(1) Nature of Business, Principles of Consolidation, Basis of Presentation, Use of Estimates and Significant Accounting Policies

Nature of Business

TMX Finance LLC and affiliates (collectively, the "Company") is an alternative finance company that originates and services automobile title loans through 756 title-lending stores in 12 states as of December 31, 2011. Affiliates include wholly-owned subsidiaries and consolidated variable interest entities ("VIEs") as described below. The parent company, TMX Finance LLC, changed its name from TitleMax Holdings, LLC to TMX Finance LLC effective June 21, 2010. The Company operates as TitleMax in 632 stores, and in 120 stores, the Company operates under a TitleBucks brand. The Company offers a second lien automobile product in Georgia under the EquityAuto Loan brand, with operations conducted within 123 TitleMax stores and through 4 standalone stores. Segment information is not presented since all of the Company's revenue is attributed to a single reportable segment: alternative financial services.

The Company is subject to laws, regulations and supervision in each of the states in which it operates. Most states have laws that specifically regulate the Company's products and services to establish allowable fees, interest and other economic terms. The terms of products and services offered by the Company vary between states to comply with each state's specific laws and regulations. In addition to state laws and regulations, the Company's business is subject to various local rules and regulations such as zoning regulation and permit licensing.

The interest rates and fees for the Company's products and services are not currently regulated directly at the federal level, but laws and regulations governing the business are subject to change. On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was enacted into law. This act established the Consumer Financial Protection Bureau ("CFPB") as a federal authority responsible for administering and enforcing the laws and regulations for consumer financial products and services. The legislation does not specifically target title lending, traditional pawn or installment lending for CFPB regulation. Furthermore, the CFPB is specifically prohibited from instituting federal usury interest rate caps. It is still unclear to what extent the CFPB will have regulatory oversight of the industry in which the Company operates.

Principles of Consolidation

TMX Finance LLC is a single member Delaware limited liability company that, through its subsidiaries, is engaged primarily in the origination and servicing of automobile title loans. TMX Finance LLC has 19 wholly-owned subsidiaries: TitleMax of Alabama, Inc., TitleMax of Arizona, Inc., TMX Finance of Florida, Inc., TitleMax of Georgia, Inc., TitleMax of Illinois, Inc., TitleMax of Mississippi, Inc., TitleMax of Missouri, Inc., TitleMax of Nevada, Inc., TitleMax of South Carolina, Inc., TitleMax of Tennessee, Inc., TitleMax of Virginia, Inc., TMX Finance of Virginia, Inc., TitleMax of Texas, Inc., TMX Finance of Texas, Inc., EquityAuto Loan, LLC ("EAL"), TMX Credit, Inc., TitleMax Funding, Inc. ("Funding"), TitleMax Financing, Inc. ("Financing") and TitleMax Finance Corporation.

In April 2006, the sole member of TMX Finance LLC formed EAL. On June 21, 2010, the sole member transferred 100% of his membership interests in EAL to TMX Finance LLC. The Company consolidated EAL effective January 1, 2010 in accordance with accounting standards related to consolidation. This transfer between entities under common control has been accounted for at the historical cost of the assets and liabilities transferred. These consolidated financial statements are presented as if the transfer took place as of the earliest period presented.

The Company conducts business in Texas through a wholly-owned subsidiary (TitleMax of Texas, Inc.) registered as a Credit Services Organization ("CSO") under Texas law. In connection with operating as a CSO, TitleMax of Texas, Inc. entered into credit services organization agreements ("CSO Agreements") with three third-party lenders (the "CSO Lenders"). The CSO Agreements govern the terms by which the Company performs underwriting services and refers customers in Texas to the CSO Lenders for a possible extension of a loan. The Company processes loan applications and commits to reimburse the CSO Lenders for any loans or related fees that are not collected from those customers. Two of the CSO Lenders operate on an exclusive basis, and the Company has determined that they are VIEs of which the Company is the primary beneficiary. Therefore, the Company has consolidated these VIEs in 2011.

