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Advance America, Cash Advance Centers, Inc. (NYSE:AEA)

Q3 2010 Earnings Call

October 28, 2010 8:00 am ET

Executives

Jamie Fulmer - Director, IR

Ken Compton - President and CEO

Patrick O'Shaughnessy - EVP and CFO

Analysts

John Hecht - JMP Securities

David Burtzlaff - Stephens

Ed Antoian - Chartwell

Operator

Good day, everyone, and welcome to the Advance America, Cash Advance Centers, third quarter earnings results conference call. At this time for opening remarks and introduction, I'd like to turn the call over to Jamie Fulmer.

Jamie Fulmer

Good morning. Before we begin, let me remind you that during this call, our comments will include certain forward-looking statements. All comments on this call, other than those relating to our historical information or our current conditions, will be forward-looking statements. For example, any statements regarding our future expenditures, financial performance, our plans for future product expansion, our business strategy or expected legislative or regulatory developments that may affect the cash advance services industry are forward-looking statements.

Please note that these forward-looking statements reflect our opinion only as of the date of this presentation, and we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events. In this regard, please keep in mind that our actual future results could differ materially from our expectations and are subject to risks, uncertainties and other factors many of which are not within our control or may not be predicted.

For a detailed discussion of some of these factors, please refer to the Risk Factors section of our Annual Report on Form 10-K for the year ended December 31, 2009, and our quarterly report on Form 10-Q for the quarter ended June 30, 2010, copies of which are available from the SEC upon request from us or by going to our website at www.advanceamerica.net.

Now, I'd like to turn the call over to our Chief Executive Officer, Ken Compton.

Ken Compton

Good morning. Welcome to our third quarter earnings call. Also joining me today is our Chief Financial Officer, Patrick O'Shaughnessy. Yesterday, the company reported the results for the quarter ended September 30, 2010. Before we discuss our results in detail, I'd like to update you on a few developments since our last call.

Yesterday, our Board of Directors approved Advance America's 24th consecutive dividend as a public company. This dividend of $0.0625 per share is payable on December 3, 2010, to stockholders of record as of November 23, 2010. Since our December 2004 initial public offering, we returned approximately $383.3 million in cash to our stockholders through the payment of our quarterly dividends together with the repurchase of shares.

As we reported last month, Advance America settled a class-action lawsuit in North Carolina and resolved all claims against the company in connection with marketing, processing or servicing of any loan in that state on or after March 1, 2003. Under the terms of this settlement, the company agreed to establish a settlement tool of $18.75 million, which is reflected in the results of the third quarter of 2010.

It's important to point out that this settlement does not involve any finding of wrongdoing on behalf of the company. But a settlement like this, one provides certainty of outcome and eliminates continuing legal cost on a geographic market where we no longer conduct business.

Net of insurance proceeds and other items, the charge for the lawsuit settlement was $16.2 million during the third quarter of 2010.

Shifting to the legislative landscape, we've discussed with you previously (inaudible) impact and especially the implementation of a new Bureau of Consumer Financial Protection. As has been widely reported, President Obama recently named Elizabeth Lauren as Assistant to the President and Special Advisor to the Treasury for this Bureau.

In her first few weeks on the job, Mrs. Warren has participated in a number of media interviews. She has largely focused her remarks on the need to level the playing field for lenders and consumers, improving and simplifying disclosures and ensuring that consumers can easily compare borrowing options. She has also said that the Bureau will not create an undue burden by layering additional excessive rules on top of existing regulations.

Above all, Mrs. Warren has voiced her strong support for a principle-based approach to reform, one that ensures a full merger of clarity and fair treatment for all consumers by giving them the information they need to choose the financial service that is best for them.

Her focus on disclosure is one Advance America wholeheartedly supports. We agree that consumers should be able to compare services side by side and evaluate them based on the costs and risks associated with each. Indeed we feel strongly that our service provides for a clear and transparent lending and that consumers benefit from having a variety of options.

Our customers continually tell us they value our service because it is simple, reliable, transparent and competitive with other short-term credit products. We are eager to share our perspective on how to balance meaningful consumer protections with the preservation of access to credit. We are confident the establishment of the agency will provide an opportunity to have a useful and informative conversation of our consumer lending and the varied financial needs of Americans.

Mrs. Warren has acknowledged the importance of involving financial services providers in this conversation, and we agree with her approach. You should expect to continue to hear a great deal of discussion about a wide array of products and services over the coming weeks and months as this agency gets up and running and our credits gear up for the coming state legislative session.

