Daniel Feehan - President and CEO
Tom Bessant - CFO
Dennis Telzrow - Stephens Inc
Rick Shane - Jefferies & Co.
John Hecht - JMP Securities
Henry Coffey - Ferris Baker
Cash America International Inc. (CSH) Q4 2007 Earning Call January 24, 2008 4:45 PM ET
Ladies and gentlemen, thank you for standing by. Welcome to the Cash America International Incorporated fourth quarter earnings release conference call. (Operator Instructions) As a reminder, this conference is being recorded Thursday, January 24, 2008.
I would now like to turn the conference over to Daniel Feehan, President and CEO. Please go ahead, sir.
Thank you, and good afternoon, ladies and gentlemen. Welcome to our fourth quarter and year-end 2007 conference call.
Joining me on the call today as usual is our Chief Financial Officer, Tom Bessant and we are going to break with tradition a bit today and have Tom lead of with the financial report on what I view as a very successful fourth quarter for Cash America.
Following Tom’s financial report, I would like to provide a brief perspective on the year just ended and discuss my outlook for 2008 and then we will have time to open the call for questions.
Before Tom gets started, please bear with me once again, while I read our Safe Harbor disclaimer. While on this call, comments made by Tom or me may contain forward-looking statements about the business, financial condition, and prospects of Cash America International, Inc. and its subsidiaries.
The actual results of the company could differ materially from those indicated by the forward-looking statements because of various risk and uncertainties including, without limitation, the risk and uncertainties contained in the company's filings with the Securities & Exchange Commission.
These risk and uncertainties are beyond the ability of the company to control nor can the Company predict in many cases all of the risk and uncertainties that could cause its actual results to differ materially from those indicated by the forward-looking statements. When used in this call, terms such as believes, estimates, plans, expects, anticipates, and similar expressions as they relate to the company or its management are intended to identify forward-looking statements.
I will now turn it over to Tom for a report on Q4. Tom?
Thanks, Dan. And welcome everyone to the fourth quarter conference call for Cash America. Typically in the fourth quarter the focus of this call revolves primarily around earnings performance of the company with less emphasis on balance sheet characteristics and performance metrics.
This is appropriate given the magnitude of earnings present in the fourth quarter in a normal business cycle. 2007 fourth quarter for Cash America is no different and that once again we posted strong growth in earnings and our key contributors during this quarter, specifically retail disposition and merchandise, and higher fees on our loan products all came in well above prior levels.
Although this quarter is particularly noticeable because of our specific performance metrics, which defy the typical seasonal trends. They are all positive for our business model going forward.
These items include the sequential decreases in loss rates on a rising asset balance from our cash advance product, surging home loan balances and the important correlation at efficient performance on inventory management. I'll highlight each of these elements throughout the call.
The basic elements of the consolidated fourth quarter results for Cash America included 21% increase in total revenue to $261.1 million leading to a 22% increase in income from operations, which reached $45.7 million compared to $37.3 million last year. Earnings per share of $0.88 in the fourth quarter of 2007 are up 23% from $0.71 in the fourth quarter of 2006.
One of the performance metrics to note, is that operating income marginal profitability in the fourth quarter achieved the prior year level at approximately 24.5%, while the quarters leading up to the fourth quarter have all being below the prior year. This improves performance is primarily a function of loan loss levels related at the cash advance product, which were down sequentially from Q3, 2007 levels and reached the lowest levels for all of 2007 in the fourth quarter.
Specifically, losses as a percentage of cash advance fees in the fourth quarter of 2007 were 38.8% on a consolidated basis, down significantly from 45.7% for Q3 and 48.7% in Q2.
Loan loss expense measured as a percentage of loans written during the quarter were 6.8%, down from 8.1% in Q3 of 2007 and 8.4% in Q2 of 2007. In both cases these levels represent a loss ratio of losses for the entire fiscal 2007 period.
Making these more impressive is the fact that typical losses ramp up from Q2 to Q3 and from Q3 to Q4. While these are consolidated performance metrics, each of the business lines reported lower levels of losses sequentially from Q3 2007 to Q4 2007.
Consolidated cash advance balances owed by customers are up 20% and loans written were up 27% year-over-year in the fourth quarter. This led to a 31% increase in consolidated cash advances fees, which reached $94.3 million for the quarter. This increase plus the 20% increase from retail disposition and merchandise and a 9% increase in fees from pawn loans grew over 21% increase in total revenue previously mentioned.