Basis of Presentation

The accompanying consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries and its consolidated VIEs. All significant intercompany transactions and balances have been eliminated in consolidation.

Use of Estimates

The preparation of consolidated 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 consolidated financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to change relate to the determination of the allowance for loan losses and the valuation of repossessed assets.

Significant Accounting Policies

The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the consumer finance industry. The following is a description of significant accounting policies used in preparing the consolidated financial statements.

Cash and Cash Equivalents

The Company maintains amounts in bank accounts which, at times, may exceed federally insured limits. The Company has not experienced losses in such accounts. Management believes the Company's exposure to credit risk is minimal for these accounts.

Goodwill and indefinite-life intangible assets acquired in a business combination are recorded using the acquisition method of accounting and are tested for impairment annually, or sooner when circumstances indicate an impairment may exist. In testing for impairment, the Company first assesses qualitative factors as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. The first step of the impairment test, if necessary, is to compare the estimated fair value of the reporting unit to its carrying value. If the fair value is less than the carrying value, then a second step is performed to determine the fair value of goodwill and the amount of impairment loss, if any. In addition, intangible assets with finite lives are amortized over their estimated useful lives and reviewed for impairment whenever events or circumstances indicate the carrying value may not be fully recoverable.

Loan Losses

Provisions for loan losses are charged to income in amounts sufficient to maintain an adequate allowance for loan losses and an adequate accrual for losses related to guaranteed loans processed for our unconsolidated CSO Lender. Factors used in assessing the overall adequacy of the allowance for loan losses, the accrual for losses related to guaranteed loans processed for our unconsolidated CSO Lender and the resulting provision for loan losses include loan loss experience, contractual delinquency of title loans receivable, the value of underlying collateral, economic and other qualitative considerations and management's judgment. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions. The Company's average loan size is approximately $1,200. The Company charges-off an account when the customer is 61 days contractually past due. Charge-offs on title loans receivable are equal to the loan balance less an estimated amount of recovery.

Loan Origination Costs

Direct costs incurred for the origination of loans, which consist mainly of employee-related costs, are deferred and recognized as a reduction of the related interest and fee income over the average life of the loan using a method that approximates the interest method.

Repossessed Assets

The Company may initiate repossession proceedings according to the respective state law if an account becomes past due. Repossessed collateral is valued at the lower of the receivable balance of the loan prior to repossession or estimated net realizable value. Management estimates net realizable value as the projected cash value upon liquidation less costs to sell the related collateral.

Property, Equipment and Aircraft

Property, equipment and aircraft held and used are carried at cost. The cost of property retired or sold and the related accumulated depreciation are removed from the accounts, and any resulting gain or loss is recognized in the consolidated statements of income. Depreciation of property, equipment and aircraft is provided by the straight-line method over the estimated useful lives of the assets, as shown in the chart below. Leasehold improvements are amortized using the straight-line method over the lesser of the useful lives of the improvements or the life of the lease. Repairs and maintenance are expensed as incurred.

 

(a) Leasehold improvements are depreciated over the terms of the lease agreements with a maximum of 5 years.

Impairment of Long-Lived Assets

The Company annually evaluates whether events or circumstances have occurred that indicate the carrying amount of long-lived assets may warrant revision or may not be recoverable. When factors indicate that these long-lived assets should be evaluated for possible impairment, the Company assesses the recoverability by determining whether the carrying value of such long-lived assets will be recovered through the future undiscounted cash flows expected from uses of the assets and their eventual disposition. Based on management's evaluation, the only impairment of the carrying value of long-lived assets was for the aircraft held for sale at December 31, 2009 and sold in May 2010.

Debt Issuance Costs

Costs incurred to obtain debt financing are amortized over the life of the related debt using a method that approximates the interest method. Amortization is included as a component of interest expense in the consolidated statements of income.

