Part I

Financial Information

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

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

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

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A – Organization and Business

America’s Car-Mart, Inc., a Texas corporation (the “Company”), is the largest publicly held automotive retailer in the United States focused exclusively on the “Buy Here/Pay Here” segment of the used car market.  References to the Company typically include the Company’s consolidated subsidiaries.  The Company’s operations are principally conducted through its two operating subsidiaries, America’s Car-Mart, Inc., an Arkansas corporation, (“Car-Mart of Arkansas”) and Colonial Auto Finance, Inc. (“Colonial”).  Collectively, Car-Mart of Arkansas and Colonial are referred to herein as “Car-Mart”.  The Company primarily sells older model used vehicles and provides financing for substantially all of its customers. Many of the Company’s customers have limited financial resources and would not qualify for conventional financing as a result of limited credit histories or past credit problems.  As of October 31, 2005, the Company operated 81 stores located primarily in small cities throughout the South-Central United States.

B – Summary of Significant Accounting Policies

General

The accompanying unaudited financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended October 31, 2005 are not necessarily indicative of the results that may be expected for the year ended April 30, 2006.  For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended April 30, 2005.

Adjustments to Reflect Stock Split

All references to the number of shares of common stock, stock options and warrants, earnings per share amounts, exercise prices of stock options and warrants, common stock prices, and other share and per share data or amounts in this Quarterly Report on Form 10-Q have been adjusted, as necessary, to retroactively reflect the three-for-two common stock split effected in the form of a 50% stock dividend in April 2005.

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 amount 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 period.  Actual results could differ from those estimates.

Concentration of Risk

The Company provides financing in connection with the sale of substantially all of its vehicles.  These sales are made primarily to customers residing in Arkansas, Oklahoma, Texas, Kentucky and Missouri, with approximately 57% of sales made to customers residing in Arkansas.  Periodically, the Company maintains cash in financial institutions in excess of the amounts insured by the federal government.  The Company’s revolving credit facility matures in April 2009.

Restrictions on Subsidiary Distributions/Dividends

Car-Mart’s revolving credit facilities limit distributions from Car-Mart to the Company beyond (i) the repayment of intercompany loans ($10.0 million at October 31, 2005), and (ii) dividends equal to 75% of Car-Mart of Arkansas’ net income.  At October  31, 2005, the Company’s assets (excluding its $98 million equity investment in Car-Mart) consisted of $76,000 in cash, $3 million in other assets and a $10.0 million receivable from Car-Mart.  Thus, the Company is limited in the amount of dividends or other distributions it can make to its shareholders without the consent of Car-Mart’s lender.  Beginning in February 2003, Car-Mart assumed substantially all of the operating costs of the Company.

Finance Receivables, Repossessions and Charge-offs and Allowance for Credit Losses

The Company originates installment sale contracts from the sale of used vehicles at its dealerships.  Finance receivables consist of contractually scheduled payments from installment contracts net of unearned finance charges and an allowance for credit losses. Unearned finance charges represent the initial amounts of interest income expected to be earned over the term of the installment contracts less the amount of interest income already earned on such contracts.  An account is considered delinquent when a contractually scheduled payment has not been received by the scheduled payment date.  At October 31, 2005 and 2004, 4.1% and 3.5%, respectively, of the Company’s finance receivable balances were over 30 days past due.

The Company takes steps to repossess a vehicle when the customer becomes severely delinquent in his or her payments, and management determines that timely collection of future payments is not probable.  Accounts are charged-off after the expiration of a statutory notice period for repossessed accounts, or when management determines that timely collection of future payments is not

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probable for accounts where the Company has been unable to repossess the vehicle. For accounts where the vehicle has been repossessed, the fair value of the repossessed vehicle is charged as a reduction of the gross finance receivable balance charged-off.  On average, accounts are approximately 59 days past due at the time of charge-off.  For previously charged-off accounts that are subsequently recovered, the amount of such recovery is credited to the allowance for credit losses.

The Company maintains an allowance for credit losses on an aggregate basis at a level it considers sufficient to cover estimated losses in the collection of its finance receivables.  The allowance for credit losses is based primarily upon historical and recent credit loss experience, with consideration given to changes in loan characteristics (i.e., average amount financed and term), delinquency levels, collateral values, economic conditions, underwriting and collection practices, and management’s expectations of future credit losses.  The allowance for credit losses is periodically reviewed by management with any changes reflected in current operations.  Although it is at least reasonably possible that events or circumstances could occur in the future that are not presently foreseen which could cause actual credit losses to be materially different from the recorded allowance for credit losses, the Company believes that it has given appropriate consideration to all relevant factors and has made reasonable assumptions in determining the allowance for credit losses.