I will discuss more of the cash advance metrics when I get to that segment, but first I will review the results in the pawn loan segment of our business. Pawn activities conducted in our 485 owned and 14 franchise locations continued its 2007 trend by posting strong results.
Net revenue was up 12% to $100.5 million, dispositions and merchandise rose to 20% year-over-year and gross profit dollars increased 22% through higher gross profit margins which reached 37.7% in the fourth quarter of 2007, compared to 36.9% in the fourth quarter of 2006.
We entered the fourth quarter with 19% more merchandise available for sale than last year and finished the quarter with only 13% above the prior year, as our retail activity continued to post favorable comparisons to other retailers.
Inventory turnover increased for the quarter to 2.9 times, compared to 2.8 times last year on higher average inventory balances throughout the quarter demonstrating the efficiency in performance.
To be fair, the strength of gold prices throughout the quarter aided our disposition result. However, when excluding the sale of refined gold retail sales still were up a strong 9% and gross profit margin excluding our refined gold was 40.2% compare to 40.7% last year and about the same is 40.4% in Q3 of 2007.
The gross profit margin on refined gold was up significantly year-over-year, due to higher gold prices and reached 32.8% compared to only 26% last year. Gross profit dollars were about $13 million and comprised 28% of total gross profit, compared to 26% in Q3 of 2007.
Pawn loan balances finished on an uptrend in the fourth quarter, which is sequentially unusual but positive overall. Typically pawn loan balances will fall from the Q3 levels, however, in 2007 pawn loan balances decreased from $137.6 million at the end the third quarter to $137.3 million at the end of the fourth quarter. The fourth quarter level of 7.8% higher than the year end level of 2006.
This year-over-year growth percentage is high in its own right, but more significant given that we shifted our Texas pawn loan portfolio from 90 to 60 day loan terms in the last half of 2007, which typically decreases pawn loan balances.
Same-store pawn loan balances were up 6.6% at December 31st, compared to down 0.5% at the end of the third quarter pawn loan yields were also up in the quarter to 128.3% compare to 122.7%. All the preceding factors lead to a 9% in finance and services charges on pawn loans, which reached $43.9 million for the quarter.
The preceding elements have increased profit in disposition activities as well as higher pawn service charges led to a same-store and net revenue increase in our pawn locations at 8.8% year-over-year in the fourth quarter, up sequentially from 5.9% in the third quarter of 2007 and at 5% from the fourth quarter in 2006.
Cash advance losses in our pawn segment represented 32.5% of fees in the fourth quarter, which is about the same level as the fourth quarter of 2006 but down sequentially from Q3, 2007 level of 44%. This improvement is consistent with the overall cash advance portfolio and is due to the company's emphasis on underwriting collection activities initiated during the third quarter.
So concluding pawn lending segment, I will reiterate that operating income rose 11% to $32.7 million in the fourth quarter of 2007 and highlight the fact that pawn activities comprised approximately 72% of the company’s consolidated operating income.
Now, moving on to the cash advance segment, we experienced the continuation of the trend of strong revenue growth year-over-year. Please note, that this is the first full quarter comparison since the company acquired the online cash advance business in September of 2006.
Equally it is important that the growth in revenue year-over-year is a favorable loss performance metrics. Now, fourth quarter revenue in the cash advance segment increased 38% to $85.5 million leading to a 68% increase in the operating income to $12.8 million.
For the first time in 2007, operating profit margin within the segment increased year-over-year to 15% of revenue compared to 12.3% of revenue last year. The Q4 operating profit margin is also the highest level at any period in 2007.
As mentioned earlier the increase in marginal profitability is largely due to the performance of the portfolio, which saw losses as a percentage of cash advance fees drop sequentially to 39.6% of cash advance fees in Q4 of 2007 from 45.9% in the third quarter and 50.2% in the second quarter. Once again, a sequential decline in fourth quarter loss metrics is highly unusual from a business cycle perspective and these are more unusual for the fourth quarter loss percentages to be the lowest for the entire year, which isn’t the case for both the cash advance segment and the company overall.
Total cash advances written within the cash advance segment were up 35% to $476.1 million and aggregate cash advance balances owed by customers before the loan loss allowance was up 25% to $130.6 million in the fourth quarter compared to prior year
And as many of you know we've broken out the cash advance segment between storefront activities and those in our online distribution platform, which is contained in the press release attachments for your convenience.
Reviewing that breakout within the segment shows that revenue from the online platform was up 88% in the quarter, and that operating income increased to 141% to $9.1 million. Operating profit margin on that $9.1 million is 18% compared to 14% in the fourth quarter of 2006.
