% 85.28% Average note balance......... $2,607 $ 2,446 $ 2,123 $ 1,959 $ 1,767 Number of notes.............. 85,887 72,242 69,291 71,302 66,264
Retail Installment Contracts: Finance receivables balance.. $ 23,263 $ 21,716 $18,800 $ 19,348 $ 20,216 Percent of finance receivables................ 9.41% 10.95% 11.33% 12.17% 14.72% Average note balance......... $ 1,927 $ 2,104 $2,072 $1,856 $ 1,677 Number of notes.............. 12,071 10,323 9,073 10,424 12,052
Net Interest Margin
The principal component of our profitability is our net interest margin, which is the difference between the interest we earn on finance receivables and the interest we pay on borrowed funds. In some states, statutes regulate the interest rates that we may charge our customers, while in other states competitive market conditions establish the interest rates we may charge. Differences also exist in the interest rates we earn on the various components of our finance receivable portfolio.
Unlike our interest income, our interest expense is sensitive to general market interest rate fluctuations. These general market fluctuations directly impact our cost of funds. Our general inability to increase the interest rates earned on new and existing finance receivables restricts our ability to react to increases in our cost of funds. Accordingly, increases in market interest rates generally will narrow our interest rate spread and lower our profitability, while decreases in market interest rates generally will widen our interest rate spread and increase our profitability. See "Item 1. Factors That May Affect Future Results of Operations, Financial Condition or Business--An increase in market interest rates may result in a reduction in our profitability and impair our ability to pay interest and principal on the debentures."
The following table presents a five-year history of important data relating to our net interest margin as of, and for the years ended September 30, 2005, 2004, 2003, 2002 and 2001:
As of, and For the Years Ended September 30, -------------------------------------------- 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- (dollars in thousands)
Finance receivables balance... $247,190 $198,407 $165,895 $159,011 $137,314
Average finance receivables... $222,567 $180,858 $164,578 $149,729 $131,741 Average interest bearing liabilities (1)............. $178,881 $144,179 $131,483 $125,561 $111,195 Total finance income.......... $ 63,182 $ 54,059 $ 50,003 $ 45,884 $ 38,965 Total interest expense........ $ 10,995 $ 9,063 $ 9,325 $ 9,599 $ 9,455 - ----------------------- (1) Averages are computed using month-end balances.
Results of Operations
Year Ended September 30, 2005 Compared to Year Ended September 30, 2004.
Finance Receivables. Our aggregate finance receivables grew 24.6% during fiscal 2005 to $247.2 million on September 30, 2005 from $198.4 on September 30, 2004. This growth was due primarily to increases in finance receivables from our Internet subsidiary, which receivables grew by more than $49.9 million or 59.3% from $84.2 million in fiscal 2004 to $134.1 million in fiscal 2005. The Internet is a lower-cost method of loan origination and proceed distribution, and we plan to continue the growth of this distribution channel in the future.
Total Revenues. Total revenues in fiscal 2005 increased to $69.4 million from $60.9 million in fiscal 2004, an increase of $8.5 million or 14.0%. These revenues consisted of:
o Finance income in fiscal 2005 increased to $63.2 million from $54.1 million in fiscal 2004, an increase of $9.1 million or 16.8%. Our average finance receivables increased 22.9% during 2005. The increase in finance receivables was primarily attributable to an increase in our loan originations and our average loan size due to the higher credit worthiness of our customers with higher military rank.
o Insurance premium and commission revenues in fiscal 2005 decreased to $4.9 million from $5.1 million in fiscal 2004, a decrease of $.2 million or 3.9%. This decline was due to a reduced number of policies reinsured with our subsidiary by an unaffiliated insurance carrier over the course of the year.
Provision for Credit Losses. Provision for credit losses in fiscal 2005 increased to $13.0 million from $10.6 million in fiscal 2004, an increase of $2.4 million or 22.6%. As our average direct loan portfolio grew by 24.2%, the net charge-offs incurred in connection with our finance receivables in fiscal 2005 also increased to $10.3 million from $8.6 million in fiscal 2004, an increase of $1.7 million or 19.8%. Net charge-offs were 4.6% of the average finance receivable balance for fiscal 2005 compared to 4.7% in fiscal 2004. Finance receivable balances 60-days or more past due as a percentage of finance receivables was approximately 4.8% at September 30, 2005, compared to 2.9% at September 30, 2004. Our allowance for credit losses at September 30, 2005 increased to $14.0 million from $11.2 million at September 30, 2004, an increase of $2.8 million or 25.0%. This increase reflects the 24.6% growth in our aggregate finance receivables during fiscal 2005, the increase of 1,700 customers leaving the military prior to repaying their loan and our continuing concern regarding the uncertainty surrounding Middle-East hostilities. If this situation were to continue to result in a protracted war, the involvement of the military personnel
in armed hostilities may increase payment delinquencies and charge-offs. See "Item 1. Business--Factors That May Affect Future Results of Operations, Financial Condition or Business--If a large number of our borrowers are wounded in combat, our profits may be adversely affected. Item 1. Business--Factors That May Affect Future Results of Operations, Financial Condition or Business--If a customer leaves the military prior to repaying our loan, there is an increased risk that our loan will not be repaid."
Interest Expense. Interest expense in fiscal 2005 increased to $11.0 million from $9.1 million in fiscal 2004, an increase of $1.9 million or 20.9%. Our average interest bearing liabilities increased by $34.7 million or 24.1% during fiscal 2005. However, this increase was slightly offset by a decrease in the effective interest rate on our debt portfolio due to the large number of notes which were issued at more favorable rates than those that we can purchase today. The weighted average interest rate on our debt decreased to 6.1% in fiscal 2005 from 6.3% in fiscal 2004.
Operating Expenses. Operating expenses in fiscal 2005 increased to $34.3 million from $32.1 million in fiscal 2004, an increase of $2.2 million or 6.9%. This increase was primarily due to higher third party marketing costs of $1.1 million, the cost of implementation of an enterprise wide loan processing system of $.6 million and a $.5 million increase in professional fees due to ongoing business matters that occur in the normal course of business.
Net Income. In fiscal 2005, income before income taxes was $11.0 million and net income was $7.2 million as compared to fiscal 2004 income before income taxes of $9.1 million and net income of $6.0 million.
Year Ended September 30, 2004 Compared to Year Ended September 30, 2003.
Finance Receivables. Our aggregate finance receivables grew 19.6% during fiscal 2004 to $198.4 million on September 30, 2004 from $165.9 on September 30, 2003. This growth was due primarily to increases in finance receivables from our Internet subsidiary, which receivables grew by more than $25.4 million or 43.2% from $58.8 million in fiscal 2003 to $84.2 million in fiscal 2004. The Internet is a lower-cost method of loan origination and proceed distribution, and we plan to continue the growth of this distribution channel in the future.
Total Revenues. Total revenues in fiscal 2004 increased to $60.9 million from $56.9 million in fiscal 2003, an increase of $4.0 million or 6.9%. These revenues consisted of:
o Finance income in fiscal 2004 increased to $54.1 million from $50.0 million in fiscal 2003, an increase of $4.1 million or 8.1%. Our average finance receivables increase 9.8% during 2004. The increase in finance receivables was primarily attributable to an increase in our loan originations and our average loan size due to the higher credit worthiness of our customers with higher military rank.
o Insurance premium and commission revenues in fiscal 2004 decreased to $5.1 million from $5.3 million in fiscal 2003, a decrease of $.2 million or 3.2%. This decline was due to a reduced number of policies reinsured with our subsidiary by an unaffiliated insurance carrier over the course of the year.
Provision for Credit Losses. Provision for credit losses in fiscal 2004 decreased to $10.6 million from $12.2 million in fiscal 2003, a decrease of $1.6 million or 13.0%. While our average direct loan portfolio grew by 9.8%, the net charge-offs incurred in connection with our finance receivables in fiscal 2004 decreased to $8.6 million from $9.2 million in fiscal 2003, a decrease of $.6 million or 6.5%. Net charge-offs were 4.7% of the average finance receivable balance for fiscal 2004 compared to 5.8% in fiscal 2003. The decrease in net charge-offs resulted from enhanced collection processes implemented in fiscal 2004. Finance receivable balances 60-days or more past due as a percentage of finance receivables was approximately 2.9% at both September 30, 2004 and 2003. Our allowance for credit losses at September 30, 2004 increased to $11.2 million from $9.2 million at September 30, 2003, an increase of $2.0 million or 21.9%. This increase reflects the 19.6% growth in our aggregate finance receivables during fiscal 2004 and our continuing concern regarding the uncertainty surrounding Middle-East hostilities. If this situation were to continue to result in a protracted war, the involvement of the military personnel in armed hostilities may increase payment delinquencies and charge-offs. See "Item 1. Business--Factors That May Affect Future Results of Operations, Financial Condition or Business--If a large number of our borrowers are wounded in combat, our profits may be adversely affected."
Interest Expense. Interest expense in fiscal 2004 decreased to $9.1 million from $9.3 million in fiscal 2003, a decrease of $.2 million or 2.8%. Our average interest bearing liabilities increased by $12.7 million or 9.7% during fiscal 2004. However, this increase was offset by decreased interest rates. The weighted average interest rate on our debt declined to 6.3% in fiscal 2004 from 7.1% in fiscal 2003.
Operating Expenses. Operating expenses in fiscal 2004 increased to $32.1 million from $29.3 million in fiscal 2003, an increase of $2.8 million or 9.5%. This increase was primarily due to a growth in employment costs of $1.9 million at our Internet subsidiary to accommodate the significant growth in our direct lending. To better leverage the Pioneer Services brand we engaged in more national and regional corporate sponsorships throughout the year, which caused a $.5 million increase in our marketing expenses.
Net Income. In fiscal 2004, income before income taxes was $9.1 million and net income was $6.0 million as compared to fiscal 2003 income before income taxes of $6.1 million and net income of $4.0 million.