Inventory

Inventory consists of used vehicles and is valued at the lower of cost or market on a specific identification basis.  Vehicle reconditioning costs are capitalized as a component of inventory.  Repossessed vehicles are recorded at fair value, which approximates wholesale value.  The cost of used vehicles sold is determined using the specific identification method.

Deferred Sales Tax

Deferred sales tax represents a sales tax liability of the Company for vehicles sold on an installment basis in the State of Texas.  Under Texas law, for vehicles sold on an installment basis, the related sales tax is due as the payments are collected from the customer, rather than at the time of sale.

Income Taxes

Income taxes are accounted for under the liability method.  Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates expected to apply in the years in which these temporary differences are expected to be recovered or settled.

From time to time, the Company is audited by taxing authorities.  These audits could result in proposed assessments of additional taxes.  The Company believes that its tax positions comply in all material respects with applicable tax law.  However, tax law is subject to interpretation, and interpretations by taxing authorities could be different from those of the Company, which could result in the imposition of additional taxes.

Stock Option Plan

The Company accounts for its stock option plan in accordance with the provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations.  As such, compensation expense is only recorded on the date of grant if the market price on such date exceeds the exercise price.  Since the exercise price of options granted has been equal to the market price on the date of grant, no compensation expense has been recorded.  Had the Company determined compensation cost on the date of grant based upon the fair value of its stock options under Statement of Financial Accounting Standards No. 123 “Accounting for Stock-Based Compensation,” the Company’s pro forma net income and earnings per share would be as follows using the Black-Scholes option-pricing model with the assumptions detailed below.  The estimated weighted average fair value of options granted using the Black-Scholes option-pricing model was $10.09 and $12.50 per share for the six months ended October 31, 2005 and October 31, 2004, respectively.

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Recent Accounting Pronouncement

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards 123R, “Share-Based Payment” (“SFAS 123R”), which is a revision of SFAS 123.  SFAS 123R supersedes APB Opinion No. 25.  Generally, the approach in SFAS 123R is similar to the approach described in SFAS 123, except that SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values.  Pro forma disclosure is no longer an alternative under SFAS 123R.  SFAS 123R was originally issued with implementation required for interim and annual periods beginning after June 15, 2005.  On April 15, 2005, the Securities and Exchange Commission delayed the required effective date of SFAS 123R to the beginning of the first fiscal year that begins after June 15, 2005.

The Company is evaluating the requirements of SFAS 123R.  The Company has not yet determined the method of adoption or the effect of adopting SFAS 123R, and it has not determined whether the adoption will result in amounts that are similar to the current pro forma disclosures under SFAS 123 above.  The Company expects to adopt SFAS 123R on May 1, 2006.

Reclassifications

Certain prior year amounts in the accompanying financial statements have been reclassified to conform to the fiscal 2006 presentation.

C – Finance Receivables

The Company originates installment sale contracts from the sale of used vehicles at its dealerships.  These installment sale contracts typically include interest rates ranging from 6% to 19% per annum, are collateralized by the vehicle sold and provide for payments over periods ranging from 12 to 36 months.  The components of finance receivables are as follows:

Changes in the finance receivables, net balance for the six months ended October 31, 2005 and 2004 are as follows:

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Changes in the finance receivables allowance for credit losses for the six months ended October 31, 2005 and 2004 are as follows:

D – Property and Equipment

A summary of property and equipment is as follows:

E – Accrued Liabilities

A summary of accrued liabilities is as follows:

F – Revolving Credit Facility

A summary of revolving credit facilities is as follows:

The Company’s revolving credit facility is collateralized by substantially all the assets of the Company including finance receivables and inventory.  Interest is payable monthly and the principal balance is due at the maturity of the facility.  Interest is charged at the bank’s prime lending rate less .25% per annum as of October 31, 2005 and at the bank’s prime lending rate per annum

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as of April 30, 2005 (6.75% and 5.75% at October 31, 2005 and April 30, 2005, respectively).  The Company’s revolving credit facility contains various reporting and performance covenants including (i) maintenance of certain financial ratios and tests, (ii) limitations on borrowings from other sources, (iii) restrictions on certain operating activities, and (iv) restrictions on the payment of dividends or distributions.  The amount available to be drawn under the Company’s revolving credit facility is a function of eligible finance receivables and inventory, with a maximum amount available of $44.5 million.  Based upon eligible finance receivables and inventory at October 31, 2005, the Company could have drawn an additional $8.9 million under the facility.  The Company was in compliance with the covenants at October 31, 2005.