Cash advance losses as a percentage of fees for the online business came in at 48.4% in the fourth quarter of 2007, which is only slightly below the 50% experienced in the fourth quarter of 2006. But the prior year margin, benefited from purchase accounting as very few loans had a chance to fully charge-off by the end of 2006.
The Q4 2007 loss percentage of 58.4% is sequentially down from 54.3% in the third quarter of 2007. This improvement and performance is a function of a lower percentage of first time customers entering system relative to the overall portfolio size, which is now comprised of a higher percentage of customers who have proven their ability to repay and utilize the product when needed.
Storefront performances was less impressive than the cash advance segment as revenue was off approximately $200,000 less than 1% to $35 million, largely due to an emphasize on underwriting activities initiated late in the third quarter of 2007.
This focus on underwriting activities led to a decrease in cash advances loss provisions to 26% of cash advances in the fourth 2007, compared to 28% for the prior year fourth quarter.
Inhibiting the profitability of the storefront activities was the addition of 11 locations in the third and fourth quarters in the current year, which detracted from profitability and a surge in borrowing activity late in December necessitating additional loss reserves with very limited contribution of revenue.
Operating income in the storefront cash advances business was down a $177,000 for the quarter. Therefore wrapping up the consolidated cash advance segment give us a 38% increase in revenue to $85.5 million with income from operations at 67% to $12.8 million and operating profit margin improvement to 15% compared to 12% in the prior year.
Given the discussion about cash advance activity, this is the good time to articulate an anomaly with the statistics surrounding the cash advance loss provision in the fourth quarter. This discussion will be almost identical with the discussion I had with you in October related to the third quarter loss provision metrics.
As you will see in the attachments to the press release information, the combined cash advance loss provision as a percentage of combined advances written were 6.8% during the during the fourth quarter of 2007, up slightly from 6.3% in the prior year but down from 8.1% reported in the third quarter of 2007.
This loss represents the loan loss provision expense taken in the quarter, based on the characteristics of the portfolio as of the end of the quarter. The performance of the portfolio has improved since the third quarter as reflected in a lower loss provision.
However, some of you will undoubtedly observe, the actual charge-offs in the fourth quarter as a percentage of loans written was 7.8%, meaning that the charge-off figure was greater than the loan loss provision.
So, I'll repeat the essences of my discussion from the third quarter to explain that charge-offs in the fourth quarter are more practically compared to loan loss provision in the third quarter whereby the company reserved 8.1% of loans compared to the 7.8% of actual charge-offs incurred in Q4. I point this out because during the third quarter discussions, we highlighted the fact that actual charge-offs were 8.3% even though the provision expense was only 8.1%.
To follow this discussion I am highlighting the fact that loan loss provision calculation is 6.8% is expected to be adequate to cover net charge-offs as we move into the first quarter based on the fact that the portfolio performance has improved at this level. There have been no changes to our methodology during the quarter.
The real issue of this overall discussion is the fact that the loan loss provision expenses as a percentage of loans written in fourth quarter were 6.8% down sequentially from 8.1% in the third quarter and down 8.4% in the second quarter. And while the Q4 2007 level was slightly higher than the 6.3% in the fourth quarter of 2006, this was largely due to the change in composition to the portfolio, which is much more heavily weighted towards the online business than the portfolio that existed in the fourth quarter of 2006.
In summation, I would report that we are very pleased with not only the characteristics of the earnings in the fourth quarter but I'm also am more excited about the outlook as we look towards 2008, given the fact that our pawn loan balances have risen significantly year-over-year.
Inventory levels have performed well, as evidenced by higher inventory turnover levels and stronger gross profit margins. That we are a still moving into the important first quarter with higher levels in inventory would allow us to execute on sales performance in the March 2008 quarter.
And finally loan loss provision and performance in the cash advance portfolio has demonstrated the levels of improvement that we expected to see over time, but showing up ahead of schedule in the fourth quarter of 2007.
As we turn our attention to 2008, we confirm the existing expectations per earnings per share for the full year as between $2.85 and $3.05. For the first quarter of 2008, we typically enjoy strong [sales] activity and a higher degree of loan redemptions driving increases in revenue from loan product.
In addition, typically we have a high degree of collections activities, which minimize the provision for loan losses as we exit the first quarter and contribute to higher overall profitability.
The first quarter of 2008 should be no different with the exception that we are uncertain about the timing of tax refund at this year, due to the reported delay of finalization of the tax code in Washington.