Delinquency Experience
Our customers are required to make monthly payments of interest and principal. We analyze our delinquencies on a recency delinquency basis. A loan is delinquent under the recency method when a full payment (95% or more of the contracted payment amount) has not been received for 60 days after the last full payment. We rarely grant extensions or deferments, or allow account revision, rewriting, renewal or rescheduling in order to bring otherwise delinquent accounts current.
The following sets forth the five-year history of our delinquency experience for accounts for which payments are 60 days or more past due and allowance for credit losses for our finance receivables:
As of September 30, -------------------------------------------- 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- (dollars in thousands)
Finance receivables balances.. $247,190 $198,407 $165,895 $159,011 $137,314
Finance receivables balances 60 days or more past due.... $ 12,005 $ 5,863 $ 4,836 $ 5,580 $ 6,369
Finance receivables balances 60 days or more past due as a percent of finance receivables................. 4.86% 2.95% 2.92% 3.51% 4.64%
Historically, our 60-day delinquency accounts have consistently remained between 2.9% and 4.9% of the entire finance receivable portfolio.
Credit Loss Experience and Provision for Credit Losses
General. Our provisions for credit losses are charged to income in amounts sufficient to maintain our allowance for credit losses at a level considered adequate to cover the probable losses inherent in our existing finance receivable portfolio. Historical credit loss experience, delinquency of finance receivables, the value of underlying collateral, current economic conditions, current military activities and management's judgment are factors used in assessing the overall adequacy of the allowance and corresponding provision for credit losses. Our allowance for credit losses is developed primarily for our direct finance receivable portfolio as our retail installment contracts are generally covered by dealer reserves. Over the past five years, our net charge-offs as a percentage of average finance receivables have remained consistently between 4.5% and 6.0%. While management believes our allowance for credit losses is adequate, we may see an increase in future losses due in part to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, which became effective on October 17, 2005. As a result, the Company expects an increase in bankruptcy related charge-offs, much of which was allowed for at the end of the fiscal year. At this time we still expect this increase to remain within historical ranges. See "- Allowance for Credit Losses." Our methodology for setting the allowance for our finance receivable portfolio is described in "--Critical Accounting Policies".
Direct Loans. Our charge-off policy is based on an account-by-account review of delinquent receivables on a recency basis. Finance receivables are charged-off when management deems them to be uncollectable through our normal collection procedures or they become 270 days past due. The 270-day limit is required by our senior lending agreement. Approximately 35% of our charge-offs occur before an account is 180 days delinquent. Our primary source of charge-offs is when a customer leaves the military prior to repaying the finance receivable. We generally structure our loans so that the entire amount is repaid prior to a customer's estimated separation from the military, and the number of our customers who depart from the military early has remained relatively constant over time. We, however, cannot predict when or whether a customer may depart from the military early. Accordingly,
we cannot implement any policy or procedure to ensure that we are repaid in full prior to our customer leaving the military. Our second greatest source of loss is when a customer declares bankruptcy. See "-- Nonearning Assets"
The following table shows a five-year historical picture of net charge-offs on direct loans and net charge-offs as a percentage of direct loans. While the total dollar amount of net charge-offs has increased, as a percentage of average monthly balances they have decreased over the past five years. The decrease in the percentage of net charge-offs to average monthly balance outstanding resulted primarily from more effective collection efforts.
As of, and For the Years Ended, September 30, --------------------------------------------- 2005 2004 2003 2002 2001 -------- -------- -------- -------- -------- (dollars in thousands)
Direct Loans: Loans charged-off........... $ 11,730 $ 9,951 $ 10,287 $ 9,555 $ 8,752 Less recoveries............. 1,386 1,352 1,048 869 1,080 -------- -------- -------- -------- -------- Net charge-offs............. $ 10,344 $ 8,599 $ 9,239 $ $8,686 $ 7,672 ======== ======== ======== ======== ======== Average monthly balance outstanding (1)............. $199,775 $160,829 $145,511 $130,223 $108,939 Percentage of net charge-offs to average monthly balance outstanding................. 5.18% 5.35% 6.35% 6.67% 7.04%
- ------------------ (1) Averages are computed using month-end balances.
Retail Installment Contracts. Under our retail merchant reserve arrangements, we withhold a percentage (usually between five and ten percent) of the principal amount of the retail installment contract purchased. The amounts withheld from a particular retail merchant are recorded in a specific reserve account. Any losses incurred on the retail installment contracts purchased from that retail merchant are charged against its specific reserve account. Upon the retail merchant's request, and no more often than annually, we pay the retail merchant the amount by which its specific reserve account exceeds 15% of the aggregate outstanding balance on all retail installment contracts purchased from them, less losses we have sustained, or reasonably could sustain, due to debtor defaults, collection expenses, delinquencies and breaches of our agreement with the retail merchant. Our allowance for credit losses is charged only to the extent that the loss on a retail installment contract exceeds the originating retail merchant's specific reserve account at the time of the loss.
The following table shows a five-year historical picture of net charge-offs on retail installment contracts and net charge-offs as a percentage of retail installment contracts. The fluctuation in net charge-offs indicates timing differences resulting from the collection of amounts charged off in prior years.
As of, and For the Years Ended, September 30, -------------------------------------------------- 2005 2004 2003 2002 2001 -------------------------------------------------- (dollars in thousands) Retail Installment Contracts: Contracts charged-off...... $ 12 $ 36 $ 83 $ 190 $ 221 Less recoveries............ 73 67 154 82 217 ------- ------- ------- ------- ------- Net charge-offs (recoveries) $ (61) $ (31) $ (71) $ 108 $ 4 ======= ======= ======= ======= ======= Average monthly balance outstanding (1)........... $22,792 $20,028 $19,067 $19,506 $22,802 Percentage of net charge-offs to average monthly balance outstanding............... (0.27%) (0.16%) (0.37%) 0.55% 0.02% - ---------------------- (1) Averages are computed using month-end balances.
Allowance for Credit Losses. The following table sets forth the five-year history of our allowance for credit losses on direct loans and retail installment contracts:
As of, and For the Years Ended, September 30, ------------------------------------------------ 2005 2004 2003 2002 2001 ------------------------------------------------ (dollars in thousands) Average finance receivables (1).......................... $222,567 $180,858 $164,578 $149,729 $131,741 Provision for credit losses.... $ 13,044 $ 10,588 $ 12,168 $ 10,594 $ 8,264 Net charge-offs................ $ 10,283 $ 8,568 $ 9,168 $ 8,794 $ 7,676 Net charge-offs as a percentage of average finance receivables.......... 4.62% 4.74% 5.57% 5.87% 5.83% Allowance for credit losses.... $ 14,002 $ 11,241 $ 9,221 $ 6,221 $ 4,421 Allowance as a percentage of average finance receivables.. 6.29% 6.22% 5.60% 4.15% 3.36% - ----------------- (1) Averages are computed using month-end balances.
The allowance for credit losses is maintained at an amount which management considers sufficient to cover estimated future losses. The Company has developed policies and procedures for assessing the adequacy of the allowance for credit losses which take into consideration the historical credit loss experience of the Company, delinquency trends, current economic conditions, current or future military deployments, and the composition of the finance receivable portfolio. The Company uses various ratio analyses in evaluating prior finance receivable losses and delinquency experience. These and other analyses are used to measure historical movement of finance receivables through various levels of repayment, delinquency, and loss. These results and management's judgment are used to estimate future losses and in establishing the current provision and allowance for credit losses. These estimates are influenced by factors outside the Company's control, such as economic conditions, current or future military deployments and completion of military service prior to repayment of loan. There is uncertainty inherent in these estimates, making it reasonably possible that they could change in the near term. See "--Critical Accounting Policies; Item 1. Business - Factors That May Affect Future Results of Operations, Financial Condition or Business - If a customer leaves the military prior to repaying our loan, there is an increased risk our loan will not be repaid."
The following table sets forth the five-year history of the components of our allowance for credit losses on direct loans and retail installment contracts:
As of, and For the Years Ended, September 30, -------------------------------------------------- 2005 2004 2003 2002 2001 ------- ------- ------- ------- ------- (dollars in thousands) Balance, beginning of period. $11,241 $ 9,221 $ 6,221 $ 4,420 $ 3,833 ------- ------- ------- ------- ------- Charge-offs: Loans charged-off.......... (11,742) (9,987) (10,370) (9,745) (8,973) Recoveries................. 1,459 1,419 1,202 952 1,296 ------- ------- ------- ------- ------- Net charge-offs.............. (10,283) (8,568) (9,168) (8,793) (7,677) Provision for credit losses.. 13,044 10,588 12,168 10,594 8,264 ------- ------- ------- ------- ------- Balance, end of period....... $14,002 $11,241 $ 9,221 $ 6,221 $ 4,420 ======= ======= ======= ======= =======
Nonearning Assets
Accrual of interest income is suspended when a payment has not been received for 60 days or more, and the interest due exceeds an amount equal to 60 days of interest charges. The accrual is resumed when a full payment (95% or more of the contracted payment amount) is received.
Nonearning assets represent those finance receivables on which both the accrual of interest income has been suspended and for which no payment of principal or interest has been received for more than 60 days. Nonearning assets at September 30, 2005 increased to $12.0 million from $5.9 million at September 30, 2004, an increase of $6.1 million or 103.4%, as compared to the increase in our finance receivables of 24.6%. Finance receivable balances 60-day or more past due as a percent of finance receivables was 4.86% and 2.95% at September 30, 2005 and 2004, respectively. This increase is primarily attributable to the time demands on our collection team during the training and transition to the new collection module of our new loan enterprise system, increase in the number of customers leaving the military prior to repaying their loan and to the recent passage of the new consumer bankruptcy law, which caused filers to accelerate their filings in an effort to meet the October 17, 2005 deadline. With more stringent bankruptcy laws now in affect, future filings should decrease relative to the overall portfolio. Nonetheless, we believe these events are manageable and we are confident improvements will be made in the coming months. See "--Delinquency Experience".