G – Weighted Average Shares Outstanding

Weighted average shares outstanding, which are used in the calculation of basic and diluted earnings per share, are as follows:

H – Commitments and Contingencies

Litigation

In February 2001 and May 2002, the Company was added as a defendant in two similar actions which were originally filed in December 1998 against approximately 20 defendants (the “Defendants”) by Astoria Entertainment, Inc. (“Astoria”).  One action was filed in the Civil District Court for the Parish of Orleans, Louisiana (the “State Claims”) and the other was filed in the United States District Court for the Eastern District of Louisiana (the “Federal Claims”).  In these actions, Astoria alleges the Defendants conspired to eliminate Astoria from receiving one of the 15 riverboat gaming licenses that were awarded by the State of Louisiana in 1993 and 1994, at a time when a former subsidiary of the Company was involved in riverboat gaming in Louisiana.  Astoria seeks unspecified damages including lost profits.  In August 2001, the Federal court dismissed all of the Federal Claims with prejudice.  In September 2004, the state court of appeals dismissed all the State Claims.  In January 2005, the Louisiana Supreme Court reversed the state court of appeals’ dismissal of the case.  The case is currently pending in the Civil District Court for the Parish of Orleans, Louisiana.  The Company believes the State Claims are without merit and intends to vigorously contest liability in this matter.

In addition to the foregoing case, in the ordinary course of business, the Company has become a defendant in various types of other legal proceedings.  The Company does not expect the final outcome of any of these actions, individually or in the aggregate, to have a material adverse effect on the Company’s financial position, annual results of operations or cash flows.  However, the results of legal proceedings cannot be predicted with certainty, and an unfavorable resolution of one or more of these legal proceedings could have a material adverse effect on the Company’s financial position, annual results of operations or cash flows.

Related Finance Company

Car-Mart of Arkansas and Colonial do not meet the affiliation standard for filing consolidated income tax returns, and as such they file separate federal and state income tax returns.  Car-Mart of Arkansas routinely sells its finance receivables to Colonial at what the Company believes to be fair market value and is able to take a tax deduction at the time of sale for the difference between the tax basis of the receivables sold and the sales price.  For tax purposes, these transactions are permissible under the provisions of the Internal Revenue Code (“IRC”) as described in the Treasury Regulations.  For financial accounting purposes, these transactions are eliminated in consolidation.  The sale of finance receivables from Car-Mart of Arkansas to Colonial provides certain legal protection for the Company’s finance receivables and, principally because of certain state apportionment characteristics of Colonial, also has the effect of reducing the Company’s overall effective tax rate by about 240 basis points.  The determination of whether or not the Company is entitled to a tax deduction at the time of sale is in part a facts and circumstances matter, and the interpretation of those facts and circumstances.  The Company believes it satisfies the material provisions of the Treasury Regulations.

Currently, the Internal Revenue Service (“IRS”) is examining the Company’s tax returns for fiscal 2002, and in particular is focusing on whether or not the Company satisfies the provisions of the Treasury Regulations which would entitle Car-Mart of Arkansas to a tax deduction at the time it sells its finance receivables to Colonial.  The Company is unable to determine at this time the amount of adjustments, if any, that may result from this examination.  At this point, the company has not accrued any costs associated with potential adjustments, if any, that may result from this examination.

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I – Supplemental Cash Flow Information

Supplemental cash flow disclosures are as follows:

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the Company’s consolidated financial statements and notes thereto appearing elsewhere in this report.

Forward-looking Information

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for certain forward-looking statements.  Certain information included in this Quarterly Report on Form 10-Q contains, and other materials filed or to be filed by the Company with the Securities and Exchange Commission (as well as information included in oral statements or other written statements made or to be made by the Company or its management) contain or will contain, forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended.  The words “believe,” “expect,” “anticipate,” “estimate,” “project” and similar expressions identify forward-looking statements, which speak only as of the date the statement was made.  The Company undertakes no obligation to publicly update or revise any forward-looking statements.  Such forward-looking statements are based upon management’s current plans or expectations and are subject to a number of uncertainties and risks that could significantly affect current plans, anticipated actions and the Company’s future financial condition and results.  As a consequence, actual results may differ materially from those expressed in any forward-looking statements made by or on behalf of the Company as a result of various factors.  Uncertainties and risks related to such forward-looking statements include, but are not limited to, those relating to the continued availability of lines of credit for the Company’s business, the Company’s ability to underwrite and collect its installment loans effectively, assumptions relating to unit sales and gross margins, changes in interest rates, competition, dependence on existing management, adverse economic conditions (particularly in the State of Arkansas), changes in tax laws or the administration of such laws, and changes in lending laws or regulations.  Any forward-looking statements are made pursuant to the Private Securities Litigation Reform Act of 1995 and, as such, speak only as of the date made.

