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QC Holdings Inc. (NASDAQ:QCCO)

Q4 2007 Earnings Call

February 7, 2008 2:00 pm ET

Executives

Don Early - Chairman and Chief Executive Officer

Darrin J. Andersen - President and Chief Operating Officer

Douglas E. Nickerson - Chief Financial Officer

Analysts

Dennis - Stephens & Company

John - JMP Securities

Henry Coffey - Ferris Baker Watts

Bruce Wilcox - Cumberland Associates

Operator

Good day ladies and gentlemen. This presentation contains forward-looking statements within the meaning of the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on the Company's current expectations and are subject to a number of risks and uncertainties, which could cause actual results to differ materially from these forward-looking statements. These risks include among others change in laws or regulatory regulations governing consumer protection or payday lending practices, litigation or regulatory action directed towards, volatility in our earnings, and the other risks detailed under Item 1A Risk Factors in our 2006 Form 10-K.

QC will not update any forward-looking statements made in this presentation or on the conference call accompanying this presentation. Also if you would like to follow any of with the slide presentation, please access the new and improve QC Holdings website at qcholdings.com, then click on the microphone webcast icon on the home page which will direct you to the slides.

I'll like to turn the call over to Mr. Don Early, Chairman and CEO. Please proceed.

Don Early - Chairman and Chief Executive Officer

Good morning and welcome to our fourth quarter earnings release. Let me begin by saying that we are pleased with our fourth quarter results and proud of the progress we have made in 2007 in a challenging macroeconomic environment. We are particularly proud of our ability to return nearly $100 million of value to our shareholders through dividends and stock repurchases over the last two and half years. As we enter 2008, with nearly 73 million in loan receivables, we are well positioned to capitalize on our 2007 momentum.

With that I'd like to turn the call over to Darrin Andersen for a discussion of our quarterly and year end results. Darrin?

Darrin J. Andersen - President and Chief Operating Officer

Welcome again to everyone on the call and thanks for your interest in QC Holdings. Today I'll review our fourth quarter and end of year financial highlights and provide an update on our operational highlights, before turning the call over to Doug for more detailed review of our financial results. Then we'll open up the call for questions.

We're pleased to report increased fourth quarter revenue by 17.7% quarter to quarter to $57.3 million, record quarterly branch gross profit of 16.1 million, and solid earnings of $0.19 per share. We are especially pleased to have generated these results in a challenging fourth quarter economic environment that included softening retail sales, declining consumer confidence, and increasing turmoil in the credit and debt markets. But the fourth quarter downturn wasn't enough to spoil our best year ever.

Our revenue increased 24% to $213.6 million. Revenue comparable branches increased 15.1%. Net income increased 59% to $14.6 million. Diluted earnings per share reached $0.75 versus $0.45 in 2006. Adjust EBITDA was $38 million and operating expenses increased only slightly, an important accomplishment given that we spent considerable effort integrating the 50 South Carolina branches we acquired in December 2006.

Operationally our key indicators of success remained strong underscoring the strong consumer demand for term loans of vintage branches continue to produce strong results as they strike the optimal balance between revenue growth and losses. Our newer branches, those that we have opened since January 2005, continue to mature and deliver results in the form of increasing revenue and profits.

Marketing efforts have become more intense and more sophisticated as we improve our processes and the quality of our marketing materials. We are doing a better job of identifying potential customers and reaching them with relevant messaging and we are doing a better job of ensuring our existing customers returned to us rather than affect to our competition.

We are currently testing television advertising with the view toward driving new customers into our branches, while establishing brand equity that will differentiate us from our competition in the long run. Finally we are encouraged that our new installment loan products have been embraced as viable solutions for our customers in Illinois and New Mexico.

This longer term larger dollar loans are enabling us to respond to regulatory issues in those states who are continuing to serve our customers. Overall we anticipate about a 6-10% increase in total revenue in 2008.

In context around our last experience, a loss ratio was up to 25.5% from 21.5% in 2006 which pushed us at the high end of our fiscal range. Please keep in mind that in addition to declining economy that brought financial hardship for many of our customer, we are also coming off record low losses in 2006 and we delivered, we clamp down our losses generated by a rapid 2005 expansion.

Moving forward, we would expect our loss ratio to be between these levels. We are focusing on collections, as a way to counter these increase losses and to help us thrive in the less than ideal economy.