Loan Origination
Our loan origination is the most important factor in determining our future revenues. Our loan origination in fiscal 2005 increased to $300.0 million from $237.4 million in fiscal 2004, an increase of $62.6 million or 26.4%. The increase in our loan originations was partly due to marketing agreements (primarily with one third party vendor), which we entered into in the first quarter of our fiscal 2004. These third party vendors market products via the Internet to military service members. These marketing efforts contributed $34.4 million or 55.0% of the $62.6 million overall increase in loan originations. See "Item 1. Business--General".
The following table sets forth the five-year history of our overall loan originations and lending activities by direct loan and retail installment contract:
As of, and For the Years Ended September 30, ------------------------------------------------------- (dollars in thousands, except for average note amounts) 2005 2004 2003 2002 2001 ------------ -------- -------- -------- -------- Total Loan Origination: Gross balance............ $299,984 $237,381 $188,464 $191,931 $158,594 Number of finance 87,337 71,713 59,670 67,483 62,123 receivable notes....... Average note amount...... $ 3,435 $ 3,310 $ 3,158 $ 2,844 $ 2,553
Direct Loans: Gross balance............ $277,524 $217,391 $173,013 $175,932 $144,693 Number of finance 79,615 64,939 55,075 62,532 57,576 receivable notes....... Average note amount...... $ 3,486 $ 3,348 $ 3,141 $ 2,813 $ 2,513
Retail Installment Contracts: Gross balance............ $ 22,460 $ 19,990 $ 15,451 $ 15,999 $ 13,901 Number of finance 7,722 6,774 4,595 4,951 4,547 receivable notes....... Average note amount..... $ 2,909 $ 2,951 $ 3,363 $ 3,231 $ 3,057
Liquidity and Capital Resources
A relatively high ratio of borrowings to invested capital is customary in consumer finance activities due to the quality and term of the assets employed. Our principal use of cash is to make new loans and purchase retail installment contracts. We use our borrowings to fund the difference between the cash used to make new loans and purchase retail installment contracts, and the cash generated from loan repayments and operations. This amount is generally our cash used in investing activities. Cash used in investing activities in fiscal 2005 was approximately
$63.0 million, compared to $43.2 million in fiscal 2004. This increase is primarily due to the growth in our loan originations, which grew by approximately $62.6 million or 26.4%.
Investing activities in fiscal 2005 were primarily funded by $21.1 million from operating activities and $41.5 million from financing activities. See "Item 1. Business - General" and Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Credit Loss Experience and Provision for Credit Losses". Financing activities primarily consist of borrowings and repayments relating to our bank debt, an unsecured revolving credit line from our parent and our investment notes. Information about the length to maturity of our debt may be found in Note 3 of the Notes to Consolidated Financial Statements. The revolving credit line from our parent consists of various borrowings at 2% above the prime rate.
Senior Indebtedness-Bank Debt. The senior lending agreement was amended and restated on October 1, 2003. The terms of the senior lending agreement are substantially the same as before the amendment. Our senior lending agreement is an uncommitted facility which provides common terms and conditions pursuant to which individual banks that are a party to this agreement may choose to make loans to us in the future. Currently, ten (10) banks are a party to the senior lending agreement, as amended. Any bank may elect not to participate in any future fundings at any time without penalty. As of September 30, 2005, we could request up to approximately $18.2 million in additional funds pursuant to the terms of the senior lending agreement, as amended. No bank, however, has any contractual obligation to lend us these additional funds. In connection with borrowing under the senior lending agreement we are subject to certain financial and other restrictive covenants.
On or before March 31 of each year, each bank that is a party to the senior lending agreement is to deliver to us a written indication of whether or not it wishes to participate in future fundings and the amounts that it expects to be willing to fund during the next 12 months. As of March 31, 2005, all the banks of that are a party to our senior lending agreement have indicated in writing their willingness to participate in fundings up to an aggregate of $250.0 million during the next 12 months, including all amounts currently outstanding under the senior lending agreement.
If a bank were to elect not to participate in future fundings, any existing borrowings from that bank under the revolving credit line would be payable in twelve equal monthly installments. We anticipate that we would repay that amount through borrowings from other banks participating in the senior lending agreement. Any existing borrowings under amortizing notes from the bank electing not to participate would be repayable according to their original terms. Currently, we limit the amount we borrow from any one bank to $25.0 million. This limitation lessens our dependence on any one bank and the potential effect on our operations and liquidity if that bank elects not to participate in future financing.
Historically, we have had adequate time to replace any lender electing not to participate in future fundings. However, there can be no assurance that we will be able to replace a lender in the future or that a lender's decision not to extend us further credit would not have a material adverse effect on our liquidity. In the event we are unable to raise adequate capital under our senior lending agreement, we would pursue alternative funding options. These alternatives might include the securitization of our finance receivables, obtaining committed financing from a bank syndicate, a private placement of debt or equity, an expansion of our investment notes program, or an initial public offering of our equity.
Our senior lending agreement gives us access to a revolving credit line and amortizing notes. As of September 30, 2005, the outstanding balance under the revolving credit line was approximately $14.0 million floating at prime rate, or 6.75%. The revolving credit line is payable upon demand in 12 equal monthly payments of principal and monthly payments of interest on the outstanding principal on the tenth day of each month. As of September 30, 2005, the outstanding balance of the amortizing notes was approximately $164.0 million, with interest rates fixed at 270 basis points over the ninety day moving average of like-term Treasury notes at the time the amortizing notes were issued. All amortizing notes have terms not to exceed 48 months, payable in equal monthly principal and interest payments. As of September 30, 2005, we had approximately 265 amortizing notes outstanding with a weighted average maturity of approximately 36.3 months and a weighted average interest rate of approximately 6.07%. Interest on all borrowings under our senior lending agreement is payable monthly.
Substantially all of our assets secure this bank debt. The senior lending agreement also limits, among other things, our ability to (1) incur additional debt from the banks that are party to the agreement beyond that allowed by specific financial ratios and tests, (2) pay dividends, (3) make certain other restricted payments, (4) consummate certain asset sales and dispositions, (5) merge or consolidate with any other person, and (6) incur additional debt for borrowed money. In addition, the senior lending agreement limits the amounts that we can pay to our parent each year. In fiscal 2005, the senior lending agreement prohibits us from paying our parent more than $713,300 for strategic planning services, professional services.
Under the senior lending agreement, we are also subject to certain financial covenants that require us, among other things, to maintain specific financial ratios and to satisfy certain financial tests. In part, these include: (a) an Allowance for Credit Losses (as defined in the senior lending agreement, as amended) equal to or greater than the Allowance for Credit Losses shown on our audited financial statements as of the end of our most recent fiscal year and at no time less than 3.0% of our net receivables, (b) a Senior Indebtedness to Tangible Net Worth Ratio (as defined in the senior lending agreement, as amended) as of the end of each quarter to not greater than 4.75 to 1.00, and (c) a Senior Indebtedness to Net Receivable Ratio (as defined in the senior lending agreement, as amended) as of the end of each quarter of no more than 80.0%. We are also required to maintain a Consolidated Total Required Capital (as defined in the senior lending agreement, as amended) of at least $12.5 million plus 50.0% of the cumulative positive net income earned during each of our fiscal years ending after September 30, 2002, which approximates $21.1 million as of September 30, 2005. The breach of any of these covenants or other terms of the senior lending agreement could result in a default under the senior lending agreement. If we breach certain financial covenants under the senior lending agreement, the banks would have the right to receive 80.0% of all payments we receive on our consumer loans and retail installment contracts. In addition, if a default occurs the lenders could seek to declare all amounts outstanding under the senior lending agreement, together with accrued and unpaid interest, to be immediately due and payable. As of September 30, 2005, we were in material compliance with all loan covenants.
Senior Indebtedness-Parent Debt. We also have a revolving line of credit, payable on demand, from our parent, Pioneer Financial Industries, Inc. Interest on this facility accrues at the prime rate plus 2.0%. At September 30, 2005, there was $1.7 million outstanding under this credit facility with an interest rate of 8.75%.
Senior Indebtedness Table. The following table sets forth a five-year history of the total borrowings and availability under our senior lending agreement and our revolving line from our parent, consisted of:
(1)Includes revolving credit line from our parent. (2)Includes 48-month amortizing term notes. (3)Maximum available credit assuming proceeds in excess of the amounts shown below under "Credit Facility Available" are used to increase qualifying finance receivables and all terms of the senior lending agreement are met, including maintaining a Senior Indebtedness to Net Receivable Ratio of not more than 80.0%. (4)Credit available based on the existing asset borrowing base and maintaining a Senior Indebtedness to Net Notes Receivable Ratio of not more than 80.0%.
Outstanding Investment Notes. We also fund our liquidity needs through the sale of our investment notes. These notes have varying fixed interest rates and are subordinate to all senior indebtedness. We can redeem these notes at any time upon 30 days written notice. As of September 30, 2005, we had issued approximately $25.1 million of these notes at a weighted average interest rate of 9.15%.
The sale of these notes provides us with additional liquidity and capital resources. Issuing these notes increases our tangible net worth, which allows us to borrow larger amounts under our senior lending agreement. To finance growth in our finance receivables portfolio, we intend to borrow additional funds under our senior lending agreement from time to time as we sell additional investment notes.
Dividends From Subsidiaries. Our reinsurance subsidiary is subject to the laws and regulations of the state of Arizona which limit the amount of dividends our reinsurance subsidiary can pay to us and require us to maintain a certain capital structure. In the past, these regulations have not had a material impact on our reinsurance subsidiary or its ability to pay dividends to us, and we do not expect these regulations will have a material impact on our business or the business of our reinsurance subsidiary in the future.
Impact of Inflation and General Economic Conditions
Although inflation has not had a material adverse effect on our financial condition or results of operations, increases in the inflation rate generally are associated with increased interest rates. A significant and sustained increase in interest rates could unfavorably impact our profitability by reducing the interest rate spread between the rate of interest we receive on our customer loans and interest rates we pay under our senior lending agreement and debentures. Inflation also may negatively affect our operating expenses.