Overview

America’s Car-Mart, Inc., a Texas corporation (the “Company”), is the largest publicly held automotive retailer in the United States focused exclusively on the “Buy Here/Pay Here” segment of the used car market.  References to the Company typically include the Company’s consolidated subsidiaries.  The Company’s operations are principally conducted through its two operating subsidiaries, America’s Car-Mart, Inc., an Arkansas corporation, (“Car-Mart of Arkansas”) and Colonial Auto Finance, Inc. (“Colonial”).  Collectively, Car-Mart of Arkansas and Colonial are referred to herein as “Car-Mart”.  The Company primarily sells older model used vehicles and provides financing for substantially all of its customers. Many of the Company’s customers have limited financial resources and would not qualify for conventional financing as a result of limited credit histories or past credit problems.  As of October 31, 2005, the Company operated 81 stores located primarily in small cities throughout the South-Central United States.

Car-Mart has been operating since 1981.  Car-Mart has grown its revenues between 13% and 21% per year over the last eight fiscal years.  Finance receivables have historically grown slightly faster than revenues.  Growth results from same store revenue growth and the addition of new stores.  Revenue growth in the first six months of fiscal 2006 (12%) is in line with the Company’s fiscal 2006 growth expectations of 10% to 14%.  Revenue growth in the first six months of fiscal 2006, as compared to the same period in the prior fiscal year, was assisted by a 4.4% increase in the average retail sales price, which is in line with historical increases.

The Company’s primary focus is on collections.  Each store handles its own collections with supervisory involvement of the corporate office.  Over the last eight fiscal years Car-Mart’s credit losses as a percentage of sales have ranged between approximately 17% and 21% (average of 19.3%).  However, over the last two fiscal years credit losses as a percentage of sales have averaged 20.7%. Credit losses in the first six months of fiscal 2006 (22.7%) were higher than the Company’s average over the last two fiscal years.  Credit losses, on a percentage basis, tend to be higher at new and developing stores than at mature stores (stores in existence for

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10 years or more).  Generally, this is the case because the store management at new and developing stores tends to be less experienced (in making credit decisions and collecting customer accounts) and the customer base is less seasoned.  Generally, older stores have more repeat customers.  On average, repeat customers are a better credit risk than non-repeat customers. Due to the rate of the Company’s growth, the percentage of new and developing stores as a percentage of total stores has been increasing over the last few years. In addition, significant negative external economic issues were prevalent during this period, including higher fuel prices. While the Company believes the most significant factor affecting credit losses is the proper execution (or lack thereof) of its business practices, the Company also believes that higher energy and fuel costs have had a negative impact on collection results.  Also, during this period, significant efforts were made by store management to identify, clean-up and write off uncollectible accounts. At October 31, 2005, 4.1% of the Company’s finance receivable balances were over 30 days past due, compared to 4.7% at July 31, 2005.

The Company’s gross margins as a percentage of sales have been fairly consistent from year to year.  Over the last eight years Car-Mart’s gross margins as a percentage of sales have ranged between approximately 44% and 48%.  Gross margins as a percentage of sales in the first six months of fiscal 2005 were 44.9%, down from 46.2% in the same period of the prior fiscal year.  The Company’s gross margins are set based upon the cost of the vehicle purchased, with lower-priced vehicles having higher gross margin percentages.  Generally, as the Company’s average retail sales price increases, its gross margin percentage decreases. Gross margin percentages were negatively affected during the period by short-term supply shortages brought on by Hurricanes Katrina and Rita, by the significant slow-down in new car sales during the period, increased vehicle repair expenses, and by increased fuel costs. The Company does not presently expect that its gross margin percentage will change significantly during the balance of fiscal 2006 from its current level.

Hiring, training, and retaining qualified associates are critical to the Company’s success.  The rate at which the Company adds new stores is sometimes limited by the number of trained managers the Company has at its disposal.  Excessive turnover, particularly at the Store Manager level, could impact the Company’s ability to add new stores. In fiscal 2005, the Company added resources to train and develop personnel. In fiscal 2006 and beyond, the Company expects to continue to invest in the development of its workforce.