Nearly all our field employees have completed a tactical collections workshop and we have improved our collection system and debt management and reporting processes. In addition, we are implementing a regional collection strategy that concentrates collections expertise at market level hubs. Regarding regulatory issues, the number of states within (Libun) legislation has remained consistent as regulatory activity each year routinely heightened in the limited number of states.

As a young industry, it is reasonable to expect increased regulatory activities as state laws evolved with the industry. Importantly the industries evolution has included in increasingly sophisticated approach to addressing customer needs, regulatory activities, and public perception.

This approach has included the adoption of a mandatory set of best practices and a public education and awareness campaign designed to help customers understand how to use our product responsibly and to help legislators understand how we help their constituents by responsibly offering products and often times the best alternative available.

Those best practices this year included the offering of a new extended payment plan to any customer who is difficult in meeting the terms of their loan agreement. It is just one of the many ways, the industry has evolved to serve reasonable customers in a responsible manner.

With diversified retail footprint of 596 branches in 24 states, QC's regulatory risk is diffused. As only two states Missouri and California account for more than 10% of our revenues. This branch reconciliation slide illustrates the rapid growth of evolution of our retail branch counts over the past 8 years including our rapidly novel expansion during 2004 and 2005. In addition to growing our national network of branches, we will continue to be proactive in closing branches that do not meet their targets due to regulatory or other performance issues.

Our aggressive 2007 reviews of such underperforming branches resulted in our closing 50 units. We will continue to review and close marginal branches through 2008 with an expectation consistent with our experience that these closing typically round about 3% of our total branch count. Regarding the novel growth, we expect to open about 20 branches in 2008. An effort that will enable us to remain focused on operations or providing a new store growth rate that is appropriate in our maturing industry.

As I mentioned, considerable time and effort was spent in integrating the 50 South Carolina branches, we acquired in 2006 and we will continue our disciplined and opportunistic approach toward growth through acquisition.

With that I will turn the call over to Doug who will provide more detailed review of our fourth quarter and year-end financial performance.

Douglas E. Nickerson - Chief Financial Officer

Great. Thanks Darrin. I really appreciate everyone taking their time to join us today. I will discuss in more detail the quarterly and full year financial results. For those following along on the slides, we are now on slide 11.

Revenues during the quarter grew 17.7%, a 57.3 million. Our other revenue component continues to grow as our installment loan product, which in now offered in Illinois and New Mexico gains acceptance. For the quarter installment, loan revenues totaled about $4 million versus $1.5 million in prior year's fourth quarter. Compared to third quarter 2007, revenues were up less than 2%, which is lower than historical averages and also indicative of the challenging economy as evidenced by the reduced consumer spending during the holiday season.

With respect to branch expenses, operating expenses were approximately $1.6 million higher than prior year's fourth quarter. This increase is primarily attributable to the inclusion of our fourth quarter's worth of salaries and benefits, and other costs for the fifty branches we acquired in South Carolina, and as a reminder that was in December of '06. With these new branches, however, our operating expenses as the percentage of revenues declined by nearly four percentage points as we continue to grow revenue while containing our costs.

Darrin spoke in some detail about loan losses, but a couple of additional statistics highlight the challenges we are facing. Returned items as the percentage of revenues were 48% this quarter compared to just 43% last year. The collection rate was 44% this quarter, down from the 52% in fourth quarter '06. Keeping in mind that 2006 was a historically better than average loss and collection year, we still have plenty of work to do to improve both the number of returned items and the collection rate.

Branch gross profit improved $1.2 million over fourth quarter 2006, reaching $16.1 million and as Darrin noted that's a record for QC. Regional and corporate expenses were up about 15% and that's primarily due to higher compensation quarter to quarter as well as to increases in public and political support activity and equity cost. The component is a little different and will continue to be important as the other expenses below the line, which include amortization and interest expense.

Amortization expense was greater by approximately $350,000 quarter-to-quarter, and that was due to our acquisition activity both last year and this year. And, then interest expense was greater by about $200,000 as a result of the $50 million term loan that funded the recent special dividend.

Diluted earnings per share was $0.19, the same as in prior year's quarter and that reflects the benefits of the stock repurchase activity over the last couple of years. And, finally adjusted EBITDA improved slightly to $8.7 million for the quarter, which is about 15% of total revenues.

Looking at the full year information on slide 12, we find many strong stories including the $41.3 million or 24% improvement in revenues over 2006. Our average loan size increased slightly this year to $366, which includes an average fee of roughly $53. What that translates to is about $3.4 million or so payday loans during 2007.