Our understanding is a summary change maybe delayed, which would simply imply that loans would be outstanding longer, creating additional income. However, they will have less time to rebounce from their lows by the end of March, meaning that the second quarter our financial performance will be lower than a typically trend year-over-year.
All in all, the first two quarters combined will perform much like the first two quarters in the prior year, so that we believe there will be a higher concentration of earnings in the first quarter relative to the second quarter in 2008 compared to 2007.
We've initiated our expectations for the first quarter result to between $0.70 and $0.75 per share, up from $0.61 per share in the prior year.
And now to give you additional insights in the calendar of 2008 and the outlook, I will turn the call over to Dan.
Thank Tom, in a sedative outset, I’d like to spend, first spend a few minutes in reflecting on the full year 2007 and then share my views on the outlook for our 2008 noting the key items that we must achieve in our financial plans for the New Year.
First in 2007 and over the exception of a precipitous drop in our share value during the latter half of the year, the year 2007 is a very successful year for Cash America. I’d like to take this brief opportunity to congratulate all my co-workers for their contribution to our success in the year.
I know many of them like me have found it a bit frustrating to watch our share value drop approximately 30% a year, when earnings were up about 30% and I find myself periodically giving speeches internally counseling our people on how market rationality does not always prevail in the short-term vendors. But I have also shared my absolute belief that the market generally gets it right over the long run.
Our job is to keep making smart strategic decisions and execute our business model to the best of our ability and if we do that well, I have told our folks we can count on the ultimate return of rational valuations.
Now to look to 2007, what I like to do is provide some accountability on the report card of things I told you that we had hoped to accomplish in 2007, when I spoke to you on this call in January of last year.
First item on my list was a goal of making 10% operating income growth in our relatively mature pawn segments. We actually achieved growth of 14%, and it appeared right then I worried about maintaining equilibrium in the earning asset base.
I came, did a great job managing that balance during the year while holding pawn yields and placing very little pressure on gross margins. Admittedly the strength of gold prices during the year was a great asset supporting both pawn loan growth and disposition activity.
The second item on my list called for a 15% to 20% growth in the storefront component of our cash advance segment. And we clearly failed to do deliver on this challenge as operating income in the storefront component actually declined 9% on revenue growth of six.
We began the full year expecting to face some tough anniversary comps in California following the discontinuation of the bank installment product in the latter half of 2006 but we did not expect that the challenges we encountered in our Cashland branded locations in the Midwest. This thing started the year with the very aggressive topline strategy but soon began to struggle with escalating loss rates.
We made some underwriting adjustments in the second quarter and again in the third quarter to regain equilibrium in this business and you can see in the financial schedules to our press release that we just finally brought our loss rates down in the fourth quarter in the storefront operation. We've got a lot more work to do here in 2008.
Next, I told you in January of last year that we expected revenues and operating income from the online component of our cash advance segment to exceed the revenue and operating income of its bricks-and-mortar counterpart in the cash advance segment by the end of 2007.
You can see in our release today that the internet lending component of our cash advance segment flew past our storefront operations with revenues of a $185 million versus a $138 million in the storefront operations and operating income of the internet lending component of $24 million versus $14 million in the storefronts.
Perhaps the success of our online channel was the most positive development for the Cash America in 2007. We faced a lot of skepticism on the economic viability of this channel at the beginning of the year, which was largely put to rest in Q3 when we first reported financial information for this channel as people could see the revenue grow and margin of profitability of internet lending and again they get to gain confidence that we would be able to manage our loss exposure online.
Our confidence in the internet model was further strengthened by its performance in the fourth quarter. That's a good safe way to the fourth item on my list, which was a prediction that our consolidated cash advance loss rates as a percentage of cash advance fees would approach 40% for the full year of 2007.
We are [expecting] it higher than planned for the full year at 43.7% but the trends in the last half of the year we are very encouraging, primarily by making significant improvements in our online business, and I am hopeful that the consolidated loss rate of 40% is well within our reach in 2008.
I also predicted continued improvement in consolidated operating expense margins again when measuring operating expenses net of loss provisions to total revenue. We did get a pretty significant improvement of about 450 basis points in the year, which again to a large extend reflects improvements in our pawn segment and a larger mix of our online business, which enjoy significant operating expense leverage when compared to the typical bricks-and-mortar model.
Next was a plan to add 30 to 40 new bricks-and-mortar units in '07. We decided during the year to reduce that goal and ended the year with 25 additions. Our decision to restrict storefront additions was influenced by the challenges we faced with our cash advance storefront operation during the year and our desire to dedicate more energy and resources to the online channel.
