QC Holdings, Inc. Q2 2008 Earnings Call Transcript

| About: QC Holdings, (QCCO)

QC Holdings, Inc. (NASDAQ:QCCO)

Q2 2008 Earnings Call

August 7, 2008 2:00 pm ET


Don Early - Chairman, Chief Executive Officer

Darrin J. Andersen - President, Chief Operating Officer

Douglas E. Nickerson - Chief Financial Officer


Dennis Telzrow - Stephens, Inc.

Daniel O’Sullivan - Utendahl Capital Partners LP


Welcome to the QC Holdings second quarter 2008 earnings conference call. (Operator Instructions)

The company has asked me to read the following forward-looking statement disclaimer. This presentation contains forward-looking statements within 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 those forward-looking statements. These risks include among others changes in laws or regulations governing consumer protection of payday leading practices, litigations or regulatory actions directed forward, volatility in our earnings, the increased leverage of the company as the result of the $48.5 million in special cash dividends in 2007, and the other risks detailed under the Item 1A “Risk Factors” in our 2007 Form 10K. 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 along with the slide presentation, please access the QC Holdings website at www.qcholdings.com, then click on the microphone webcast icon on the home page which will direct you to the slides.

Now I would like to turn the presentation over to your host for today’s call, Don Early, Chairman and CEO.

Don Early

I’m joined on today’s call by our President, Darrin Andersen, and our Chief Financial Officer, Doug Nickerson.

We are pleased with our second quarter performance of our core operations during challenging economic times. Demand for short-term credit was negatively impacted by the $100 billion worth of stimulus checks distributed by the federal government. We were also impacted by higher energy and food costs.

Still, our comparable branches performed well evidenced by growth in revenue and gross profit. Given the lagging economy, these results serve as a testament to the strength of our business and the excellent job our field managers have done in balancing revenue growth and loan losses. We are well positioned to continue delivering value to shareholders, customers and employees.

Signaling our optimist outlook for the second half of 2008 our Board of Directors is pleased to increase the dividend to shareholders to $0.10 per share. Thanks again for your interest in QC.

And now I’d like to turn the call over to our President, Darrin Andersen.

Darrin J. Andersen

I’m pleased to report our second quarter 2008 results. Today I will review our financial highlights for the quarter, provide an update on our regulatory environment and thoughts about the second half of the year.

As Don indicated, we are generally pleased with the performance of our core operations in a challenging economic environment. Our revenue increased 5.1% to $53.4 million compared to $50.8 million in the second quarter of 2007. Importantly, revenue from our core operations or comparable branches which now account for 560 of our 584 branches was up 4% or $2 million to $51.4 million and gross profit at our comparable branches grew 8.5% to $15.3 million. While our core business showed good growth, our bottom line was impacted by additional interest expense and regulatory costs including store closures and increased government relations spending. Income from continuing operations was $2.2 million or $0.12 per diluted share.

On Slide 5, a few notable facts about our second quarter operations. We originated $316.4 million of payday loans in the second quarter, a quarter-to-quarter increase of 6.2% over 2007. Both our average loan size and average fee were up slightly to $369.75 and $53.31 respectively. Our adjusted EBITDA was $7.1 million. Finally, as Don announced, our Board of Directors as a result of its optimism about the second half of 2008 increased the dividend to shareholders to $0.10 per share.

Loan losses are a key indicator of how we manage our business especially during economic downturn. Our loan losses quarter-to-quarter were slightly better than last year exclusive of net sales. This year we sold $243,000 worth of debt compared to $850,000 worth in the second quarter of 2007. Our loss experience was within typical second quarter seasonal range and expectations and consistent with prior year experience.

Even in a challenging environment, our collections process has proven itself as an effective blend of field and central collection efforts. We are pleased with the growth and performance of our central collections group as it supports our overall collection strategy.

Regarding regulatory activity, several new laws will impact the industry but not consumer demand for short-term credit.

In Virginia a new law will go into effect in January of 09 that reduces rates and limits customer usage. Virginia currently accounts for about 4% to 5% of QC’s revenue. While we are early in the development phase, we are excited about a new alternative product that will provide increased flexibility for Virginia consumers and therefore growth potential for QC.