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Consolidated Operations

(Operating Statement Dollars in Thousands)

Three Months Ended October 31, 2005 vs. Three Months Ended October 31, 2004

Revenues increased $4.8 million, or 9.5%, for the three months ended October 31, 2005 as compared to the same period in the prior fiscal year.  The increase was principally the result of (i) revenue growth from stores that operated a full three months in both periods ($2.8 million, or 5.9%), (ii) revenue growth from stores opened during the three months ended October 31, 2004 or stores that opened or closed a satellite location after July 31, 2004 ($.3 million), and (iii) revenues from stores opened after October 31, 2004 ($1.7 million).

Cost of sales as a percentage of sales increased 1.4% to 55.6% for the three months ended October 31, 2005 from 54.2% in the same period of the prior fiscal year.  Generally, as the Company’s average retail sales price increases, its gross margin percentage decreases. Additionally, gross margin percentages were negatively affected during the period by short-term supply shortages brought on by Hurricanes Katrina and Rita, by the significant slow-down in new car sales during the period, increased vehicle repair expenses, and by increased fuel costs.

Selling, general and administrative expense as a percentage of sales increased 1.1% to 19.0% for the three months ended October 31, 2005 from 17.9% in the same period of the prior fiscal year.  The increase was principally the result of an increase in legal and professional fees related to compliance with the Sarbanes-Oxley Act of 2002, the timing of certain other expenditures, some of which were associated with upgrading the Company’s information technology systems, and overall higher utility costs. While compensation expense has increased in the current period on a dollar basis, it has decreased as a percentage of sales.  The decrease in compensation expense, as a percentage of sales, is partially the result of selling higher-priced vehicles.  Selling higher-priced vehicles increases sales without necessarily increasing compensation expense.

Provision for credit losses as a percentage of sales increased 4.3%, to 24.6% for the three months ended October 31, 2005 from 20.3% in the same period of the prior fiscal year.  The increase was primarily the result of higher charge-offs as a percentage of sales.  As discussed in the Overview section above, credit losses, on a percentage basis, tend to be higher at new and developing stores than at mature stores. Due to the rate of the Company’s growth, the percentage of new and developing stores as a percentage of total stores has been increasing over the last few years.  In addition, significant negative external economic issues were prevalent during this period, including higher fuel prices. While the Company believes the most significant factor affecting credit losses is the proper execution (or lack thereof) of its business practices, the Company also believes that higher energy and fuel costs have had a negative

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impact on collection results. Also, during this period, significant efforts were made by store management to identify, clean-up and write off uncollectible accounts. At October 31, 2005, 4.1% of the Company’s finance receivable balances were over 30 days past due compared to 4.7% at July 31, 2005.

Interest expense as a percentage of sales increased ..5%, to 1.1% for the three months ended October 31, 2005 from .6% in the same period of the prior fiscal year.  The increase was attributable to higher average borrowings during the three months ended October 31, 2005 (approximately $35 million) as compared to the same period in the prior fiscal year (approximately $25 million), and an increase in the rate charged during the three months ended October 31, 2005 (average rate charged of 6.5% per annum) as compared to the same period in the prior fiscal year (average rate charged of 4.6% per annum).  The increase in interest rates is attributable to increases in the prime interest rate of the Company’s lender as the Company’s interest rate fluctuates with the prime interest rate of its lender.

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Consolidated Operations

(Operating Statement Dollars in Thousands)

Six Months Ended October 31, 2005 vs. Six Months Ended October 31, 2004

Revenues increased $12.2 million, or 12.0%, for the six months ended October 31, 2005 as compared to the same period in the prior fiscal year.  The increase was principally the result of (i) revenue growth from stores that operated a full six months in both periods ($7.7 million, or 8.1%), (ii) revenue growth from stores opened during the six months ended October 31, 2004 or stores that opened or closed a satellite location after April 30, 2004 ($2 million), and (iii) revenues from stores opened after October 31, 2004 ($2.5 million).

Cost of sales as a percentage of sales increased 1.3% to 55.1% for the six months ended October 31, 2005 from 53.8% in the same period of the prior fiscal year.  Generally, as the Company’s average retail sales price increases, its gross margin percentage decreases. Additionally, gross margin percentages were negatively affected during the period by short-term supply shortages brought on by Hurricanes Katrina and Rita, by the significant slow-down in new car sales during the period, increased vehicle repair expenses, and by increased fuel costs.