We also predicted higher debt and interest expense levels principally associated with the earn-out payments on the CashNet acquisition. Both average to debt levels and interest expense were up 45% to 50% for the year. We are also hoping for stable gold prices and interest rates and as you know gold prices rose pretty significant during the year and interest rates remained relatively stable.
I would also tell you we planned on about our 100 basis points bump in our effective tax rate in 2007 due to the new Texas margin tax that was to become effective in 2007, and due to certain credits available for us and delays in implementation of the tax, we did not experience that increase until this fourth quarter when our effective tax rates climbed by 114 basis points.
The rates for the full year of 2007 was actually down from 2006 slightly, and going forward we expect the Texas margin tax will permanently add about 50 basis point to our effective tax rate.
Our key non financial goals for us in 2007 were the successful implementation of the first phase of our new point of sale system, and that implementation had been delayed until early 2008.
And finally our plan that soon we would have no major legislative or regulatory disruption in our key markets and while there was some disruption in the payday industry none of them affected us to a significant degree.
In addition to these items, I would include our planned manage that reorganization that we announced in August in CashNets July entry into the UK as positive developments in 2007.
Now with that backdrop of 2007 performance let me move on my perspective and outlook in 2008. As Tom outlined we are confirming our previously established earnings guidance range of $2.85 to $3.05 for 2008. This range represents a respectable recurring earning growth rate of 15% to 23%.
And while this rate is a bit below the growth rates we had experienced in the past two years, we believe our plans for 2008 is aggressive, particular given the burden of the additional cost and expenses we will occur in a initial rollout of our new point of sale system. We are not expecting this system to produce any immediate gains and most of the financial benefits should occur in periods beyond 2008.
Now there are a handful of key things we must deliver on in 2008 to achieve our plan. The first of these is continued earning asset and revenue growth in our pawn segment. We are once again expecting asset and revenue growth for the pawn business in mid to high single digits.
We expect to report an operating income growth in the segment to be in the low to mid single digits after the burden of administrative cost allocations and new depreciation expense. Also note, after those additional cost and the expenses, we anticipate a sharp contribution of operating income growth would be in the mid teens.
Now, we would expect stable pawn loan yields and slightly lower gross profit margins on disposition activities and no significant change in the price of gold from where it is today. And a stable gold price should provide the opportunity for a positive revenue comp on disposition side, given the hedge strategy that we've employed throughout 2007 and will continue in 2008.
The second item on my list is that we expect cash advance segment to provide the lions share of reported earnings growth in 2008. And this will require strong performances from both the online and storefront channels.
We would expect the revenue growth rate for the internet lending to moderate from 2007 levels but still outstrip the revenue growth rate of our storefront operations about a multiple of three to four.
We are also expecting a significant improvement in margin of profitability from the online channel, which reflects the ongoing maturation of its customer base, a continued success with its proprietary scoring models.
One of the big challenges I envision for our management team this year is to regain the momentum in our cash advance storefront operations, which not includes 304 units in seven states. The analytics team at CashNet in Chicago has been working with our storefront team in Fort Worth and our collections team in Cincinnati for the past few months, on the development of a new proprietary scoring model for all of our bricks-and-mortar locations. And we expect to test and implement this model in the next few months and are hopeful it will add a lift in profitability later in the year.
The next item is that we are focused on the management of our POS rollout and controlling the costs associated with that project. We mentioned in our conference call last quarter that we are expecting as much as an additional $0.10 a share related to depreciation of the software of that new point of sale system.
We also face in additional depreciation of approximately $0.04 to $0.06 for the accelerated rollout of new shop hardware. And we'll be taking addition expense pressure from network communication cost, software maintenance, the travel and training cost associated with the rollout and duplicate cost of maintaining two systems.
All of these costs and expenses have been baked into our 2008 plan but they will require careful management to keep in check.
Next we are planning for significant capital outflows related to the CashNet earn-out payments, which will occur in May and November, and ongoing investments in technology. Average outstanding debt levels will rise during the year and we are expecting some relief from lower interest rates.
Finally, we are planning for very little bricks-and-mortar unit growth in 2008. Part of that decisions stems from the capital commitment we've already have in place, but more importantly that the decision stems from the strategic decision, to spend this year supporting our online channel, enhancing the unit profitability of our existing storefront operation and making sure we get the new system implemented with the minimum amount of disruption.
We will continue our work on expanding the geographical footprints of the online channel in both the US and elsewhere. Now consistent with my comments to you last year, the 2008 plan assumes that we have no major legislative or regulatory disruption into our business in the New Year.