In Ohio, the group Ohioans for Financial Freedom is mounting an effort to repeal House Bill 545 which would serve as a prohibition bill by instilling a 28% rate cap on short-term lending. The effort is currently in its signature gathering phase and is also working legally to ensure that the state’s constitutionally protected 90-day window to petition is afforded to the campaign.

In Arizona, the group Arizonans for Financial Reform already has on the November ballot an initiative that would create a new law that includes rate and term modifications while eliminating the 2010 sunset provision.

Both Ohio and Arizona efforts will include significant public education and awareness campaigns designed to help voters understand the industry and its business practices.

A few comments on the second half of 2008 before I turn the call over to Doug. We are certain the economic stimulus checks had a widespread impact on demand for short-term credit among our core customers. That impact has diminished as these checks have worked their way through the economy. Energy prices have also had a widespread impact on our consumer costs and spending. As energy prices stabilize, so too should consumer confidence, retail spending and demand for credit. With these factors minimized, the second half of 2008 will provide the opportunity for QC to get its loan balance back in line with historical averages. July and August have already shown signs of improvement and we anticipate stronger revenue growth through the second half of 2008.

Now I’d like to turn the call over to Doug for more detail on our first quarter financial performance.

Douglas E. Nickerson

I’ll be spending some time discussing in more detail the quarterly financial results.

For those following along on the web, we are now on Slide 9 which is our income statement for the second quarter. There are several items on which I will comment for the quarter, starting with revenues. Our revenue grew 5.1% to $53.4 million for the three months ended June 30, 2008 from $50.9 million in prior quarter. This growth was attributable to our payday installment loan product which is now being offered in Illinois and New Mexico. Payday revenue represented a little over 80% of the total revenue for the quarter, down from about 86% in prior year. Note that the bulk of our revenues from New Mexico were payday last year and our installment this year accounting for much of the growth in installment this year. As a final general comment on revenues, even though the tax stimulus checks certainly had an impact on our revenue this quarter customer demand continues to be strong.

With respect to branch expenses, operating expenses were approximately $1.9 million higher than prior year second quarter. This increase includes higher compensation associated with branch maturation whereby branches achieve a certain number of loans at which another part or full-time customer service rep is needed. In addition occupancy costs were higher quarter-to-quarter. And lastly on operating expenses, the current year period includes cost of sales on vehicles in our buy here, pay here group which are all new this year compared to last year as we didn’t have the operation then.

Darrin shared some details about our loan loss experience during the period noting that our loss ratio improved over last year’s second quarter. The 27.5% loss ratio is within our typical seasonal second quarter range and as a reminder, we received about $850,000 from the sale of older debt in the second quarter of 07 versus just $243,000 this year.

Branch gross profit improved slightly over second quarter 07 reaching $14.9 million. Gross profit from our comparable branches improved $1.2 million reaching $15.3 million for the six month period. This improvement reflects increases in the majority of our states partially offset by reduced profit in New Mexico as we transition our customers to the installment product. We’re only about six or seven months into this transition so there’s still some work on the learning curve for our customers and for the New Mexico branches.

Moving to below the line, regional and corporate expenses were up about $1.2 million and that’s primarily due to governmental affairs spending in the second quarter for the reasons Darrin discussed earlier. This additional new spend had about a $0.03 effect during the second quarter alone.

As we mentioned in our earnings release it is likely that we will incur between $750,000 and $1 million of costs during the second half of the year associated with regulatory initiatives and that spend will be above and beyond our normal amounts for these types of issues. Obviously where we end up with respect to these additional expenditures will be impacted by the progress on the various company and industry legislative initiatives, and all of those of course are real-time decision making.

One of the big differences between last year and this year is interest expense. The nearly $1 million increase quarter-to-quarter which is about $0.03 per share is attributable to the indebtedness utilized to fund the special dividend in December of 07. Obviously such a difference will continue throughout the year.

Finally on this slide, diluted earnings per share from continuing operations was $0.12 versus $0.16 last year. If we were to exclude branch closing costs in prior year second quarter associated with the Oregon closings, earnings per share for second quarter 07 would have been $0.18.