Selling, general and administrative expense as a percentage of sales increased .5% to 18.1% for the six months ended October 31, 2005 from 17.6% in the same period of the prior fiscal year.  The increase was principally the result of fees incurred in connection with completion of the Company’s fiscal 2005 audit and compliance with the Sarbanes-Oxley Act of 2002, the timing of certain other expenditures, some of which were associated with upgrading the Company’s information technology systems, and increased utility costs.  The Company anticipates that its future Sarbanes-Oxley Act compliance expenses will be lower than the expenses it incurred in the first and second quarters of the current fiscal year. The increases above were partially offset by lower compensation expense as a percentage of sales. While compensation expense has increased in the current period on a dollar basis, it has decreased as a percentage of sales.  The decrease in compensation expense, as a percentage of sales, is partially the result of selling higher-priced vehicles.  Selling higher-priced vehicles increases sales without necessarily increasing compensation expense.

Provision for credit losses as a percentage of sales increased 2.8%, to 22.7% for the six months ended October 31, 2005 from 19.9% in the same period of the prior fiscal year.  The increase was primarily the result of higher charge-offs as a percentage of sales.  As discussed in the overview section above, credit losses, on a percentage basis, tend to be higher at new and  developing stores than at

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mature stores. Due to the rate of the Company’s growth, the percentage of new and developing stores as a percentage of total stores has been increasing over the last few years.  In addition, significant negative external economic issues were prevalent during this period, including higher fuel prices. While the Company believes the most significant factor affecting credit losses is the proper execution (or lack thereof) of its business practices, the Company also believes that higher energy and fuel costs have had a negative impact on collection results. Also, during this period, significant efforts were made by store management to identify, clean-up and write off uncollectible accounts. At October 31, 2005, 4.1% of the Company’s finance receivable balances were over 30 days past due compared to 4.7% at July 31, 2005 and 3.5% at April 30, 2005.

Interest expense as a percentage of sales increased to 1.0% for the six months ended October 31, 2005 from .5% in the same period of the prior fiscal year.  The increase was attributable to higher average borrowings during the six months ended October 31, 2005 (approximately $32 million) as compared to the same period in the prior fiscal year (approximately $24 million), and an increase in the rate charged during the three months ended October 31, 2005 (average rate charged of 6.5% per annum) as compared to the same period in the prior fiscal year (average rate charged of 4.3% per annum).  The increase in interest rates is attributable to increases in the prime interest rate of the Company’s lender as the Company’s interest rate fluctuates with the prime interest rate of its lender.

Financial Condition

The following table sets forth the major balance sheet accounts of the Company as of the dates specified (in thousands):

Historically, the growth in finance receivables on an annual basis tends to grow slightly faster than growth in revenue on an annual basis.  The Company expects the historical relationship between net finance receivables growth and revenue growth to continue in the future.  Also, historically finance receivables growth tends to be the greatest in the first fiscal quarter of each year.  This is due to the strong sales levels that typically occur in the first quarter, coupled with collection results and account charge-offs.

Inventory levels have grown by $1.4 million between April 30, 2005 and October 31, 2005. The growth in inventory was planned and is needed to support higher sales levels resulting from new store openings, expansions of existing stores and anticipated sales increases during income tax refund season.

Property and equipment, net increased $2.0 million during the six months ended October 31, 2005 as the Company acquired real estate for three locations (one new store and the relocation of two existing stores), made improvements at several properties and purchased new computer equipment in connection with upgrading its information technology systems.

Accounts payable and accrued liabilities increased $1.8 million during the six months ended October 31, 2005.  The increase was largely due to an increase in cash overdraft ($2.0 million) offset by the net decreases in other categories. The timing of payment for vehicle purchases is primarily tied to when the seller presents a title for the purchased vehicle.  Cash overdraft fluctuates based upon the day of the week, as daily deposits vary by day of the week and the level of checks that are outstanding at any point in time.

Borrowings on the Company’s revolving credit facilities fluctuate based upon a number of factors including (i) net income, (ii) finance receivables growth, and (iii) capital expenditures.  Historically, income from operations has funded the majority of finance receivables growth and borrowings from its credit facilities have been used to purchase capital assets.  The level of stock repurchases also affects the Company’s borrowings under its revolving credit facilities.

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Liquidity and Capital Resources

The following table sets forth certain summarized historical information with respect to the Company’s statements of cash flows (in thousands):

The Company generates cash flow from net income from operations.  Most or all of this cash is used to fund finance receivables growth.  To the extent finance receivables growth exceeds net income from operations, generally the Company increases its borrowings under its revolving credit facilities.

The Company has had a tendency to lease the majority of the properties where its stores are located. As of October 31, 2005, the Company leased approximately 75% of its store properties.  The Company expects to continue to lease the majority of the properties where its stores are located.  In general, in order to preserve capital and maintain flexibility, the Company prefers to lease its store locations.  However, the Company does periodically purchase the real property where its stores are located, particularly if the Company expects to be in that location for 10 years or more.