Unlike last year when I did not feel compelled to comment on the macro economic trends as a backdrop to our 2007 plan, I knew one of the issues I had cautioned this year is that our financial plan does not include any factors associated with significant changes in the economic environment.
I have found over the years that most people are confused about how economic cycles affect our business, largely due to the fact that certain effects of cycles on our business can be [counter intuitive]. I have always held the belief and consistently communicated over the years that brief and shallow downturns in the economy may benefit our business model in the near term, but deep and extended periods of downturn or extended periods of stagflation are generally not good for our business.
Overall though we felt very good about our plan in 2008 and are obliviously committed to achieving that plan
With that I’d like to open the line for questions at this point operator.
And our first question comes from the line Dennis Telzrow with Stephens Inc. Please proceed with your question.
Dennis Telzrow - Stephens Inc
Good afternoon, Dan and Tom obliviously great work on the loss rate.
Dennis Telzrow - Stephens Inc
A couple of small items here I am sure would be probably explained relatively easy. In the payday storefront numbers in the Q4, it looked like the operating expenses were up on reserve. Is that allocation changes versus last year?
Well, one of the factors I mentioned in the call, Dennis, is we added some stores in the fourth quarter, which pushed those numbers up. They did have a variety of costs here and there, nothing overly significant that burnt that business yield daily and overall it was only mainly those new 11 stores, [noticeable together].
Dennis Telzrow - Stephens Inc
Yeah. And you mentioned on your comment on the cash advance, you saw late surge and demand in December is that -- it sounds like that's a little unusual or is that normal or…?
Well, we like to see strong balances coming off of the year. We did see a lot of incremental loans written the last week of the year, particularly out in the Midwest and when that happens we immediately reserve against that on our balance sheet, we only recognize that revenue ratably over the period of the loan. So it has a tendency to be dilutive if you will relative to loss provision. Not necessarily unusual when you see a big surge, as we talked about our volumes have been moderating throughout quarter, it was a bit of turnaround for us.
Dennis Telzrow - Stephens Inc
And Dennis we were -- only just to add to that -- we were a bit surprised that the strength of the loan demand in both cash advance and pawn segments in December. So quite frankly, I find it encouraging to some degree, particularly given the underwriting changes that we had made coming into the fourth quarter.
Dennis Telzrow - Stephens Inc
And Dan you did mention it per se any perspective on the UK and I know you've going slow, is that still sort of the status of that?
Yeah, I mean we are -- it is not significant up to this point to warrant mention in our prepared comment status, but we are making good progress in the UK, I am very pleased with the work that our team in Chicago has done to get up and operating there. We are still in an operating loss position in the UK, through both the third quarter and the fourth quarters.
We are beginning to gain greater confidence in the scoring model the teams put together specifically for the UK, which obviously is different than the model we use in the US, although there are a lot of comparable metrics involved in both models. But we are gaining enough confidence to begin stepping up some volume activity in the UK and I would expect that business sometime around the mid year to turn corner on profitability.
Dennis Telzrow - Stephens Inc
Okay. Thank you. Again, fantastic job on the last quarter, great trend.
And our next question comes from line of Rick Shane with Jefferies and Company. Please proceed with your question.
Rick Shane - Jefferies and Company
Hey guys. Thanks for taking my question. When you are talking about improving the underwriting standards -- and obviously we are seeing the impact in the credit results in the fourth quarter -- if you were talking about mortgage loans for example, we know what the metrics you would be tweaking in order to drive better underwriting, you would be looking FICO scores and collateral values, within payday lending, one of the metrics that you lookout, what sort of factors play into that?
Well, there are lot of factors we’d like to play into our models particularly on the internet side and again we got, fortunately part of the great asset we acquired with the CashNet deal was a very strong analytical team in Chicago, who is constantly working data on a [relative] basis every month, updating their models to try to determine two things. To try to determine if at what point do we eliminate folks on the bottom end of the spectrum, folks that we don’t want to take the risk on and at what a level at the top end of this spectrum do we add to the [available] loan amounts that we’re willing to loan people. So, to some degree we are cutting people out on the low end and adding to the average loan amounts to the good customers on the top end.
As much as I would like to go through an entire list of things that we look at, I am not going to do that on this call. I do think one of the great competitive advantages that we have with particularly the online business is the scoring model that we put in place and the types of things that we look at there and again we are going to protect that model and protect the way that we go about the decision making process and let the results speak for how effective we are at bringing that in play.