Over the year operating expenses increased to about 8% exclusive of the cost associated with the branch closing in Q1 and Q2. Operating expenses grew about 6% and this increase is consistent with our expectations for 2008 as well.

The increase for 2007 was attributable to a full year's worth of expenses from our South Carolina branches offset by well controlled costs at existing branches and lower costs because we closed and consolidated branches as noted earlier. Importantly, our comp branches expanded approximately $13,200 per branch per month in '07, and that was up slightly over prior year which I believe is about $13,050.

Losses were 25.5% of revenues in '07 versus 21.5% in '06 for the same reasons discussed in the quarterly comments. Clearly, this is an area of focus for us, particularly given the more modest revenue growth expectations moving forward.

Corporate and regional administrative cost increased about $4 million as a result of higher compensation equity cost, and public awareness and education expenditures. As a percentage of revenues these admin costs dropped to 16.6% from the 18.2% in 2006, and starting to get to a more normalized historical level.

Our other net component includes approximately $1.8 million related to the branch closing, $2.4 million of DNA, and net interest expense of nearly $700,000. Each of the DNA and interest expense amounts to about a million more than they were in 2006, which reflects the investment and return transactions we completed during late '06 and throughout 2007.

Diluted earnings per share grew to $0.75, which is a 67% improvement over '06. Exclusive of the branch closing cost diluted EPS were $0.85. Adjusted EBITDA grew 61% to nearly $38 million, which is about 18% of revenues and nearing historical averages for EBITDA margin.

Onto the balance sheet, as you can see our balance sheet continues to be strong and provide for great flexibility. We ended the year with cash of around $24 million and receivables of nearly $73 million, which is a 2.5% increase over '06.

On the liability side, we have total borrowings of about $75 million as of year end, $50 million of which is under a term loan. Typical of our cash flow seasonality we will pay down a portion of the facility fees during first quarter and then depending on investment activity the remainder of the year we'll re-borrow as loans grow.

We ended the year with equity of $52.5 million. Over the last two and half years we have paid dividends of 57 million and repurchased almost 39 million of QC stock. We now stand with a similar mix of long term debt and equity as we evaluate capital opportunities moving forward.

On our revenue by branch vintage slide, I'll draw your attention to the percentage change column. Consistent with this year's first three quarters our pre 99 group reflects the influx of competition in Kansas during '06 and '07. After that law changed in mid 2005. We believe we have weathered that storm and will not suffer the declines we experienced during '07.

In the 1999 vintage we can see the impact of improvements in California which as you may recall struggled last year. And similarly the 2000 and 2002 groups of branches reported nice double-digit growth reflecting the acceptance of the installment product in Illinois. Those growth rates will moderate next year as we believe that these branches will now be more of a typical older more established branch.

The big story here is obviously the 51% growth in the 2005 group of branches. These branches which now average roughly 30 months of age improved their average revenue per branch metric by $8000 per month compared to '06. It was nice to see this investment accelerate to its contribution to the company this year.

At the bottom of the slide you may note that closed and consolidate branches contributed about 2.2 million in revenues this year. Obviously those branches will not be around in '08, so our core beginning revenue level is really about 211.5 million.

Moving now on to profitability by vintage, the boxed in-column is where I will first focus. As you can see the more established branches tend to hover around 15,000 per branch per month in gross profit. That is our target for our newer branches. We made some nice head way in the '04 and '05 groups improving 3000 to 4000 per branch per month for each of those vintages.

We expect to continue to see improvement here as those groups march to their targeted level. On the loss side we can see there are older branches reported higher losses than historical averages. As Darrin mentions, we have not changed our approach for lending and have been very diligent from a collection standpoint. So it's reasonable to expect that we have been affected by the decline in consumer confidence and the ripple effect of the debt market issues. Lastly the all in gross margin of 30.4% and loss ratio of 25.5% each provide a nice starting point for improvement as we enter 2008.

This last slide of the presentation is a new one for us. More than anything it graphically highlights the story we have been discussing the last several quarters. We started 2006 coming from a year in 2005, where we experienced reduced earnings and adjusted EBITDA due to significant investment in the future. We started the earnings rebound in 2006 as newer branches kicked in and other costs including corporate and regional infrastructure investment moderated. Then in 2007 earnings and EBITDA accelerated as the maturation process continued. These investments from de novo to acquisition to return of capital to investors have set the stage for a solid 2008.

I think with that, we are ready to open the discussion up to questions.

Question-and-Answer Session

Operator

(Operators Instructions). First question comes from the line of Dennis with Stephens & Company. Please proceed.