Car-Mart’s revolving credit facilities, which total $44.5 million, limit distributions from Car-Mart to the Company beyond (i) the repayment of an intercompany loan ($10.0 million at October 31, 2005), and (ii) dividends equal to 75% of Car-Mart of Arkansas’ net income.  At October 31, 2005, the Company’s assets (excluding its $98 million equity investment in Car-Mart) consisted of $ 76,000 in cash, $3.0 million in other assets and a $10.0 million receivable from Car-Mart.  Thus, the Company is limited in the amount of dividends or other distributions it can make to its shareholders without the consent of Car-Mart’s lender.  Beginning in February 2003, Car-Mart assumed substantially all of the operating costs of the Company.  The Company was in compliance with loan covenants at October 31, 2005.

At October 31, 2005, the Company had $.3 million of cash on hand and an additional $8.9 million of availability under its revolving credit facilities.  On a short-term basis, the Company’s principal sources of liquidity include income from operations and borrowings from its revolving credit facilities.  On a longer-term basis, the Company expects its principal sources of liquidity to consist of income from operations and borrowings from revolving credit facilities.  Further, while the Company has no present plans to issue debt or equity securities, the Company believes, if necessary, it could raise additional capital through the issuance of such securities.

The Company expects to use cash to grow its finance receivables portfolio by a percentage that is slightly larger than the percentage of its revenue growth, and to purchase property and equipment of approximately $3 to $5 million in the next 12 months in connection with opening new stores and refurbishing existing stores.  In addition, from time to time the Company may use cash to repurchase its common stock.  During the six months ended October 31, 2005 the Company repurchased 22,000 shares of its common stock for $391,387.

The Company’s revolving credit facilities mature in April 2009.  The Company expects that it will be able to renew or refinance its revolving credit facilities on or before the date they mature. The Company believes it will have adequate liquidity to satisfy its capital needs for the foreseeable future.

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As discussed in Note H to the financial statements, the IRS is currently examining the Company’s tax returns for fiscal 2002, and in particular is focusing on whether or not the Company satisfies the provisions of the Treasury Regulations that would entitle Car-Mart of Arkansas to a tax deduction at the time it sells its finance receivables to Colonial.  The Company is unable to determine at this time the amount of adjustments, if any, that may result from this examination.

Contractual Payment Obligations

There have been no material changes outside of the ordinary course of business in the Company’s contractual payment obligations from those reported at April 30, 2005 in the Company’s Annual Report on Form 10-K.

Off-Balance Sheet Arrangements

The Company has entered into operating leases for approximately 75% of its store and office facilities.  Generally these leases are for periods of three to five years and usually contain multiple renewal options.  The Company expects to continue to lease the majority of its store and office facilities under arrangements substantially consistent with the past.

Other than its operating leases, the Company is not a party to any off-balance sheet arrangement that management believes is reasonably likely to have a current or future effect on the Company’s financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company to make estimates and assumptions in determining 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 the Company’s estimates.  The Company believes the most significant estimate made in the preparation of the accompanying consolidated financial statements relates to the determination of its allowance for credit losses, which is discussed below.  The Company’s accounting policies are discussed in Note B to the accompanying consolidated financial statements.

The Company maintains an allowance for credit losses on an aggregate basis at a level it considers sufficient to cover estimated losses in the collection of its finance receivables.  The allowance for credit losses is based primarily upon historical credit loss experience, with consideration given to recent credit loss trends and changes in loan characteristics (i.e., average amount financed and term), delinquency levels, collateral values, economic conditions, underwriting and collection practices, and management’s expectation of future credit losses.  The allowance for credit losses is periodically reviewed by management with any changes reflected in current operations.  Although it is at least reasonably possible that events or circumstances could occur in the future that are not presently foreseen which could cause actual credit losses to be materially different from the recorded allowance for credit losses, the Company believes that it has given appropriate consideration to all relevant factors and has made reasonable assumptions in determining the allowance for credit losses.

Recent Accounting Pronouncement

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards 123R, “Share-Based Payment” (“SFAS 123R”), which is a revision of SFAS 123.  SFAS 123R supersedes APB Opinion No. 25.  Generally, the approach in SFAS 123R is similar to the approach described in SFAS 123, except that SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values.  Pro forma disclosure is no longer an alternative under SFAS 123R.  SFAS 123R was originally issued with implementation required for interim and annual periods beginning after June 15, 2005.  On April 15, 2005, the Securities and Exchange Commission delayed the required effective date of SFAS 123R to the beginning of the first fiscal year that begins after June 15, 2005.