That’s much less sophisticated on the brick-and-mortar side of the business, a lot of the changes that we made, we have a more rudimentary scoring model on the bricks-and-mortar side of the business and we started taking the gold instrument in the second and third quarter on the brick-and-mortar side of the business and cut out people at the lower end of our scoring range, reduced across the range, reduced the amounts of that we are willing loan people. Clearly that has an impact on volume as well as loss rates and again we try to find a wide equilibrium to that business but again we are trying very hard to get to the point from an analytical standpoint where we can introduce a fairly sophisticated scoring model, a proprietary model in our bricks-and-mortar business as well and I am pretty upbeat on the potential of that here in 2008.
Rick Shane - Jefferies and Company
And I obviously respect the fact that a lot of that information is proprietary and the result in some ways do speak for themselves, I couldn’t convince you to sort of tease with just one or two of the things on the margin that you look at?
No you can't, I'm sorry.
Rick Shane - Jefferies and Company
And our next question comes from the line of John Hecht with JMP Securities. Please proceed with your question.
John Hecht - JMP Securities
Good afternoon guys, thanks.
John Hecht - JMP Securities
I hope this one is -- kind of just following on from Rick’s question who has got this [already maybe]. I wanted to disclose this, but I think there was sort of public discussion of maybe focusing on more of a recurring customer base through the quarter and can you shed any light on that, that you might have, you have a higher component of recurring customers or customers who are not first time given the credit trends in the fourth quarter?
Well part of that is just again the maturation of the customer base. As CashNet mart is up sort of the S curve in their growth rate particularly in states that like Texas and Florida that were new in 2007. Just a natural course of our maturing customer base moves people to a greater weight of recurring our existing customers and we have separate models as it relates to separate scoring models that relate to new customers and they relate to our existing customers. And so some of the improvement that you've seen in the quarter and some of the improvement that we've had sequentially here is a function of that maturing customer base and a mix between brand new customers, who in any model, whether it's online or in bricks-and-mortar, certainly you are on a greater risk with people you have no history with than people that you may have lent made, a loan to in the past who has demonstrated their capacity to repay that loan and use the product responsibly.
So again there is an ongoing shift in that mix. In any time, for instance the reason that we are at an operating loss in the UK is that we've got a large component of first time and brand new customers that we have taken risk on, as we try to build a model around the metrics of the unique aspects of lending in UK. Over 2008, we would expect to step up that volume, gain more intelligence and mature that customer base as well; which again, I think probably about in the middle of the year will get us to be in a position of profitability there. But that is a function definitely but also I think just on-going specification of our modeling capabilities had a large impact as well.
John Hecht - JMP Securities
Okay, and I know the answer to the question is going to end somewhat upon the timing of the receipt of tax rebate here but last year given the growth of the online division, you kind of grew through the first quarter, I guess because given that the infancy here that where you are in the last cycle, that you cruise the first quarter when you normally see balances decline along with the receipt of tax rebates, given that you mentioned you kind so good in the maturity of the business, should we expect that type of trend with balances this year or you still on the under a growth trajectory that would you need that sense?
Yeah, John, we talked about in our first quarter of last year, how unusual that is, unprecedented literally, to have growth in balances from December to March. That was brought on by opening up significant markets in Texas and Florida in the online channel. We don’t have that kind of market, new market creation in 2008, so you will see a much more normalized trend. I would fully expect cash advance balances along with pawn balances to follow their traditional trend of decline from December to March.
John Hecht - JMP Securities
And then the last question is that the, can you tell us, was there any variability with respect to November to December kind of retail trends at the customer base that would be reflective of the general economic backdrop or did you guys see sort enormous sales pattern during that season?
Yeah, our customer tends to shop the last couple or three weeks at every year, we are not like a traditional retailer that sees trends immediately after Thanksgiving. We were, much like we were throughout the year, we were strong through out the quarter as we have been in all the quarters in 2007.
John, December sales were pretty strong when you look at everything that’s been reported in the overall retail arena. So, also quite frankly I was a little bit surprised at how strong our over-the-counter sales were in December, we also had a good November. So as Tom said entire quarter was pretty positive.
John Hecht - JMP Securities
All right, guys. Thanks very much.
Our next question comes from the line of Henry Coffey with Ferris Baker Watts. Please proceed with your question.
Henry Coffey - Ferris Baker Watts
Yeah, good afternoon everyone.
Henry Coffey - Ferris Baker Watts
I appreciate all these comments. Two things, digging into the internet business, are you seeing anything happening in the customer acquisition front? And I don't expect you to tell us what you are paying for new customers -- but given whatever status that portion of the industries is in, is the cost of buying customers from lead generation companies going up, going down, staying the same?