Critical Accounting Policies
General. Our accounting and reporting policies are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the finance company industry. The significant accounting policies used in the preparation of the consolidated financial statements are discussed in Note 1 to the Consolidated Financial Statements. Critical accounting policies require management to make estimates and assumptions, which affect the reported amounts of assets, liabilities, income and expenses. As a result, changes in these estimates and assumptions could significantly affect our financial position and results of operations.
Allowance for Credit Losses and Provision for Credit Losses. We consider our policies regarding the allowance and resulting provision for credit losses to be our only critical accounting policy due to the significant degree of management judgment that is applied in establishing the allowance and the provision.
To manage our exposure to credit losses, we use credit risk scoring models for finance receivables that we originate or perform due diligence investigations for finance receivables that we purchase. In addition, we generally structure the repayment terms so that the entire loan is repaid prior to the customer's estimated separation from the military. See "Item 1. Business--Factors That May Affect Future Results of Operations, Financial Condition or Business--If a customer leaves the military prior to repaying our loan, there is an increased risk that our loan will not be repaid."
We have a credit committee that evaluates our finance receivable portfolio quarterly. Our portfolio consists of a large number of relatively small, homogenous accounts. None of our accounts is large enough to warrant individual evaluation for impairment. Our credit committee considers numerous qualitative and quantitative factors in estimating losses inherent in our finance receivable portfolio, including the following:
o Civilian status o Current or future military deployments o Current economic conditions o Prior finance receivable loss and delinquency experience o The composition of our finance receivable portfolio
Our credit committee uses several ratios to aid in the process of evaluating prior finance receivable loss and delinquency experience. Each ratio is useful, but each has its limitations. These ratios include:
o Delinquency ratio - finance receivables 60 days or more past due as a percentage of finance receivables
o Allowance ratio - allowance for finance receivable losses as a percentage of finance receivables
o Charge-off ratio - net charge-offs as a percentage of the average of finance receivables at the beginning of each month during the period
o Charge-off coverage - allowance for finance receivable losses to net charge-offs
We use migration analysis as one of the tools to determine the appropriate amount of allowance for credit losses. Migration analysis is a statistical technique that attempts to predict the future amount of losses for existing pools of finance receivables. This technique applies empirically measured historical movement of like finance receivables through various levels of repayment, delinquency, and loss. These results are used to estimate future losses for the finance receivables existing at the time of analysis. We calculate migration analysis using different scenarios based on varying assumptions in order to evaluate the widest range of possible outcomes.
If we had chosen to establish the allowance for credit losses at the highest and lowest levels produced by the various migration analysis scenarios, our allowance for credit losses at September 30, 2005 and provision for credit losses and net income for fiscal 2005 would have changed as follows:
Increase (decrease) ------------------------ (in thousands) Highest Lowest ------- ------ Allowance for credit losses.................. $ 986 $(2,661) Provision for credit losses.................. $ 986 $(2,661) Net income................................... $ (631) $ 1,703
In addition to these models, our credit committee exercises its judgment, based on each committee member's experience in the consumer finance industry, when determining the amount of the allowance for finance receivable losses. We consider this estimate to be a critical accounting estimate that affects our net income in total and the pretax operating income of our business. See "--Credit Loss Experience and Provision for Credit Losses."
Contractual Obligation. We have the following payment obligations under current financing and leasing arrangements as of September 30, 2005:
- ---------------------------- (1) Includes $1,659,396 owed to our parent.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk Management
Our profitability and financial performance are sensitive to changes in the U.S. Treasury yields and the spread between the effective rate of interest we receive on customer loans and the interest rates we pay on our borrowings. Our finance income is generally not sensitive to fluctuations in market interest rates. The primary exposure that we face is changes in interest rates on our borrowings. A substantial and sustained increase in market interest rates could adversely affect our growth and profitability. The overall objective of our interest rate risk management strategy is to mitigate the effects of changing interest rates on our interest expense through the utilization of short-term variable rate debt and medium and long term fixed rate debt. We have not entered into any derivative instruments to manage our interest rate risk.
The amounts set forth below show the impact on earnings of changes in interest rates on our variable rate debt as of the time it is scheduled to adjust, and upon the debt that is scheduled to mature during 2005, assuming adjustments to, or refinancing at, rates available to us at September 30, 2005. Changes in our interest expense for various possible fluctuations in the interest rates of our debt for fiscal 2005 may be estimated as follows:
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PIONEER FINANCIAL SERVICES, INC.
CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2005 AND 2004
(WITH INDEPENDENT AUDITORS' REPORT THEREON)
Page
Report of Independent Registered Public Accounting Firm.............. 26
Consolidated Balance Sheets September 30, 2005 and 2004.............. 27
Consolidated Statements of Income for the years ended September 30, 2005, 2004 and 2003.................................... 28
Consolidated Statements of Stockholder's Equity for the years ended September 30, 2005, 2004 and 2003........................ 29
Consolidated Statements of Cash Flows for the years ended September 30, 2005, 2004 and 2003.............................. 30
Notes to Consolidated Financial Statements........................... 31
Report of Independent Registered Public Accounting Firm -------------------------------------------------------
Board of Directors Pioneer Financial Services, Inc. Kansas City, Missouri
We have audited the accompanying consolidated balance sheets of Pioneer Financial Services, Inc., a Missouri corporation (the "Company"), as of September 30, 2005 and 2004, and the related consolidated statements of income, stockholder's equity and cash flows for each of the years in the three-year period ended September 30, 2005. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Pioneer Financial Services, Inc. as of September 30, 2005 and 2004, and the results of its operations and its cash flows for each of the years in the three-year period ended September 30, 2005 in conformity with accounting principles generally accepted in the United States of America.
BKD, LLP Kansas City, Missouri November 11, 2005
PIONEER FINANCIAL SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2005 AND 2004
ASSETS
2005 2004 ------------- -------------
Cash and cash equivalents $ 1,734,925 $ 2,078,178 Other investments 2,196,096 2,055,923
Finance receivables: Direct receivables 223,926,765 176,691,292 Retail installment contracts 23,262,974 21,715,543 ------------- ------------- Finance receivables before allowance for credit losses 247,189,739 198,406,835 Allowance for credit losses (14,001,868) (11,240,868) ------------- ------------- Net finance receivables 233,187,871 187,165,967
Furniture and equipment, net 1,504,082 1,539,838 Unamortized computer software 1,987,541 1,225,146 Deferred income taxes 4,279,232 3,692,100 Prepaid and other assets 2,449,999 514,801 ------------- -------------
Total assets $ 247,339,746 $ 198,271,953 ============= ==============
LIABILITIES AND STOCKHOLDER'S EQUITY
Revolving credit line - banks $ 13,965,005 $ 12,620,000 Revolving credit line - affiliate 1,659,396 2,613,823 Accounts payable 1,394,315 2,012,486 Accrued expenses and other liabilities 9,150,199 9,997,410 Amortizing term notes 163,973,031 121,912,164 Investment notes 25,125,450 23,222,252 ------------- -------------
Total liabilities 215,267,396 172,378,135 ------------- -------------
Stockholder's equity: Common stock, $100 par value; authorized 20,000 shares; issued and outstanding 17,136 shares 1,713,600 1,713,600 Retained earnings 30,347,500 24,180,218 Accumulated other comprehensive income 11,250 - ------------- -------------
Total stockholder's equity 32,072,350 25,893,818 ------------- -------------
Total liabilities and stockholder's equity $ 247,339,746 $ 198,271,953 ============= ==============
See Notes to Consolidated Financial Statements
PIONEER FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF INCOME
Year Ended September 30, ---------------------------------------------- 2005 2004 2003 ------------ ------------ ------------
Revenue Finance income $ 63,182,000 $ 54,058,834 $ 50,003,315 Insurance premiums and commissions 4,921,871 5,120,498 5,287,574 Other income, fees and commissions 1,250,406 1,695,854 1,645,888 ------------ ------------ ------------ Total revenue 69,354,277 60,875,186 56,936,777
Provision for credit losses 13,043,644 10,587,502 12,167,529 Interest expense 10,995,602 9,063,272 9,325,322 ------------ ------------ ------------
Net revenue 45,315,031 41,224,412 35,443,926
Operating expenses Employee costs 21,024,706 20,661,557 18,762,187 Facilities 5,786,475 4,988,827 4,997,806 Marketing 2,619,490 2,532,868 2,063,488 Professional fees and other 4,841,387 3,917,252 3,501,576 ------------ ------------ ------------
Total operating expenses 34,272,058 32,100,504 29,325,057
Income before income taxes 11,042,973 9,123,908 6,118,869 Provision for income taxes 3,875,000 3,136,053 2,139,000 ------------ ------------ ------------
Net income $ 7,167,973 $ 5,987,855 $ 3,979,869 ============ ============ ============
Net income per share, basic and diluted (17,136 shares) $ 418.30 $ 349.43 $ 232.25 ------------ ------------ ------------
See Notes to Consolidated Financial Statements
See Notes to Consolidated Financial Statements
See Notes to Consolidated Financial Statements
PIONEER FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2005, 2004 AND 2003
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations and Concentration - --------------------------------------
Pioneer Financial Services, Inc., a Missouri corporation (the "Company"), is a specialized financial services company which originates and services consumer loans and provides other products and financial services exclusively to active duty or retired career military personnel or Department of Defense employees. The Company's revenues are primarily earned from the making of direct loans and the purchase of retail installment contracts. The Company also earns revenues from commissions from the sale of credit-related insurance placed with non-related insurance companies and from reinsurance premiums on credit accident and health insurance. Additionally, the Company sells non-loan related products and services, including roadside assistance programs and discount healthcare cards.