Dennis

Good afternoon, Darrin and Dough.

Darrin J. Andersen

Yes.

Dennis

Just a couple of quick questions fairly simply. Your capital spending in '08 any estimate there?

Douglas E. Nickerson

Yes we will. I think what Darrin mentioned we're going to open maybe 20 or so stores. It costs us about 50 to 60 grand to open the store. And then with respect to our existing branch we typically estimate about $5000 per branch per year. So that’s just kind of a rough estimate for what you might see next year.

Dennis

Okay. And borrowing anything you'll have a fair amount of excess cash flow, which I assume would pay down debt or go to whatever else you deem it to be correct?

Douglas E. Nickerson

Yeah that’s correct, Dennis.

Dennis

And Darrin I think you mentioned your expectations as a loss rate for '08. Did I hear that correctly where you said it would be somewhere between '06 and '07 rate.

Darrin J. Andersen

Yeah that’s correct.

Dennis

Okay. Thanks that all I needed.

Darrin J. Andersen

Thanks Dennis.

Operator

(Operators Instructions). Your next question comes from the line of John with JMP Securities. Please proceed.

John

Good Afternoon, guys. Darrin, you usually give us a little bit of regulatory update, I wonder if you could at least address sort of the state you guys are focused on and may be we all saw in the last few days, the bill has been made it to the House in Virginia, may we talk about that. Any other states you guys are focused on and where are you focused?

Darrin J. Andersen

Sure, you know talked briefly about kind of where the overall environment is which I think is fairly consistent over the last several years, certainly number of states with enabling legislation has remained consistent. And it seems like each year we see in a heightened activity in a handful of states.

This year, it looks like those states are Virginia, South Carolina, Ohio. Right now, we certainly have got an eye on California as that starts to move in this session. You brought up kind of some of the activity in Virginia that session got started little bit earlier than some of the others, so there is probably little more activity now before the crossover between the House and Senate and bills have to move between House and Senate. That bill that's in there right now is got through committee is going to be voted off to move over the other side. Certainly we are involved in that state on a pretty significant level.

We really focused similar to our national campaign with the reasonable amount of broad public education about responsibly use of the product and also public education about who our customers are and how they use the product. We are partnering with some third-party groups to help promote that message.

We continued to try to educate legislators kind of through discussions and through those broader topics, so certainly we are going to be continued to be involve in Virginia throughout the rest of the session, South Carolina as well and Ohio has a similar type of localized campaign of partly with third parties and the public education. You know, one of the things that they were pretty pleased about in support of all that is the research that comes out.

We have talked about the research done by the economist with the Federal Reserve Bank in New York, which has shown that our product actually enhances the wealth for other communities its offered in and at the states where the products has been taken away Georgia, North Carolina that the customers are actually worse off after payday loans have left the state. The number of bankruptcy has increased, the amount of late fees and bank charges has increased. So certainly that supports a lot of the message and it's good to have that third party research. Recently there has been another study released by professors at Colby college, I am talking about a clinical study they did, the value of payday lending and how it actually helps consumer survive from the financial hardship, so that kind of research appears to be increasing and certainly helps in that broader effort.

John

Is it Comby college?

Darrin J. Andersen

Colby college

John

Colby, and is that a publicly available study.

Darrin J. Andersen

Yes, it is. I think it was released yesterday,

John

Okay. Second question is you guys could address this is what you are seeing in terms of de novo maturation rates now, may be relative to what they were two, three, or four years ago.

Douglas E. Nickerson

Well John that's a good question. Obviously after our '05, we scale back in '06, we only opened 46 branches and this year it’s just 20. But I think look on the slide on event revenue, actually profitably by slide one of the things was interesting as I have putting this together and reviewing it is, the '06 de novo are basically very close to break even and those stores average about 16 months of age. So when you link back to the '05 and I don't have the exact timeframe, but it was probably more like – where they crossed over in November 1, of '07. So it took them longer. So our '06 ramp quicker than the '05 did, '07 frankly are just too new to really know, but certainly is positive that the '06 has gotten to almost break even within 16 months.

John

If you attribute that, I mean what you attribute that to I guess is it more selective site positioning or is it despite you had fewer branches you were able to focus on that more or is there anything you can lead out of that?

Darrin J. Andersen

Yes. That's a good question. I think it's kind of handful of reasons. Some of the '05 branches were in some Texas for instance and there was little bit of regulatory turmoil when we initially opened those, somewhere in a little more competitive state like Ohio. The recent stores that we've opened up, we've also had kind of our improved marketing push that has helped those and certainly when we filled in the footprint we got the experienced trained management that's able to open those stores. So, I think all of those have helped ramp up the stores more quickly.