You rarely read or hear about our company's considerable efforts to provide consumers with meaningful consumer protections. For example, in states where permitted by law, we provide our customers with an extended payment plan, an option to repay an advance over a longer period of time at no additional charge. We're also deeply committed to truthful advertising and fair collection practices and transparency and clarity around all transactions.

In addition, we continue to opt for the Worry-Free Advance for consumers who involuntarily lose their source of income during the time they have an outstanding loan with us. The Worry-Free Advance, which we introduced last year, allows customers to forego repayment of the initial loan fee when they provide proof of involuntary loss of income during the loan period.

These are unique and unparalleled features among financial service companies. They are part of our continual efforts to find innovative solutions to benefit consumers and to create a higher standard of service that helps our customers to protect their financial health and make sound decisions.

With regard to state legislative activity, most sessions have concluded. As of today, legislation in 28 of the states we're monitoring have adjourned for the year. There have been no new developments in these states since I reported to you on our last call.

Of course, we previously discussed new laws that have gone into effect in South Carolina, Washington and Kentucky, which continue to affect our operations negatively in those states. We've also previously discussed recent regulatory changes in Colorado where a new law went into effect in August and Arizona where we concluded that an economically viable alternative product or service did not exist after the law permitting cash advances expired on June 30, 2010.

As we adjust to these changes in certain key states, we remain committed to the fundamentals that have guided our company's business decisions for years, control cost, maintain a strong balance sheet and explore opportunities to generate value for our shareholders when they arise. As a company, we remain committed to our efforts to expand our service offerings for our customers.

Our initiative to develop an alternative channel for cash advances continues to exhibit promise and results. For example, customers continue to exhibit a strong interest in our online cash advance applications through Advance America's website which began in 2008. I think it is worthwhile to point out that our online service is unlike many other online cash advance providers.

Our process is governed by specific state-based laws and regulations. By going to our websites, customers can apply for cash advances and either come to a center to complete their transaction or receive an advance from a third-party lender who deposits it directly to their bank account.

Through the end of the third quarter, our online services had generated over 210,000 loans and approximately 43,000 new customers online since the initiative began.

During the third quarter, we registered approximately 54,000 prepaid cards, an increase of 98% over the third quarter of 2009, and loaded approximately $35 million on these cards for our customers. Since the inception of this offering, we have registered approximately 700,000 prepaid cards and loaded over $475 million.

We continue to be pleased with our money transfer services in which we service as an agent for third-party vendors. During the third quarter, we recorded over 360,000 MoneyGram transactions with the face value exceeding $89 million. Once again, we continue to experience solid and steady growth with all of our MoneyGram services we offer.

I mentioned during our last call that we've begun rolling out a utility bill payment program. We now offer these services in 11 states.

I'll now turn the call over to Patrick for an overview of our financial results for the quarter and nine months ended September 30, 2010.

Patrick O'Shaughnessy

Good morning. For the quarter ended September 30, 2010, our total revenues decreased 8.2% to $154.2 million compared to $167.9 million for the same period of 2009. Please keep in mind that these comparisons include the results of operations in Virginia, Washington, South Carolina, Kentucky and now Colorado where changes to state laws and regulations of our industry have negatively impacted the company's revenue and profitability. These results also include Arizona where we've ceased operations.

Revenues in these six states were $17.6 million for the quarter ended September 30, 2010, compared to $35.4 million for the same period in 2009. Excluding the results of these six states from both years, revenues increased by 3% for the quarter ended September 30, 2010, compared to the same period in 2009.

For the third quarter, total revenues for centers opened prior to July 01, 2009, and still opened as of September 30, 2010, decreased by 1.4% compared to the same period in 2009. Again, excluding revenues from the six states I mentioned, for the quarter ended September 30, 2010, total revenues for the company's centers opened prior to July 01, 2009, and still opened as of September 30, 2010, increased 2.8% compared to the same period in 2009.

The provision for doubtful accounts as a percent of total revenues for the quarter ended September 30, 2010, decreased to 21.6% compared to 23.1% for the same period in 2009. Charge-offs net of recoveries for the quarter were $29.1 million compared to $36.9 million in the same period in 2009. The company did not sell any previously written-off receivables during the third quarters of 2010 or 2009.

During the third quarter, the company closed or consolidated 122 centers in 14 different states, 101 of which were in Arizona, Washington and Colorado. We had approximately $2.4 million of consolidation and center closing costs during the quarter ended September 30, 2010, compared to $200,000 during the same period in 2009, excluding any increases as a provision for doubtful accounts. Closing costs include severance, the center tear-down costs, lease termination costs and the write-down of fixed assets.