Principles of Consolidation and Business Combinations - -----------------------------------------------------
The accompanying consolidated financial statements include the accounts of Pioneer Financial Services, Inc. (a wholly-owned subsidiary of Pioneer Financial Industries, Inc.) and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated from the accompanying consolidated financial statements.
Use of Estimates - ----------------
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash Equivalents - ----------------
The Company considers all liquid investments to be cash equivalents, which consisted of a money market account at September 30, 2005 and 2004. From time to time, the Company's cash accounts exceed federally insured limits.
Investments - -----------
Investments consist primarily of certificates of deposit, amounting to $358,135 and $357,018; stock, amounting to $134,640 and $0; and debt securities, amounting to $1,703,321 and $1,698,905 at September 30, 2005 and 2004, respectively, consist of corporate and United States government bonds. Stocks for which the Company has no immediate plan to sell but that may be sold in the future are classified as available for sale and carried at fair value. Unrealized gains and losses are recorded, net of related income tax effects, in stockholder's equity. The debt securities, which the Company has the positive intent and ability to hold until maturity, are classified as held-to-maturity and valued at historical cost, adjusted for amortization of premiums and accretion of discounts computed by the level-yield method. Of the held-to-maturity debt securities at September 30, 2005, $1,566,570 matures in between one and five years and $136,751 matures in six or more years. The recorded value of these investments approximates fair value at September 30, 2005 and 2004. Investments aggregating $1,889,345 and $1,855,923 at September 30, 2005 and 2004, respectively, were required as statutory reserves and are on deposit with regulatory authorities or maintained in trust accounts.
Revenue Recognition - -------------------
Interest income on finance receivables is recognized using a method which approximates the level-yield method. Late charges are credited directly to income when received. Accrual of interest income on finance receivables is suspended when a payment has not been received for 60 days or more, and the interest due exceeds an amount equal to 60 days of interest charges. The accrual is resumed when a full payment (95% or more of the contracted payment amount) is received.
PIONEER FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Credit property, life, accident and health insurance premiums are placed with non-related insurance companies. Premiums on such insurance are remitted to the insurance companies, net of applicable advance commissions, which commissions are credited to income ratably over policy terms. Retrospective insurance commissions, if any, on this insurance are taken into income only as received. Pioneer Military Insurance Company, a subsidiary of the Company, reinsures from a non-affiliated insurance company risks on the credit accident and health insurance policies written on a portion of loans to customers of the Company. Reinsurance premiums are recognized as revenue over the period of risk in proportion to the amount of insurance protection provided.
Credit property insurance was discontinued in the fourth quarter as management determined that the Company should fine-tune the installment loan program in order to continue as a responsible alternative in an increasingly competitive military lending market. Secured lending is now limited to loans that are secured by real property and/or titled vehicles. The majority of loans will continue to be unsecured and the Company no longer accepts other personal property as security for secured loans.
Allowance for Credit Losses - ---------------------------
The allowance for credit losses is maintained at an amount which management considers sufficient to cover estimated future losses. Finance receivables are charged-off when management deems them to be uncollectable through normal collection procedures or they become 270 days delinquent. The Company has developed policies and procedures for assessing the adequacy of the allowance for credit losses which take into consideration the historical credit loss experience of the Company, delinquency trends, current economic conditions, current or future military deployments, and the composition of the finance receivable portfolio. The Company uses various ratio analyses in evaluating prior finance receivable losses and delinquency experience. These and other analyses are used to measure historical movement of finance receivables through various levels of repayment, delinquency, and loss. The results and management's judgment are used to estimate future losses and in establishing the current provision and allowance for credit losses. These estimates are influenced by factors outside the Company's control, such as economic conditions and current or future military deployments. There is uncertainty inherent in these estimates, making it reasonably possible that they could change in the near term.
Furniture and Equipment - -----------------------
Furniture and equipment are carried at cost and depreciated over the estimated useful life of each asset. Annual depreciation is computed using the straight-line method. At September 30, 2005 and 2004, accumulated depreciation was $3,585,169 and $3,153,661, respectively.
Software and Development Costs - ------------------------------
The Company capitalizes purchased software which is ready for use and amortizes the cost on a straight-line basis over its estimated useful life. The Company capitalizes costs associated with software developed or obtained for internal use when both the preliminary project stage is completed and management has authorized further funding for the project. Management generally authorizes further funding when it deems it is probable that the project will be completed and used to perform the function intended. Capitalized costs include only direct external costs and payroll and payroll-related costs for employees directly associated with the internal-use software project. Research and development costs and other computer software maintenance costs related to software development are expensed as incurred. Software development costs are amortized on a straight-line basis over the estimated useful life of the software.
PIONEER FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Impairment of Long-Lived Assets - -------------------------------
Long-lived assets and certain identifiable intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Recoverability of assets to be held and used is measured by comparison of the carrying amount of the asset to future net cash flows expected to be generated by the assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amounts of the assets exceed the fair value less costs to sell. The Company has not reported any provision for impairment of long-lived assets.
Net Income per Share - --------------------
Net income per share is computed based upon the weighted-average common shares outstanding of 17,136 during each period. There are no potentially dilutive securities issued and outstanding.
Income Taxes - ------------
The Company files its federal income tax return on a consolidated basis with its parent company, Pioneer Financial Industries, Inc., and other affiliates. The provision for income taxes in the accompanying consolidated statements of income represents the Company's share of the consolidated income tax provision on a separate return basis.
Deferred tax assets and liabilities are recognized for the tax effects of differences between the financial statement and tax bases of assets and liabilities. A valuation allowance is established to reduce deferred tax assets if it is more likely than not that a deferred tax asset will not be realized.
Fair Value of Financial Instruments - -----------------------------------
The fair values of finance receivables and borrowings were calculated by discounting expected cash flows, which method involves significant judgments by management and uncertainties. Because no market exists for these financial instruments and because management does not intend to sell these financial instruments, the Company does not know whether the fair values represent values at which the respective financial instruments could be sold individually or in the aggregate. The carrying amounts for cash, accounts payable and current liabilities are a reasonable estimate of their fair values. The fair value of other investments is based on quoted market prices. Additional information about the fair value of financial instruments is contained in Notes 2 and 3.
NOTE 2: FINANCE RECEIVABLES
Loan Portfolio - --------------
At September 30, 2005 and 2004, finance receivables totaled $247,189,739 and $198,406,835, respectively; all receivables originated from direct loans and retail installment contracts. Direct loans originated in 2005 and 2004 averaged $3,486 and $3,348 with a weighted maturity of 27.7 and 26.1 months, respectively, while retail installment contracts averaged $2,909 and $2,951 with a weighted maturity of 25.6 and 26.9 months, respectively. Approximately 94% and 95% of finance receivables were paid electronically via the Government Allotment System or through the National Automated Clearinghouse Association for the years ended September 30, 2005 and 2004, respectively. At September 30, 2005 and 2004, the accrual of interest income had been suspended on $12,005,384 and $5,862,643 of loans, respectively.
At September 30, 2005 and 2004, the fair value of notes receivable approximates book value.
PIONEER FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2: FINANCE RECEIVABLES (Continued)
Allowance for Credit Losses ---------------------------
Changes in the allowance for credit losses are as follows:
For the Year Ended, September 30, --------------------------------------------- 2005 2004 2003 ------------ ----------- ------------
Balance beginning of period $ 11,240,868 $ 9,220,868 $ 6,220,869 ------------ ----------- ------------ Charge-offs: Loans charged-off (11,742,047) (9,987,389) (10,370,150) Recoveries 1,459,403 1,419,887 1,202,621 ------------ ----------- ------------ Net charge-offs (10,282,644) (8,567,502) (9,167,529) Provision for credit losses 13,043,644 10,587,502 12,167,528 ------------ ----------- ------------
Balance end of period $ 14,001,868 $ 11,240,868 $ 9,220,868 ============ ============ ============
NOTE 3: BORROWINGS
Senior Lending Agreement - ------------------------
On September 30, 2005, the Company had a senior lending agreement with a group of banks, which is an uncommitted facility that provides common terms and conditions pursuant to which individual banks that are a party to this agreement may choose to make loans to the Company in the future. At September 30, 2005, the Company had the ability to request up to $250.0 million in the form of revolving credit lines and amortizing notes if it satisfied all terms of its senior lending agreement including maintaining a Senior Indebtedness to Net Receivable Ratio (as defined in the senior lending agreement) of not more than 80%. At September 30, 2005, pursuant to the terms of the senior lending agreement, the Company could request up to $18,154,359 in additional funds from ten banks. Any bank may elect not to participate in any future funding at any time without penalty. No bank, however, has any contractual obligation to lend the Company these additional funds. This senior lending agreement matures October 1, 2006.
On or before March 31 of each year, each bank that is a party to the senior lending agreement is to deliver to the Company a written indication of whether or not it wishes to participate in future fundings and the amounts that it expects to be willing to fund during the next 12 months. As of March 31, 2005, ten banks indicated in writing their willingness to participate in fundings up to an aggregate of $250.0 million during the next 12 months, including all amounts currently outstanding under the senior lending agreement.
If a bank were to elect not to participate in future fundings, any existing borrowings from that bank under the revolving credit line would be payable in twelve equal monthly installments. The Company anticipates that it would repay that amount through borrowings from other banks participating in the senior lending agreement. Any existing borrowings under amortizing notes from the bank electing not to participate would be repayable according to their original terms.
Advances outstanding under the revolving credit line were $13,965,005 and $12,620,000 at September 30, 2005 and 2004, respectively. The revolving credit line is payable upon demand in 12 equal monthly payments of principal. Interest on borrowings under the revolving credit line is payable monthly and floats with prime, which was 6.75% at September 30, 2005. At September 30, 2005 and 2004, the aggregate balance outstanding under amortizing notes was $163,973,031 and $121,912,164, respectively. Interest on the amortizing notes is fixed at 270 basis points over the ninety day moving average of like-term Treasury notes when issued. There were 265 and 214 amortizing and term notes outstanding at September 30, 2005 and 2004 with a weighted average interest rate of 6.07% and 5.85 %, respectively. Interest on all borrowings under the senior lending agreement is payable monthly. Substantially all of the Company's assets secure this bank debt. The senior lending agreement limits, among other things, the Company's ability to (1) incur additional debt from the banks that are party to the agreement beyond that allowed by specific financial ratios and tests, (2) pay dividends, (3) make certain other restricted payments, (4) consummate certain asset sales and dispositions, (5) merge or consolidate with any other person and (6) incur additional debt for borrowed money.