The Company is evaluating the requirements of SFAS 123R.  The Company has not yet determined the method of adoption or the effect of adopting SFAS 123R, and it has not determined whether the adoption will result in amounts that are similar to the current pro forma disclosures under SFAS 123.  The Company expects to adopt SFAS 123R on May 1, 2006.

Seasonality

The Company’s automobile sales and finance business is seasonal in nature.  The Company’s third fiscal quarter (November through January) is historically the slowest period for car and truck sales.  Many of the Company’s operating expenses such as administrative personnel, rent and insurance are fixed and cannot be reduced during periods of decreased sales.  Conversely, the Company’s fourth fiscal quarter (February through April) is historically the busiest time for car and truck sales as many of the Company’s customers use income tax refunds as a down payment on the purchase of a vehicle.  Further, the Company experiences

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seasonal fluctuations in its finance receivable credit losses.  As a percentage of sales, the Company’s first and fourth fiscal quarters tend to have lower credit losses (averaging 19.0% over the last five fiscal years), while its second and third fiscal quarters tend to have higher credit losses (averaging 20.3% over the last five fiscal years).

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

The Company is exposed to market risk on its financial instruments from changes in interest rates.  In particular, the Company has exposure to changes in the federal primary credit rate and the prime interest rate of its lender.  The Company does not use financial instruments for trading purposes or to manage interest rate risk.  The Company’s earnings are impacted by its net interest income, which is the difference between the income earned on interest-bearing assets and the interest paid on interest-bearing notes payable.  As described below, a decrease in market interest rates would generally have an adverse effect on the Company’s profitability.

The Company’s financial instruments consist of fixed rate finance receivables and variable rate notes payable.  The Company’s finance receivables generally bear interest at fixed rates ranging from 6% to 19%.  These finance receivables generally have remaining maturities from one to 36 months.  The Company’s borrowings carry a variable interest rate that fluctuates with market interest rates (i.e., the rate charged on the Company’s revolving credit facility fluctuates with the prime interest rate of its lender).  However, interest rates charged on finance receivables originated in the State of Arkansas are limited to the federal primary credit rate (4.75% at October 31, 2005) plus 5.0%.  Typically, the Company charges interest on its Arkansas loans at or near the maximum rate allowed by law.  Thus, while the interest rates charged on the Company’s loans do not fluctuate once established, new loans originated in Arkansas are set at a spread above the federal primary credit rate which does fluctuate.  At October 31, 2005, approximately 62% of the Company’s finance receivables were originated in Arkansas.  Assuming that this percentage is held constant for future loan originations, the long-term effect of decreases in the federal primary credit rate would generally have a negative effect on the profitability of the Company.  This is the case because the amount of interest income lost on Arkansas originated loans would likely exceed the amount of interest expense saved on the Company’s variable rate borrowings (assuming the prime interest rate of its lender decreases by the same percentage as the decrease in the federal primary credit rate).  The initial impact on profitability resulting from a decrease in the federal primary credit rate and the rate charged on its variable interest rate borrowings would be positive, as the immediate interest expense savings would outweigh the loss of interest income on new loan originations.  However, as the amount of new loans originated at the lower interest rate increases to an amount in excess of the amount of variable interest rate borrowings, the effect on profitability would become negative.

The table below illustrates the estimated impact that hypothetical changes in the federal primary credit rate would have on the Company’s continuing pretax earnings.  The calculations assume (i) the increase or decrease in the federal primary credit rate remains in effect for two years, (ii) the increase or decrease in the federal primary credit rate results in a like increase or decrease in the rate charged on the Company’s variable rate borrowings, (iii) the principal amount of finance receivables ($167.5 million) and variable interest rate borrowings ($35.6 million), and the percentage of Arkansas originated finance receivables (62%), remain constant during the periods, and (iv) the Company’s historical collection and charge-off experience continues throughout the periods.

A similar calculation and table was prepared at April 30, 2005.  The calculation and table was materially consistent with the information provided above.

Item 4.  Controls and Procedures

Under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this quarterly report on Form 10-Q (October 31, 2005), and, based on their evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures were not effective as a result of a material weakness (discussed below) with its information technology (“IT”) controls.

During the first and second quarters ended July 31, 2005 and October 31, 2005, the Company did not make any change in its internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.  However, the Company did make a number of improvements in the IT area including (i) hiring a seasoned Director of IT, (ii) improving password controls at the corporate office, (iii) improving access and security controls at the corporate office, (iv) improving the physical security of IT equipment at the corporate office, and (v) improving software program change controls.

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Item 6.  Exhibits

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SIGNATURES

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

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