For the third quarter of 2010, our total advertising expense was $5.5 million or 3.6% of revenues compared to $4.2 million or 2.5% of revenues in the third quarter of 2009.

In spite of the fluctuations from quarter-to-quarter based on the timing of various initiatives and related business needs, we expect the company's marketing expense will be approximately 3.5% of revenue for the full year 2010.

General and administrative expenses for the quarter ended September 30, 2010, were $14.4 million compared to $14.3 million for the same period in 2009.

As Ken mentioned, the results for the quarter ended September 30, 2010, include a net legal settlement expense of $16.2 million, primarily related to the previously disclosed settlement of losses in North Carolina.

Income before income taxes for the quarter ended September 30, 2010, decreased to $3.9 million compared to $20.7 million for the same period in the prior year. Excluding legal settlements, income before income taxes for the quarter would have been $20.1 million.

The effective income tax rate as a percentage of income before income taxes was 39.3% and 64.3% for the three months ended September 30, 2009, and 2010 respectively. The effective income tax rate as a percentage of income before income taxes was 37.7% and 46.7% for the nine months ended September 30, 2009, and 2010 respectively.

The increase in the effective tax rate in the current year is primarily a result of a reduction in state tax expense recognized in the prior year and lower pre-tax profits primarily as a result of the previously discussed legal settlements, along with other discrete items recognized in the current year.

Net income for the third quarter of 2010 decreased to $1.4 million compared to $12.6 million for the same period in 2009. Diluted earnings per share was $0.02 for the quarter ended September 30, 2010, compared to $0.20 for the same period in 2009. Again, excluding the legal settlement charges, diluted earnings per share for the quarter ended September 30, 2010, would have been $0.18.

During the nine months ended September 30, 2010, the company generated cash flow from operations after funding of advance receivables of $26.4 million. As of September 30, we had $111 million borrowed under our revolving credit facility and $18.8 million in cash and cash equivalents.

With regard to some of the key operating metrics for the third quarter, the average amount of the cash advance made, excluding installment loans that are on the way and lines of credit in Virginia, during the third quarter of 2010 increased to $371 compared to $362 for the third quarter 2009. The average P&L cash advances made was approximately $55 during the third quarter of 2010 compared to $53 during the same period in 2009.

The total principal amount of cash advances originated during the third quarter was approximately $961 million compared to $1 billion during the same period in 2009, again excluding installment loans and lines of credit. The average duration of all cash advances completed was approximately 18.1 days for the third quarter of 2010 compared to 17.6 days for the third quarter of 2009.

As of September 30, 2010, the company had an operating network of 2,360 centers and 64 limited licensees in 31 states in the United Kingdom and Canada.

Now, I'll turn the call back over to Ken.

Ken Compton

Thank you, Patrick. At this point, we will conclude the presentation and turn it back over to the operator for any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from John Hecht of JMP Securities.

John Hecht - JMP Securities

From a modeling perspective and the exclusion of settlement and lobbying expenses, what would a normal tax rate be?

Patrick O'Shaughnessy

John, I think the normal tax rate is going to be nearly 45% for the period.

John Hecht - JMP Securities

Okay. And is that the rate we should give out for calendar year type rate 2011?

Patrick O'Shaughnessy

Again, if you're excluding those expenses, yes.

John Hecht - JMP Securities

And then the impact from the states you mentioned, Colorado, Kentucky, South Carolina, Arizona and so forth, is that the negative $18 million drag on revenue? Is that a stable figure or should we see greater impact in the coming quarters or less as you're offering the products? What's the way to think about that?

Patrick O'Shaughnessy

I guess there is productivity through that. one is clearly the reduction in Arizona is permanent. And in the Q we will break out those states individually. But I think at least for some period of time, we expect there to be pressure on all of those states.

John Hecht - JMP Securities

What percentage of total revenues or services, I guess that's classified and identified as a traditional store-based lending services, and that would include the internet services, money transfer services, prepaid, what percentage of revenue for those types of services is right now?

Patrick O'Shaughnessy

They are still all fairly small as a percent of total revenues. They aren't large enough for us to break those out individually at this time. But I would say that they are significant to the bottomline because for the most part there is no additional cost for offering those services.

John Hecht - JMP Securities

So you're seeing some modest growth now, would you exclude states' impact by regulatory changes? Can you correct down that growth for new customers versus traditional customers that are increasing their borrowing?

Patrick O'Shaughnessy

It's difficult to isolate exactly how much growth is coming from new customers versus existing customers. But I would say that year-over-year our new customer numbers are down. So we're seeing a larger increase from former customers that are being reactivated and coming back towards our product.