PIONEER FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3: BORROWINGS (Continued)
The senior lending agreement also contains certain restrictive covenants that require the Company, among other things, to maintain specific financial ratios and to satisfy certain financial tests including: (a) an Allowance for Credit Losses (as defined in the senior lending agreement) equal to or greater than the Allowance for Credit losses at the end of the prior fiscal year and at no time less than 3% of net receivables, (b) a Senior Indebtedness to Tangible Net Worth Ratio (as defined in the senior lending agreement) as of the end of each quarter not greater than 4.75 to 1.00, and (c) Senior Indebtedness to Net Receivable Ratio (as defined in the senior lending agreement) as of the end of each quarter of no more than 80%. The Company is also required to maintain a Consolidated Total Required Capital (as defined in the senior lending agreement) of at least $12.5 million plus 50% of the cumulative net income during each fiscal year ending after September 30, 2002 ($21,067,849 at September 30, 2005). The breach of any of these covenants could result in a default under the senior lending agreement, in which event the lenders could seek to declare all amounts outstanding to be immediately due and payable. As of September 30, 2005, the Company is in material compliance with all loan covenants.
Parent Company Line of Credit - -----------------------------
The Company has an unsecured revolving line of credit for the amount equal to the greater of two million dollars or 2.5% of the outstanding principal amount of senior debt from its sole shareholder, Pioneer Financial Industries, Inc., which is due upon demand. The maximum outstanding principal was $4,443,951 at September 30, 2005. Advances outstanding under this revolving line of credit were $1,659,396 and $2,613,823 at September 30, 2005 and 2004, respectively. Interest is charged at prime plus 2% (8.75% at September 30, 2005) and is payable monthly.
Investment Notes - ----------------
The Company has also borrowed through the issuance of investment notes with an outstanding balance of $25,125,450 and $23,222,252 at September 30, 2005 and 2004, respectively. The investment notes are non-redeemable before maturity by the holders, are issued at various rates and mature one to ten years from date of issue. The Company, at its option, may redeem and retire any or all of the investment notes upon 30 days written notice. All investment notes are renewable for a like term at the prevailing interest rate, unless presented for payment. The average investment note size was $24,754 and $24,114, with a weighted interest rate of 9.15% and 9.45% at September 30, 2005 and 2004, respectively.
On May 13, 2003, the Securities and Exchange Commission declared the Company's registration statement effective permitting the sale of $25 million principal amount of investment notes on a continuous basis. On February 10, 2005, the Securities and Exchange Commission declared the Company's post-effective amendment effective.
The retainment percentages for the investment notes maturing in 2005 and 2004 are as follows:
Fiscal Total Retainment Year Retained Amount Due Percentage - ----- ------------ ----------- ---------- 2005 $ 2,691,958 $ 6,125,064 43.95% 2004 $ 1,635,342 $ 3,174,757 51.51%
Maturities - ----------
A summary of maturities for the amortizing notes and investment notes at September 30, 2005, follows:
PIONEER FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3: BORROWINGS (Continued)
Amortizing Investment Term Notes Total Notes ------------- ------------ ------------- 2006 $ 59,345,948 $ 2,485,973 $ 61,831,921 2007 48,805,765 1,797,913 50,603,678 2008 37,558,065 2,473,490 40,031,555 2009 18,263,253 2,690,520 20,953,773 2010 - 2,219,346 2,219,346 2011 - 2,551,997 2,551,997 2012 - 1,930,137 1,930,137 2013 - 1,071,122 1,071,122 2014 - 2,425,202 2,425,202 2015 and thereafter - 5,479,750 5,479,750 ------------- ------------ ------------- Total 2005 $ 163,973,031 $ 25,125,450 $ 189,098,481 ============= ============ =============
At September 30, 2005 and 2004, the fair value of borrowings approximates book value.
NOTE 4: INCOME TAXES
The provision for income taxes included in the accompanying consolidated statements of income consists of the following:
2005 2004 2003 ---------- ---------- ----------- Taxes currently payable $4,462,132 $3,463,453 $ 3,172,700 Deferred income taxes (587,132) (327,400) (1,033,700) ---------- ---------- ----------- Total provision $3,875,000 $3,136,053 $ 2,139,000 ========== ========== ===========
The tax effects of temporary differences related to deferred taxes shown on the September 30, 2005 and 2004 consolidated balance sheets are as follows:
2005 2004 ---------- ----------- Deferred tax assets: Allowance for credit losses $5,040,672 $4,046,700 Accumulated depreciation (142,767) (277,900) Deferred origination costs (11,800) (558,576) Other (64,900) (60,097) ---------- ---------- Net deferred tax asset $4,279,232 $3,692,100 ========== ==========
A reconciliation of the provision for income taxes at the normal federal statutory rate of 34% to the provision included in the accompanying consolidated statements of income is shown below:
PIONEER FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5: INTANGIBLE ASSETS
The carrying basis of recognized intangible assets (computer software) at September 30, 2005 and 2004 was $3,818,023 and $2,507,966, respectively, and the related accumulated amortization was $1,830,481 and $1,282,820, respectively.
Amortization expense for the years ended September 30, 2005, 2004 and 2003 was $556,878, $187,091 and $210,271, respectively. Amortization expense for the years ending September 30, 2006, 2007 and 2008 is estimated to be $847,509, $800,193 and $339,839, respectively.
NOTE 6: RELATED PARTY TRANSACTIONS
A description of significant transactions with the Company's sole shareholder, Pioneer Financial Industries, Inc. and other related entities (collectively referred to as PFI) for the years ended September 30, 2005, 2004 and 2003 follows.
The Company has an unsecured revolving line of credit with PFI. The line of credit is due on demand and interest accrues at the prime rate plus 2%. During fiscal 2005, 2004 and 2003, the Company made interest payments on this debt of $152,111, $145,313 and $121,346, respectively.
During fiscal 2005, 2004 and 2003, the Company paid $706,333, $694,663 and $695,578, respectively, to PFI for strategic planning, professional services and service charges. The amount charged to the Company is based on PFI's costs plus a mark-up of not more than 50%. Management of the Company believes the charges are a reasonable estimate of the value received.
Pursuant to an agreement with PFI dated September 21, 2001, which automatically renews annually, the Company sells health discount cards through its retail sales offices on a commission basis. These health discount cards were developed and procured through vendors by PFI and provided to the Company through a sales agent agreement. The Company retains a commission for the sale of each card and remits the remainder to PFI. The amount remitted to PFI was $238,215, $529,808 and $491,340 in fiscal 2005, 2004 and 2003, respectively, which approximates costs. The Company's commissions on the sale of health cards were $690,297, $794,821 and $717,767 in fiscal 2005, 2004 and 2003, respectively.
During fiscal 2003, the Company paid PFI a fee of approximately $100 for each loan customer referral for its Germany operations. Fees paid in fiscal 2003 aggregated $597,715, which approximated the cost of identifying and making these referrals. On September 30, 2003, the Company purchased the German subsidiary from PFI.
The Company leases certain office equipment, signs and automobiles from Midstate Leasing, LLC, an entity owned by PFI's controlling shareholder and other shareholders. These operating leases are generally for nine-month periods and are automatically renewable. During fiscal 2005, 2004 and 2003, payments under these leases totaled $180,852, $190,488 and $192,389, respectively.
The Company's customers execute a master credit agreement in connection with direct loans. The extended effectiveness of this agreement helps expedite the extension of subsequent loans to the customer. PFI's principal shareholder developed and copyrighted the form of this agreement, and the Company licensed it from him in return for a royalty pursuant to a trademark licensing agreement that automatically renews annually. In fiscal 2005, the royalty averaged $2.76 per loan, and aggregated $219,481. In fiscal 2004 and 2003, the royalty averaged $2.65 and $2.47 per loan, and aggregated $170,356 and $135,786, respectively.
Amounts due to PFI under the revolving line of credit are discussed in Note 3. There are no other amounts due to PFI or other related entities at September 30, 2005 or 2004.
PIONEER FINANCIAL SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7: LEASE OBLIGATIONS
At September 30, 2005, the Company was obligated under non-cancelable operating leases covering its facilities and certain equipment expiring through 2010. Aggregate minimum annual rentals payable are summarized as follows:
Year Ending September 30: 2006 $ 949,847 2007 892,794 2008 875,949 2009 583,274 2010 379,472
The minimum rentals shown above do not include rents payable on a "month-to-month" or "cancelable" basis. Rental expense charged against operations totaled $1,786,861, $1,590,200 and $1,701,984, for the fiscal years ended September 30, 2005, 2004 and 2003, respectively. Included in these amounts were $180,852, $190,488 and $336,389, for the fiscal years ended September 30, 2005, 2004 and 2003, respectively, paid to related parties.
NOTE 8: PROFIT-SHARING PLAN
The Company participates in a profit-sharing plan, which covers substantially all employees who are 21 years of age and have been employed by the Company for one year. The Company contributes an amount to the plan each year that is determined by the board of directors. In fiscal 2005 and 2004, the Company matched 50.0% and 33.3%, respectively, of participant 401(k) deferrals up to a maximum of 5% of total compensation. Participant interests are vested after three years of service. Contributions to the plan were $700,580, $901,466 and $705,321, for the years ended September 30, 2005, 2004 and 2003, respectively.