As a general comment about the business globally Henry, I would say that it's about the same or moved up very marginally, since we made the acquisition in '06. More specifically as it relates to our online business and the strategy that we've employed. Our team in Chicago has employed and acquiring customers. Our cost of acquisition has increased more significantly I think than the global market and that's by choice and again what our strategy has been as to gain a competitive advantage through business intelligence, that we are able to go out and acquire better customers and we are willing to pay more for customers that are modeled indicates are a strong chance to repay.
So our models are based on profitability, they are not based simply on cost of lead generation. So when we are looking at the profitability of a particular customer we may pay more than the next guy to get that lead.
Henry Coffey - Ferris, Baker Watts
Tom, made this comment during the course of the year, that the internet business was the equivalent of, I think that the number you used Tom was you said X-100 stores and watching them grow, produced 24 months of growth almost overnight. Obviously you have done a great job of managing that. When we look in to '08 and '09 should we assume that business sort of grows like a mature store chain would 34%, 40% instead of the kind of which is about what a mature store chain would do in its third and fourth year or should we expect something higher in terms of growth. I will let you put whatever numbers you want on it. Tom’s laughing, isn't he?
You'll take that or you want me to take.
Well, what I am going to say Henry is, you are exactly right. Your analogy is right on target when we look at the volume of loans written last year on our online space, it’s obviously significant and virtually from a very limited growth you've got, our storefront has been around for years and years doing less than $0.25 million in the current quarter, and online doing more than $0.25 of million in the current quarter.
So it's like you put in the entire platform in a very short period of time and it was incrementally profitable all the way through. You are right, you are not going to see the explosive growth, the kind of numbers that we wouldn't even talk about, because they are a 100% in the first two quarters. You just see more a normalize trends, again we are not opening out major markets like Florida and Texas but we are pursuing other market.
So we look for what I'll call impressive levels. I'll leave that up to you to conclude what impressive levels are. But what we are really driving here is marginal profitability. As I've said in the past we saw a huge revenue growth in that segment in the early stages of 2007, it wasn’t as efficient as many people thought that …
Because of the loss rates were so great. Now we are showing the improvement in marginal profitability and into the logical tapering of revenue growth and the continued expansion in marginal profitability at the bottom line going forward.
Yeah Henry and I will add from a strategic perspective. We look out beyond a year or two with our online channel. We are focused on as I said in my prepared comments expanding the geographic footprint of that business and we are also strategically continuing to talk about what sort of additional financial service products we can distribute online.
Our interest in that channel when we made the acquisition was not simply to be in the online cash advance business, but it was to acquire a platform that we could use to develop other financial services products to distribute over that channel. I don't have anything to talk to you about today about a specific product, but I will tell you that it is consistently part of our strategic discussions with the team in Chicago and I'll be disappointed over the next few years if we can't find additional products and services to distribute over that channel, which then have different implications for the growth rate of that channel.
Henry Coffey - Ferris, Baker Watts
And I apologize for this but every time you talk about the new point of sales system, I hear some numbers and I kind of grab them in one of the ear and I have been too lazy to look at the transcripts. But, is it $0.10 of sort of incremental cost? Is that the figure I keep hearing?
Dan reiterated that figure we talked about in Q3 just…
Yeah. We are looking at approximately $0.10 in pure deprecation cost in 2008.
And now that $0.10 would be with you going beyond 2008?
And because of the new system we will basically accelerate the hardware deployment in our stores, we are constantly replacing hardware in our stores. Normally that just occurs in the normal course of business. So we will be deploying hardware consistent with that rollout as well and so there is some additional depreciation thing there and computer hardware doesn't have the kind of useful life it used to have. So that will hit us as well. But, those were embedded costs, our company is growing and has been highly successful because of our capabilities on the technology side, that's a cost of doing business. We just wanted to make sure we alert people to it and our growth rates are designed to absorb that.
Henry Coffey - Ferris, Baker Watts
Great. Thank you very much and it's again a great quarter?
Our next question comes from line of [Forest Tampoo with Hyaline Partners]. Please proceed with your questions. Oh, I’m afraid he just disconnected. There are no further questions from the phone line for the moment.
It’s okay, I appreciate everybody's attendance on the call. Again as we always say at the conclusion of these calls, feel free to give us a follow-up call here in Fort Worth, if you have any further questions or comments. Thank you very much.
Ladies and gentlemen that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.
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