Moving now to year-to-date information, our revenue grew 8.4% to $107.3 million. Our payday loan volumes reached $621 million for the six months and our company average loan fee for the year is $16.86 per $100. With respect to branch expenses, prior year’s numbers include approximately $1.6 million related to branch closing costs. If you were to pull those costs out, operating expenses increased $2.7 million period-to-period for those same reasons I discussed in the quarterly discussion, and that is compensation, occupancy and automobile cost of sales.

Our loss ratio was 22% versus 20.5% last year. Pulling the debt sales out for each period the loss ratio was essentially the same. We had $1.8 million in debt sales last year versus the $243,000 this year. The debt sales market continues to be tough as credit card debt rolls in and the buyers prefer that to ours. One last comment on losses, our returned item and collection rates are very similar period-to-period with returns around 45% of revenues and collections about 50% of returns.

With respect to our administrative, regional and corporate expenses costs were up about $2.2 million primarily due to governmental affairs as noted before but also to compensation to accommodate inflation gains. Interest expense was up about $2 million period-to-period. That’s about $0.06 or $0.07 per diluted share.

Diluted earnings per share from continuing operations was $0.41 about $0.07 more than last year. If you pulled out the branch closing costs and prior year earnings per share for the six months ended June 30, 2007 would have been $0.45.

And finally, adjusted EBITDA is consistent period-to-period totaling $19.9 million through six months for each six month period.

With respect to the balance sheet which is Slide 11, we finished the quarter with about $17.7 million in cash. Loans receivable were down about 10% from year-end balances reaching $65.5 million as of June 30, 2008. This decline compares to prior year June receivables that were about 95% of 12/31/06 balances. This difference is likely attributable to the tax stimulus check impact.

On the liability side, we have total borrowings of $66.2 million at the end of the quarter compared to $74.5 million at year end. Our level of debt reflects our capital allocation choices throughout the year which has included stock repurchases, dividends, branch investment, debt repayment and new product development.

As of June 30, 2008 we had total stockholders’ equity of $48 million. During the six months we repurchased about 1.3 million shares of our stock for $11 million. We still have about 10 million left under our 60 million authorized repurchase program.

Moving now to the revenue by branch vintage slide, I’ll draw your attention to the percent change column where we have some nice points. Our pre-1999 group is down 6.4%. Basically that’s indicative of the challenges of managing through macroeconomic issues at a very established branch. Our 1999 through 2002 groups reflect modest gains which is a positive given the environment that we’ve talked about during these first six months. Growth in the branches added in 2004 and thereafter experienced double-digit growth.

And just as an additional comment, our 2005 group of branches average about three years of age right now and that group can be kind of thought of as a typical mature level branch. The 2004, 2005 and 2006 branches continue to march to the $30,000 per branch per month bogey we see with some of the older branches.

At the bottom of the slide, you may note that closed branches contributed about $2.4 million in revenues in 2007 none of which obviously repeats this year. The bulk of the 2008 total in that line item relates to revenue from our buy here, pay here locations.

As we have discussed previously we expect revenue growth this year between 5% and 10%. Based on the lower receivable level as of June 30, we’ll have some work to do to reach the high end of that range but we are hopeful that our various development initiatives will help boost growth during the second half of 2008.

Now with respect to profitability by branch vintage our more mature branches, and that is our pre-2004 branches, experienced gross margins ranging from 37% to 48%. The 2004 branches are moving to the historical margin as are the 50 acquired 2006 branches. We still have some work in the 2005 group which provides nice upside as these branches gain efficiency.

With respect to gross profit by branch our more established branches generated in excess of $15,000 per branch per month in gross profit. The newer branches continue to charge to this $15,000 target.

With respect to loss ratios over on the right side of the slide, most vintages reflected a typical six month rate. A couple of items of note here. First, the 2000 group of branches is higher than would be expected and this is attributable to the new installment product in New Mexico. As our customers and employees become more acquainted with the product the loss experience will improve but during the initial transition months, much like our experience in Illinois, we will have these higher losses. The second item of note is the 2005 group of branches where our loss ratio is narrowing to a typical mature-type branch. All in, we had gross profit of $36.2 million which is a gross margin of 33.7%. With a strong second half in store for us we look forward to seeing our gross margin continue to climb over time.