(1) Nature of Business, Principles of Consolidation, Basis of Presentation, Use of Estimates and Significant Accounting Policies (continued)

Income Recognition

Interest and fee income is recognized using the interest method. Accrual of interest and fee income on title loans receivable is discontinued when no payment has been received for 35 days or more. The accrual of income is not resumed until the account is less than 5 days past due on a contractual basis, at which time management considers collectability to be probable. Effective October 1, 2009, management changed its accounting estimate related to the Company's suspension of interest and fee income. Prior to this date, accrual of interest and fee income on title loans receivable was suspended when no payment had been received for 30 days or more pursuant to contractual terms. Based on additional information and analysis of current customer payment trends, management determined that the likelihood of receiving a payment from a customer greatly diminishes when no payment has been received for 35 days. As a result, management revised its policy for the suspension of interest and fee income. The effect of this change in estimate for the year ended December 31, 2009 was an increase in interest receivable and interest and fee income of approximately $2.7 million.

Advertising Costs

The Company incurs advertising costs principally related to advertising on television, the internet, billboards and yellow pages. These costs are expensed as incurred.

Income Taxes and Distributions

The Company, with the consent of the sole member, elected in prior years to be taxed under sections of the federal and state income tax laws, which provide that, in lieu of corporate income taxes, the sole member separately accounts for the Company's items of income, deduction, losses and credits. The consolidated financial statements generally do not include a provision for income taxes as long as these elections remain in effect. Certain subsidiaries operate in states that impose an entity-level tax that is a percentage of income.

Given the Company's income tax elections made, the assets and liabilities with significant estimated net differences between the tax bases and the reported amounts are presented below as of December 31, 2011 and 2010. The estimated net differences disregard the assets and liabilities of the consolidated CSO Lenders.

TMX FINANCE LLC AND AFFILIATES

Notes to Consolidated Financial Statements

The tax bases were less than the carrying amounts as follows:

 

While the Company's tax status and income tax elections remain in effect, the Company may occasionally make distributions to the sole member in amounts sufficient to pay some or all of the taxes due on the Company's items of income, deductions, losses, and credits which have been allocated for reporting on the sole member's income tax return. The Company anticipates making distributions to its sole member to pay 2011 federal and state income taxes. These distributions are expected to total approximately $24 to $27 million. The Company may make future distributions to the sole member in addition to those required for income taxes as permitted under the terms of the bond indenture. At December 31, 2011, the remaining availability of permitted distributions to our sole member for purposes other than estimated personal income tax payments was approximately $5.8 million (calculated net of an estimate for personal income tax distributions anticipated on taxable income during the period).

TMX FINANCE LLC AND AFFILIATES

Notes to Consolidated Financial Statements

(1) Nature of Business, Principles of Consolidation, Basis of Presentation, Use of Estimates and Significant Accounting Policies (continued)

Employee Equity Option and Phantom Stock Award

The Company accounts for share-based employee compensation by measuring all share-based payments to employees using the intrinsic value method and recording the resulting expense in the consolidated statements of income. The Company measures the liability for grants of phantom stock by using an agreed-upon calculation defined by the terms of the phantom stock award.

Recent Accounting Standards

In December 2010, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update ("ASU") No. 2010-28 to modify the first step of the goodwill impairment test for reporting units with zero or negative carrying amounts. For these reporting units, an entity must assess whether it is more likely than not that goodwill impairment exists. When qualitative factors exist that indicate goodwill is more likely than not impaired, an entity can no longer assert that a reporting unit is not required to perform the second step of the goodwill impairment test when the carrying amount of the reporting unit is zero or negative. The Company adopted the provisions of this guidance in 2011 with no material impact on the Company's financial position, results of operations or cash flows.

In May 2011, the FASB issued ASU No. 2011-04 to provide a consistent definition of fair value and ensure that fair value measurements and disclosure requirements are similar between accounting principles generally accepted in the United States of America and International Financial Reporting Standards. This guidance changes certain fair value measurement principles and enhances the disclosure requirements for fair value measurements. This guidance is effective for interim and annual periods beginning after December 15, 2011 and is not expected to have an impact on the Company's financial position, results of operations or cash flows.