John

Okay. And, one more question. Before asking I want to thank you guys for answering all my questions, but the last one is you guys, I missed the first five minutes of the call. You were addressing online lending or any other new products at all?

Darrin J. Andersen

We didn't talk about those. So, you didn't miss that but we certainly are as we've talked about in the past spending some time and effort on the online lending, haven't made a big push to grow that business yet. We're still working on the regulatory framework to offer those and understand kind of the underwriting and collections that should take to do online which is a little bit different than what we do in the store front.

I did talk about the installment loan product that we offer and it went away, and we're again offering in New Mexico in the fourth quarter. That has been well received and we feel pretty positive about how that fills in, meets customer needs for larger and longer term loans. We'll look to begin to expand that product during 2008.

John

Great. Thank you guys, very much.

Darrin J. Andersen

Thanks.

Operator

Your next question comes from the line of Henry Coffey with Ferris Baker Watts. Please proceed.

Henry Coffey

Yes. Good afternoon every one. Two questions, then I'll just sit back and listen. Just looking at your vintage store data and the projections for next year growth of only sort of in the 8% to 10% range, does that mean the '05 stores are not going to have sort of the outstanding kind of year that they had this year or where is that slowdown coming from and then secondly I was wondering if you could quantify if the new law that was enacted in Virginia today under the terms of the house what would happen to numbers?

Darrin J. Andersen

I'll do the Virginia first and I'll let Doug speak to the revenue growth. The bill I discussed right now is fairly unique, as they all are but the 36% rate cap is something that we can't operate under. So, you saw in Oregon and we talked about with the military, 36% APR is a probation that's now reformed. So, in the extent it has 36% rate cap that would prohibit the product from being offered.

Certainly that's not at all what we anticipate working through. That's where it is right now. It's been through one committee and it's got a long way to go before it gets out of both houses and is signed by the governor. So, I would anticipate that it will continue to be amended and modified as it moves through the process.

Douglas E. Nickerson

And then Henry with respect to the revenue growth rate expectation for next year there are several things that come into play. I mean obviously we're in a more difficult economic environment and we don't have anything at least none of the news we're seeing now indicates that environment is going to change. We were soft in the fourth quarter and we saw 2% growth in our revenues which historically we grew 5% or so in the fourth quarter over third quarter. So, that environment really hasn't changed. I think broader through certainly the '05 branches had a tremendous year from the revenue growth perspective of 51%. There is definitely still some sale for those but they are 30-month old so they are entering this month, they are going to enter the fourth year and as they enter the fourth year, they start to get more of their maturations. This does not mean that they still don't have some growth and they'll have double digit growth which is now going to be 50%.

The other aspect comes into play here is New Mexico which we have handful of 20 some stores in. The regulations changed there and obviously that's going to have an impact from a revenue standpoint. Although we've implemented and now are doing installment loans, we've to see how those play out and we're only two and a half months into that process to see. Our hope and expectation is that we can get those to a level like Illinois experience but we don't know that yet because it's a new product down there.

Henry Coffey

Great. Thank you.

Operator

Your next question comes from the line of Bruce Wilcox with Cumberland Associates. Please proceed.

Bruce Wilcox

Hi good afternoon everybody. Could you update us on your current thinking on your regular dividend, quarterly dividend?

Darrin J. Andersen

Sure, we just said $2.20 per share at the end of December.

Bruce Wilcox

I remember.

Darrin J. Andersen

Yeah, almost $40 million or $50 million, the board was pleased to get that done. And certainly in this debt market, we are in right night, pleased to have funded that. As the board considered our capital obligation in the fourth quarter didn't declare a dividend but certainly as we move through the rest of the year and through the first quarter and second quarter, I think the board is going to continue to allocate or evaluate desire to either do stock buyback or dividends or combination of both.

Bruce Wilcox

Okay Darrin. That's fine. Thank you very much.

Darrin J. Andersen

Thanks.

Operator

I show no further questions.

Don Early

Great. Thanks again everybody for your interest in QC. We’re pleased, as we talked about our national base of maturing branches, a strong focus on delivering industry-leading customer service, and impact-free cash flow it feels like we're positioned just well to continue to return value to shareholders.

So again thanks for everybody's time and we look forward to talking to you at the end of the first quarter.

Operator

This concludes the presentation and you may all now disconnect. Good day.

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