NOTE 9: LITIGATION
We became aware, in the second quarter of fiscal year 2005, that the Florida Attorney General was planning to file a lawsuit against a subsidiary of ours accusing it of violating Florida lending laws and requiring it to comply with such laws in connection with 216 loans that were made by our subsidiary during the period December 2001 to March 2003. We have relied upon the case of Pioneer Military Lending v. Manning, 2 F.3d 280 (8th Cir. 1993), the Eighth Circuit Court of Appeals held that the Commerce Clause of the U.S. Constitution prevents the lending laws of the State in which a non-resident military borrower is stationed from regulating such loan transactions. In the eleven years since the Manning decision, more than 25 states have accepted the rationale in that decision and allowed us to utilize the aforementioned business model without local state regulation. While not obligated to do so, we have been cooperating fully with an inquiry conducted during the past two and a half years by the Florida Attorney General regarding the loans made from our subsidiary in Georgia to non-resident U.S. military personnel stationed in Florida. In March 2005, our subsidiary received another subpoena from the Attorney General's Office, that we interpreted as indicating that the Florida Attorney General was planning to file a lawsuit. We believe we cannot continue to meet the borrowing needs of U.S. military personnel if we are required to comply with the lending laws of each of the significant number of states that have military installations. On April 29, 2005, Pioneer Military Lending of Georgia, Inc., a Georgia corporation and wholly-owned subsidiary of ours, filed a Complaint for Declaratory Judgment, Injunctive Relief and Damages against Charlie Crist, the Attorney General of Florida, in the United States District Court for the Northern District of Florida. The complaint seeks a determination that, among other things, we and our affiliates are not subject to Florida lending laws and licensing requirements. The Company is also currently involved in various litigation matters in the ordinary course of business. The Company is not currently involved in any other litigation or proceeding that it expects, either individually or in the aggregate, will have a material adverse effect on our financial condition, results of operations and cash flows.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Our management, under the supervision and with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the fiscal year, which is the subject of this Annual Report on Form 10-K. Based on this evaluation, our principal executive officer and principal financial officer have concluded that the design and operation of our disclosure controls and procedures are effective. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date the evaluation was completed.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information regarding each person who serves as a director or executive officer of Pioneer as of September 30, 2005:
Name Age Position ---- --- --------
William D. Sullivan 68 Chairman, Chief Executive Officer and sole Director Thomas H. Holcom, Jr. 59 President and Chief Operating Officer Randall J. Opliger 48 Chief Financial Officer, Treasurer and Secretary
William D. Sullivan is the Chairman and sole member of our board of directors. He has been a director since 1957. Mr. Sullivan has been associated with Pioneer since 1957 and has served in all levels of branch office operations as well as all management and executive capacities. He has been our Chief Executive Officer since 1963. Mr. Sullivan was one of the founders of a Kansas City bank, which merged with a multi-billion dollar bank holding company. After 20 years of service, he retired in 1987 as a member of their Kansas City regional bank executive committee and its board of directors. In addition, he has served as President of the National Second Mortgage Association, Kansas Association of Financial Services and the Consumer Credit Counseling Service. He is also former officer of the Missouri Financial Services Association and the Better Business Bureau.
Thomas H. Holcom, Jr. is our President and Chief Operating Officer. He has been associated with Pioneer since 1985 when he joined us as our Chief Financial Officer. He was named President and Chief Operating Officer in September, 2000. Prior to joining us, Mr. Holcom spent 19 years with a regional bank with assets over $1 billion and was Executive Vice President of that bank. His career has encompassed strategic planning, corporate finance, consulting, investments, risk management and marketing. He served on the boards of numerous professional and civic organizations.
Randall J. Opliger joined us as our Chief Financial Officer, Treasurer and Secretary in April, 2000. Mr. Opliger received his CPA designation in 1982, and his prior experience includes both public accounting and other executive level responsibilities, including serving as a chief financial officer of a consumer finance company of a similar size.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth all cash compensation we paid during each of our last three fiscal years to our Chief Executive Officer and to the other two executive officers whose total annual salary and bonus paid during fiscal year 2005 exceeded $100,000. As sole director, Mr. Sullivan has determined executive compensation with input from Mr. Holcom, as President and Chief Operating Officer.
- -------------------- (1) Amounts attributable to the non-business use of a company car.
Options Grants
We have not granted any options or equity-based incentives.
Employment Agreement
We have entered into an employment agreement with Randall J. Opliger pursuant to which we have agreed to pay him a base salary. The employment agreement may be terminated by either party upon five days notice, except that we may terminate the agreement without notice for cause or if Mr. Opliger violates any provision of the agreement. The agreement contains customary non-disclosure provisions and prohibits Mr. Opliger from competing with us or soliciting any of our customers or employees for two years following his termination or resignation. In addition, both parties agree to arbitrate most disputes arising under the agreement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
As of November 30, 2005, Pioneer Financial Industries, Inc., a Nevada corporation, owns 17,136 shares of our common stock, which constitutes all of our issued and outstanding shares of common stock. We have no other class of capital stock authorized. The address of Pioneer Financial Industries, Inc. is 955 South Virginia Avenue, Suite 116, Reno, Nevada 89502. Pioneer Financial Industries, Inc. has sole voting and investment power with respect to the shares of our common stock set forth above. Neither our director nor any of our executive officers own any shares of our common stock.
As of November 30, 2005, as the trustee or beneficiary of various trusts, William D. Sullivan had sole or shared voting or investment power over 171,420 shares, or 95.3%, of the common stock of Pioneer Financial Industries, Inc. Upon the death of Mr. Sullivan, the trust department of a commercial bank will exercise the voting rights over these shares.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
We are privately held and after the sale of the debentures we will continue to be privately held. Our sole shareholder, Pioneer Financial Industries, Inc., has the flexibility of structuring our operating activity so as to optimize our ability to borrow capital for use in our lending activities and to reduce our exposure to the risks of developing new products and services. As a result, certain expenditures and assets related to our operations have been paid for or financed by Pioneer Financial Industries, Inc and its subsidiaries. We then lease or purchase these products and services from them.
At September 30, 2005, we had borrowed $1,659,396 from our parent, Pioneer Financial Industries, Inc. ("PFI"), pursuant to an unsecured revolving line of credit. The line of credit is due on demand and interest accrues at the prime rate plus 2.0%. During fiscal 2005, 2004 and 2003, we made interest payments on this debt in the amount of $152,111, $145,313 and $121,346, respectively.
During fiscal 2005, 2004 and 2003, we paid $706,333, $694,663 and $695,578, respectively, to our parent and its subsidiaries for strategic planning, professional services and service charges, including (i) $0, $0 and $157,995, respectively, paid to Pioneer Licensing Services, Inc. ("PLS"), to acquire, develop and maintain intellectual property assets employed by us, including names, trademarks, websites, logos, branding rights and software, and to license those intellectual property
rights to us as needed; and (ii) $214,333, $192,663, and $110,000, respectively, paid to Penwith Corporation ("Penwith") for strategic planning and professional services, including product identification and procurement. On September 30, 2003, as part of a corporate re-alignment, the Company purchased PLS from our parent Pioneer Financial Industries, Inc. The purchase price paid was approximately $106,000, which equaled the carrying amounts of the net assets of PLS.
We share with Armed Services Benefits ("ASB"), a subsidiary of our parent, a portion of the commission received on each health discount card sold based on our agreement with ASB. The portion paid to ASB is approximately 26% of the total commission received. During fiscal 2005, 2004 and 2003, we paid ASB a total of $238,215, $529,808, and $491,340, respectively, in commissions and we retained a total of $690,297, $794,821 and $717,767, respectively. The amount remitted to ASB approximates its costs.
Pioneer Sales Services, GmbH ("PSS"), a Germany subsidiary, receives a fee of approximately $100 for each loan customer it refers to one of our lending subsidiaries. During fiscal 2003 we paid this entity $597,715 which approximates its cost of identifying and making these referrals. On September 30, 2003, as part of the corporate re-alignment, the Company purchased PSS from our parent Pioneer Financial Industries, Inc. The purchase price paid was approximately $41,900, which equaled to the carrying amounts of the net assets of PSS.
Midstate Leasing, LLC ("Midstate"), an entity owned by the controlling shareholder and certain other shareholders of our parent, leases certain office equipment, signs and automobiles to several of our subsidiaries. These operating leases are generally for nine month periods and are automatically renewable. During fiscal 2005, 2004 and 2003, payments under these leases totaled $180,852, $190,488 and $192,389, respectively.
Prior to fiscal 2004, we rented a building from Westport Investment Corp. ("Westport"), a subsidiary of our parent. The lease expired on September 30, 2003. During fiscal 2003 we made lease payments to Westport in the amount of $144,000.
Our customers execute a master credit agreement in connection with direct loans. The extended effectiveness of this agreement helps expedite the extension of subsequent loans to the customer. William D. Sullivan developed and copyrighted the form of this agreement, and we license it from him in return for a royalty. In fiscal 2005, the royalty averaged $2.76 per loan, and Mr. Sullivan received a total of $219,481 in royalty payments. In fiscal 2004 and 2003, the royalty averaged $2.65 and $2.47 per loan, respectively, with Mr. Sullivan receiving a total of $170,356 and $135,786 in royalty payments, respectively.
The table below summarizes our transactions with affiliated parties:
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Audit Fees
The aggregate fees billed for professional services rendered in fiscal years 2005 and 2004, respectively, by BKD, LLP for the audit of the Company's annual financial statements and the review of the financial statements included in our quarterly reports on Form 10-Q were $58,000 and $60,328, respectively.
Audit-Related Fees
The aggregate fees billed for audit-related services rendered in fiscal years 2005 and 2004, respectively, by BKD, LLP, which are not reported under "Audit Fees" above were $1,693 and $1,263, respectively. These fees were primarily for out of pocket expenses and research done for audit and tax services.