Operator

Our next question comes from David Burtzlaff of Stephens.

David Burtzlaff - Stephens

Got a couple of questions. Patrick, in Arizona was there any increase in the losses due to shutting down the business.

Patrick O'Shaughnessy

No not materially. Generally speaking, when we've closed states as long as we do it in a reasonably orderly fashion, we're reserved enough that we don't have to take an additional reserve due to exiting the states. And that was also the case in Arizona.

David Burtzlaff - Stephens

I mean the reported loss rate is a pretty good number, maybe it wouldn't show that could have been better with Arizona?

Patrick O'Shaughnessy

That's correct.

David Burtzlaff - Stephens

Can you break down the $2.4 million of center closing cost, where that is and the income statement.

Patrick O'Shaughnessy

It will be in the Q, but I think I've got it right.

Operator

Our next question comes from Ed Antoian of Chartwell.

Ed Antoian - Chartwell

If you guys could give us more detail as much as you're willing to frankly on the prepaid cards. I've got a lot of questions, I'll just kind of ask the big global one. Number one, how are you guys distributing these? There was some cash advance players, and check cash in players and payday loan players that are requiring their customers to accept a prepaid card, one they get alone. I don't know if you guys are doing that. So how are you guys distributing them?

And then what are the economics? Who is the issuing card bank? Who is the issuing brand that you're using? And do you guys participate in continued reloads? And do you participate in the transaction fees that are charged to customers?

Patrick O'Shaughnessy

We allow people to either come in, and we load cards three different ways basically. We'll load the proceeds of a loan on to a card of the customer's choice. They're not required to do so in any market. They can come in and pay cash and buy a prepaid card from us.

We also will cash a third party check and load the proceeds onto a card in most of our sellers. So that's what we use if for, we don't provide any loans on the card. There's no credit feature on our card. The issuing bank is MetaBank and the vendor is NetSpend, and we're really a commissioned player for them.

We get paid based on cards issued and reloads as a commission. And we don't participate. There is no receivable because there is no loan on the card and we don't participate in any backend.

Ed Antoian - Chartwell

Meta and NetSpend do have a micro loan lending feature. At least they used to. And you did not allow your customers to get that lending feature?

Patrick O'Shaughnessy

That's correct. We never offered that to our customers.

Ed Antoian - Chartwell

Is there a push in the company to try to increase the percentage of transactions that end up on your check cashing or payday loan that end up being distributed on a prepaid card versus cash?

Patrick O'Shaughnessy

I wouldn't say there is a direct push. We market the cards like we market any other product. As a courtesy to the consumer, it's not a strategic push for the company.

Ken Compton

I think it's just a convenience feature for the customer. Some people like to have the money, own the card when they walk out the door, some would rather have the cash. I would characterize it more as a convenience than anything else.

Ed Antoian - Chartwell

A lot of these cards, especially with direct deposit customers are allowing micro lending up to $600 unsecured if you're a direct deposit customer. Needless to say that's a competitive offering to you guys, how do you view that?

Patrick O'Shaughnessy

Obviously, we do view it as competition to us. But we've decided that at least for know lending on the card is not something that we want to do.

Going back to the prior question, David; if you recall, in Arizona, we took most of the asset impairment during the second quarter when we determined we were going to close. So in this quarter, that $2.4 million is almost all in-center expenses. $600,000 is their salaries and severance, and $1.8 million is occupancy and other center expenses. Only about $21,000 of that is lock-on disposal below the line cost.

Operator

And, David, your line is open.

David Burtzlaff - Stephens

I just had one or two more other questions. Legal costs for the settlement that you had, how much was that running you that you should save going forward?

Patrick O'Shaughnessy

Actually I don't have that number in front of me, David. I am not going to estimate it.

Ken Compton

I could certainly find out for you, David.

David Burtzlaff - Stephens

When you look at the SG&A line, do you anticipate an increase maybe in government affairs spending next year now that you know that the bureau and you are not fighting the fin reg as much? Will that number do you think stay pretty high, or is it too early to tell right now?

Patrick O'Shaughnessy

I would say that it's too early to tell. We're in the very early stages. I would not try to predict a lot of change one way or another at this point. David, the answer to your question back on North Carolina, I think we would estimate it to be about $1 million a year.

Operator

I am showing no further questions at this time.

Ken Compton

Thank you for your participation in today's call, and we look forward to speaking with you after the fourth quarter. Thank you.

Operator

Ladies and gentlemen, that does conclude today's conference. You may all disconnect and have a wonderful day.

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