That concludes our prepared comments, and I believe we are ready to open the discussion to questions.

Question-and-Answer Session


(Operator Instructions) Our first question comes from Dennis Telzrow - Stephens, Inc.

Dennis Telzrow - Stephens, Inc.

You closed 13 stores in Ohio but kept roughly 20 or a little less than that open. What was the decision in closing some and leaving some open? Is that just performance based?

Darrin J. Andersen

We closed 13 and we’ve got 19 left open. The thought was that this new law really makes it unprofitable for us to operate in the state. So we were going to close roughly half of them now and keep the remainder open in hopes that either the repeal works or some alternative product is created in the state and can keep those stores open. If neither of those things happens, we’ll end up closing the remainder of the stores in the state.

Dennis Telzrow - Stephens, Inc.

In Virginia you talked about alternative product. Any concerns that that just gets the opposition up in arms and that you’re skirting the new law so to speak?

Darrin J. Andersen

Certainly that’s a possibility that they just don’t want our customers to have any options for short-term credit. But the new laws or the new products are going to be certainly somewhat different depending on who’s going to be there. I think there are going to be many more variances to products that are offered in the state than there were under the payday law. With the payday law most people charged similar rates and had similar terms. I think with the alternative product there’s going to be a lot more variation in rates, in terms, in structure and things. So I think that will take a while to see how that plays out over time. It would seem like the other side would recognize some of the advantages there of competition and things, but it’s hard to say what they’ll do.


Our next question comes from Daniel O’Sullivan - Utendahl Capital Partners LP.

Daniel O’Sullivan - Utendahl Capital Partners LP

Doug, can you give us the revenue number for the 05 branches last year in the second quarter?

Douglas E. Nickerson

Give me a couple seconds to get that for you.

Daniel O’Sullivan - Utendahl Capital Partners LP

And Darrin, on the alternative product in Virginia, did you give a timeframe when you’re going to roll that out?

Darrin J. Andersen

I didn’t talk about a timeframe but the new law takes effect in the first of January in 09. We would like to have that new product well in place for that transition. So we anticipate testing it in a few stores in the next several months and then be prepared to move it into all of our stores the first of the year.

Daniel O’Sullivan - Utendahl Capital Partners LP

Doing what? A repeat of Illinois from a couple years ago where you didn’t have the product already rolled out and it took some time to get that out there?

Darrin J. Andersen

We’re not going to be behind the rest of the market in Virginia like we were in Illinois a couple years ago. We’ll be offering a new product the same time everybody else is in the state to the best of my knowledge.

Daniel O’Sullivan - Utendahl Capital Partners LP

Taking a look at growth, is there anything in the hopper, even buy here, pay here or small niche acquisitions in payday or other consumer lending type of operations you guys are - Is there a priority beginning in acquisitions over the next six to nine months do you think?

Darrin J. Andersen

Good question. Certainly our branch growth has slowed and certainly some of the revenue growth has slowed in our existing stores. So we have spent more time and effort on trying to identify additional products to offer through our stores as well as similar businesses. You touched on one of them, buy here, pay here, that we’re looking at.

As far as through our stores we’ve got debit cards at all of our stores that we can. We’re looking at miscellaneous products and when I say that it’s maybe a couple hundred bucks a store of potential incremental revenue there. We’re spending more time on installment loans. We’re pleased with installment loans where they’ve taken the place of payday loans primarily Illinois and New Mexico. We’ll look to roll them into other states here in the next couple of months to test at how they complement payday loans, not replace them. And we’re looking forward to that.

But the thing that we’re probably the most excited about right now is the buy here, pay here piece. We’ve got two lots open in Kansas City. We look to open a third lot by the end of the year. We’ve been pleased with the progress of those lots and that business, and look forward to seeing that continue to grow. We feel like we’re taking a very disciplined approach to that in an effort to not grow too fast, trying not to let that blow up on us.

We feel like the losses have been certainly within lines of where we thought. The acquisition of the car business has gotten a little tougher in this environment than where it has been but generally we’re pleased with that business and where it’s headed. And that could have reasonably good growth next year assuming it continues on the same path it is right now.

Douglas E. Nickerson

Dan, I have those numbers for you. Last year the 05 branches did between $9.4 million and $9.5 million for the second quarter. And they were about $10.8 million this year.