Tax Fees
The aggregate fees billed for tax services rendered in fiscal years 2005 and 2004, respectively, by BKD, LLP were $27,000 and $40,110, respectively. These fees were primarily for preparation of federal and state taxes returns.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as exhibits to this annual report:
Exhibit No Description - ---------- -----------
3.1 Restated Articles of Incorporation of the Company (Incorporated by reference to Exhibit 3.1 of the Company's Registration Statement on Form S-1, as amended, filed with the Securities and Exchange Commission on February 8, 2003 (Commission No. 333-103293) (the "Initial Registration Statement")). 3.2 Certificate of Amendment to Articles of Incorporation of the Company (Incorporated by reference to Exhibit 3.2 of the Initial Registration Statement). 3.3 Amended and Restated By-Laws of the Company (Incorporated by reference to Exhibit 3.3 of the Initial Registration Statement). 4.1 Amended and Restated Indenture dated as of December 15, 2004 (Incorporated by reference to Exhibit 4.1 of the Post Effective Amendment No. 2 to the Registration Statement filed with the Securities and Exchange Commission dated December 17, 2004 (Commission No. 333-103293) ("Post Effective Amendment No.2"). 4.2 Form of investment note certificate (Incorporated by reference to Exhibit 4.2 of the Post Effective Amendment No. 2). 4.3 Form of junior subordinated debenture prior to November 1, 2002 (Incorporated by reference to Exhibit 4.3 of the Initial Registration Statement). 4.7 Form of Agreement between the Company and various banks named in Amended and Restated Senior Lending Agreement (Incorporated by reference to Exhibit 4.7 of the Initial Registration Statement). 4.9 Amended and Restated Senior Lending Agreement dated October 1, 2003 among the Company and various banks named therein (Incorporated by reference to Exhibit 4.9 of the Post Effective Amendment No. 1 to the Registration Statement filed with the Securities and Exchange Commission dated December 12, 2003 (Commission No. 333-103293) ("Post Effective Amendment No.1"). 4.10 Promissory Note dated October 1, 2003 between the Company and Pioneer Financial Industries, Inc. 4.11 Form of Rate Supplement (Incorporated by reference to Exhibit 4.11 of the Post Effective Amendment No. 2). 4.12 Form of IRA Application (Incorporated by reference to Exhibit 4.12 of the Post Effective Amendment No. 2). 4.13 Form of Offer to Purchase (Incorporated by reference to Exhibit 4.13 of the Post Effective Amendment No. 2). 10.1 Form of Readi-Loan Licensing Agreement (Incorporated by reference to Exhibit 10 of the Initial Registration Statement). 10.2 Office Building Lease dated January 31, 2001, between the Company and Belletower Partners, L.L.C. (Incorporated by reference to Exhibit 10.2 of the Initial Registration Statement). 10.3 Addendum to Office Building Lease between the Company and Belletower Partners, L.L.C. (Incorporated by reference to Exhibit 10.3 of the Initial Registration Statement). 10.4 First Amendment to Office Building Lease dated July 19, 2001, between the Company and Belletower Partners, L.L.C. (Incorporated by reference to Exhibit 10.4 of the Initial Registration Statement). 10.5 Employment Contract between the Company and Randall J. Opliger (Incorporated by reference to Exhibit 10.5 of the Initial Registration Statement). 10.6 Trademark Licensing Agreement dated October 10, 2000 between the Company and Pioneer Licensing Services, Inc. (Incorporated by reference to Exhibit 10.6 of the Initial Registration Statement). 10.7 Transfer of Shares dated as of September 30, 2003 between the Company and Pioneer Financial Industries, Inc. (Incorporated by reference to Exhibit 10.7 of the Post Effective Amendment No. 1). 10.8 Capital Contribution Agreement dated as of September 30, 2003 between the Company and Pioneer Financial Industries, Inc. (Incorporated by reference to Exhibit 10.8 of the Post Effective Amendment No. 1). 10.9 Stock Purchase Agreement dated October 29, 2003 between the Company and Pioneer Financial Industries, Inc. (Incorporated by reference to Exhibit 10.9 of the Post Effective Amendment No. 1). 10.10 Stock Purchase Agreement dated October 29, 2003 between the Company and Pioneer Financial Industries, Inc. (Incorporated by reference to Exhibit 10.10 of the Post Effective Amendment No. 1). 12 Statement regarding computation of ratios (Incorporated by reference to Exhibit 12 of the Post Effective Amendment No. 2). 21 Subsidiaries of the Company (Incorporated by reference to Exhibit 21 of the Post Effective Amendment No. 1). 31.1 Certificate of the Chief Executive Officer of Pioneer Financial Services, Inc. dated December 20, 2005 for the Annual Report on Form 10-K for the year ended September 30, 2005. 31.2 Certificate of the Chief Financial Officer of Pioneer Financial Services, Inc. dated December 20, 2005 for the Annual Report on Form 10-K for the year ended September 30, 2005.
32.1 18 U.S.C. Section 1350 Certification of Chief Executive Officer of Pioneer Financial Services, Inc. dated December 20, 2005. 32.2 18 U.S.C. Section 1350 Certification of Chief financial Officer of Pioneer Financial Services, Inc. dated December 20, 2005.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PIONEER FINANCIAL SERVICES, INC.
By: /s/ WILLIAM D. SULLIVAN ------------------------------------- William D. Sullivan Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Exhibit No Description - ---------- -----------
3.1 Restated Articles of Incorporation of the Company (Incorporated by reference to Exhibit 3.1 of the Company's Registration Statement on Form S-1, as amended, filed with the Securities and Exchange Commission on February 8, 2003 (Commission No. 333-103293) (the "Initial Registration Statement")). 3.2 Certificate of Amendment to Articles of Incorporation of the Company (Incorporated by reference to Exhibit 3.2 of the Initial Registration Statement). 3.3 Amended and Restated By-Laws of the Company (Incorporated by reference to Exhibit 3.3 of the Initial Registration Statement). 4.1 Amended and Restated Indenture dated as of December 15, 2004 (Incorporated by reference to Exhibit 4.1 of the Post Effective Amendment No. 2 to the Registration Statement filed with the Securities and Exchange Commission dated December 17, 2004 (Commission No. 333-103293) ("Post Effective Amendment No.2"). 4.2 Form of investment note certificate (Incorporated by reference to Exhibit 4.2 of the Post Effective Amendment No. 2). 4.3 Form of junior subordinated debenture prior to November 1, 2002 (Incorporated by reference to Exhibit 4.3 of the Initial Registration Statement). 4.7 Form of Agreement between the Company and various banks named in Amended and Restated Senior Lending Agreement (Incorporated by reference to Exhibit 4.7 of the Initial Registration Statement). 4.9 Amended and Restated Senior Lending Agreement dated October 1, 2003 among the Company and various banks named therein (Incorporated by reference to Exhibit 4.9 of the Post Effective Amendment No. 1 to the Registration Statement filed with the Securities and Exchange Commission dated December 12, 2003 (Commission No. 333-103293) ("Post Effective Amendment No.1"). 4.10 Promissory Note dated October 1, 2003 between the Company and Pioneer Financial Industries, Inc. 4.11 Form of Rate Supplement (Incorporated by reference to Exhibit 4.11 of the Post Effective Amendment No. 2). 4.12 Form of IRA Application (Incorporated by reference to Exhibit 4.12 of the Post Effective Amendment No. 2). 4.13 Form of Offer to Purchase (Incorporated by reference to Exhibit 4.13 of the Post Effective Amendment No. 2). 10.1 Form of Readi-Loan Licensing Agreement (Incorporated by reference to Exhibit 10 of the Initial Registration Statement). 10.2 Office Building Lease dated January 31, 2001, between the Company and Belletower Partners, L.L.C. (Incorporated by reference to Exhibit 10.2 of the Initial Registration Statement). 10.3 Addendum to Office Building Lease between the Company and Belletower Partners, L.L.C. (Incorporated by reference to Exhibit 10.3 of the Initial Registration Statement). 10.4 First Amendment to Office Building Lease dated July 19, 2001, between the Company and Belletower Partners, L.L.C. (Incorporated by reference to Exhibit 10.4 of the Initial Registration Statement). 10.5 Employment Contract between the Company and Randall J. Opliger (Incorporated by reference to Exhibit 10.5 of the Initial Registration Statement). 10.6 Trademark Licensing Agreement dated October 10, 2000 between the Company and Pioneer Licensing Services, Inc. (Incorporated by reference to Exhibit 10.6 of the Initial Registration Statement). 10.7 Transfer of Shares dated as of September 30, 2003 between the Company and Pioneer Financial Industries, Inc. (Incorporated by reference to Exhibit 10.7 of the Post Effective Amendment No. 1). 10.8 Capital Contribution Agreement dated as of September 30, 2003 between the Company and Pioneer Financial Industries, Inc. (Incorporated by reference to Exhibit 10.8 of the Post Effective Amendment No. 1). 10.9 Stock Purchase Agreement dated October 29, 2003 between the Company and Pioneer Financial Industries, Inc. (Incorporated by reference to Exhibit 10.9 of the Post Effective Amendment No. 1). 10.10 Stock Purchase Agreement dated October 29, 2003 between the Company and Pioneer Financial Industries, Inc. (Incorporated by reference to Exhibit 10.10 of the Post Effective Amendment No. 1). 12 Statement regarding computation of ratios (Incorporated by reference to Exhibit 12 of the Post Effective Amendment No. 2). 21 Subsidiaries of the Company (Incorporated by reference to Exhibit 21 of the Post Effective Amendment No. 1). 31.1 Certificate of the Chief Executive Officer of Pioneer Financial Services, Inc. dated December 20, 2005 for the Annual Report on Form 10-K for the year ended September 30, 2005. 31.2 Certificate of the Chief Financial Officer of Pioneer Financial Services, Inc. dated December 20, 2005 for the Annual Report on Form 10-K for the year ended September 30, 2005. 32.1 18 U.S.C. Section 1350 Certification of Chief Executive Officer of Pioneer Financial Services, Inc. dated December 20, 2005. 32.2 18 U.S.C. Section 1350 Certification of Chief financial Officer of Pioneer Financial Services, Inc. dated December 20, 2005.