Daniel O’Sullivan - Utendahl Capital Partners LP

I have a bigger number I guess because there are some discontinued stuff or something?

Douglas E. Nickerson

Yes. Some of those that were previously in 05.

Daniel O’Sullivan - Utendahl Capital Partners LP

Darrin just to talk a little more to those points you were mentioned, it’s only the middle of 08 but can you give us a sense of next year for de novo growth at all in your payday stores and maybe a sense of what you’re kicking around what you might open up in buy here, pay here next year in 09?

Darrin J. Andersen

Certainly a good point on it is just middle of 08 right now and we’ve got to get through the rest of this year and see where the payday environment rolls out post-election and some of the regulatory stuff. But I would not anticipate that our branch growth for payday would be much greater than it is this year which is going to be less than 20 new stores. Again, as we get through the rest of the year we’ll update you on that. From the buy here, pay here perspective again we’re pretty early into this product. We’re going to open up this third store by the end of the year but if that moves as planned, we could look for maybe another four to 10 next year on top of those stores depending on how they do.

Daniel O’Sullivan - Utendahl Capital Partners LP

The store that you’ve opened up already, what’s the cap ex not including inventory to open up something like that?

Douglas E. Nickerson

It doesn’t take a whole bunch to open it up Dan. It’s really not much different than a payday store. What costs are the cars. Depending on what your average cost of your car’s going to be and in our case it’s going to be somewhere between four and five right now, it just depends on how many cars you think you’re going to have on that lot and what your day’s turn you’re expecting and all that. And that’s stuff frankly that we’re still learning. We’ve got a lot of benchmarks in the industry because the buy here, pay here industry has a nice association that provides details of what various folks are doing. But ultimately you’ve got to determine what you’re going to do with that and the challenge of buy here, pay here is you have to buy the cars and then you have the receivables that you collect over time. So the cash goes out up front of your actual collections.

Daniel O’Sullivan - Utendahl Capital Partners LP

Just to talk more to the investing more in the business. You guys took on the depth of the dividend last year; you paid a $0.10 dividend this quarter; you’re moving into the buy here, pay here and Doug as you just mentioned that’s more capital intensive. What do you guys think as far as capital structure, paying down some of that debt, maybe not paying a dividend, maybe not buying back stock and investing more in growing the buy here, pay here? What are your thoughts on all that?

Darrin J. Andersen

The Board has spent a good amount of time discussing capital allocation and where and how and what’s the best way to do that. We’ve kept our eyes open and looked pretty hard at some acquisitions over time. Right now we haven’t really seen anything that makes a lot of sense to buy, so the acquisition market’s fairly quiet for us. But as we’re looking at investing in the business, some of the new products through our existing stores, not a lot of capital requirements for that. Returning some cash to shareholders right now in this current tax environment is much better than it sounds like it may be in the future. With 15% capital gains and dividends, it seems likely that may go up in the future.

So I think as the Board has looked at some of the uses for cash right now, what the tax rate is, they’ve liked the idea of distributing some of the profits we’ve got through dividends. As that tax environment changes next year or as acquisitions become available or more valuable or as the buy here, pay here continues to perform or exceed expectations, that capital allocation may change. But right now we’re pleased with returning some value to shareholders through buy-backs and dividends.

Daniel O’Sullivan - Utendahl Capital Partners LP

One last one. Obviously you’ve seen your governmental spending go up. Can we anticipate that’s going to happen again next year? Should we from a modeling standpoint expect that there’s going to be more costs involved in defending the payday lending product next year?

Darrin J. Andersen

We’re going to continue to spend what we need to spend to defend the product and defend our customers’ access to choices and alternatives. I would not anticipate that spending going down next year from where it is or where it has been.


At this time I will pass the call over to Mr. Darrin Andersen for closing remarks.

Darrin J. Andersen

Again, thanks everybody for your interest and your time today. We appreciate that. As we said we’re pleased with the results from our core operations. We’re good in a challenging second quarter. Certainly several factors and our early indicators have us optimistic about our business in the second half of 2008. And we look forward to our third quarter call in November. Again, we appreciate your interest in QC and have a nice day.

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