Aaron's (AAN) John W. Robinson on Q2 2016 Results - Earnings Call Transcript

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Aaron's, Inc. (NYSE:AAN) Q2 2016 Earnings Call July 29, 2016 8:30 AM ET

Executives

Garet Hayes - Director-Public Relations

John W. Robinson - President, CEO & Non-Independent Director

Douglas A. Lindsay - President, Aaron’s Sales & Lease Ownership

Ryan Woodley - Chief Executive Officer, Progressive Leasing, Aaron's, Inc.

Steven A. Michaels - Chief Financial Officer and President of Strategic Operations

Analysts

Bradley B. Thomas - KeyBanc Capital Markets, Inc.

John Baugh - Stifel, Nicolaus & Co., Inc.

J. R. Bizzell - Stephens, Inc.

David Joseph Vargas - Raymond James & Associates, Inc.

David G. Magee - SunTrust Robinson Humphrey, Inc.

Operator

Good morning, and welcome to the Aaron's, Inc. Second Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. Please note, this event is being recorded.

Participating this morning are John Robinson, Aaron's CEO; Douglas Lindsay, President of Aaron's Sales & Lease Ownership; Steve Michaels, Aaron's CFO and President of Strategic Operations; and Ryan Woodley, CEO of Progressive Leasing.

At this time, I would like to introduce Garet Hayes, Director of Public Relations. You may proceed.

Garet Hayes - Director-Public Relations

Thank you and good morning, everyone. Welcome to our conference call to discuss Aaron's second quarter results issued today. All related material, including Form 8-K, are available on the company's Investor Relations website, investor.aarons.com, and this webcast will be archived for replay there as well.

Before the results are discussed, I would like to read the company's Safe Harbor statement. Except for historical information, the matters discussed today are forward-looking statements. As such, they involve a number of risks and uncertainties, which could cause actual results to differ materially from those predicted in Aaron's forward-looking statements. Please see our SEC filings for certain risks inherent in our business that may cause actual results to differ.

Forward-looking statements that may be discussed today include Aaron's and Progressive projected results for future periods, Aaron's strategy and other matters including those listed in the forward-looking statement disclaimer in our earnings press release published today. Listeners are cautioned not to place undue emphasis on forward-looking statements, and we undertake no obligation to update any such statements.

During this call, we will also be referring to certain non-GAAP financial measures, including adjusted EBITDA, non-GAAP EPS, and non-GAAP net earnings, which have been adjusted for certain items, which may affect the comparability of our performance with other companies. These non-GAAP measures are detailed in the reconciliation tables included with our earnings release.

I will now turn the call over to Aaron's CEO, John Robinson. John?

John W. Robinson - President, CEO & Non-Independent Director

Thanks, Garet. Good morning, everyone. Thank you for joining us today. We're pleased with our overall results in the second quarter. Revenues were $789 million, representing a 2.6% increase over the second quarter in 2015. The increase was driven by 16.7% year-over-year growth at Progressive, which now accounts for almost 40% of our consolidated revenues. We achieved top-line growth with an 11.2% adjusted EBITDA margins, which underscores our commitment to running a disciplined business.

Progressive had excellent financial performance in the quarter and generated double-digit, door, invoice, revenue and EBITDA growth. The business is benefiting from better execution across multiple areas. We're excited about our strong pipeline of new retail partners and are confident in the quality of Progressive's lease portfolio.

Core business results were mixed in the quarter. The business had positive trends in both comparable store revenues and write-offs, which continue to be areas of focus. However, revenues were pressured by lower beginning agreement balances, a soft demand environment, and reduced promotional activity during the quarter.

As we noted in our press release this morning, we're taking action to realign our expense structure and right-size our store base. I'm confident we have the right team to improve the core business. I'm also pleased we completed the sale of HomeSmart, which will enable our team to focus on activities that have the highest potential for return.

Moving to the balance sheet, we reduced our debt by another $25 million in the second quarter and ended the quarter with $242 million in cash. Our net debt to capitalization was 13% at the end of the quarter, down from 30% to end 2015. Our strong financial profile leaves us well-positioned to fund growth, as well as invest in other strategic priorities.

With that, I'll turn the call over to Douglas Lindsay to discuss the core business. Douglas?

Douglas A. Lindsay - President, Aaron’s Sales & Lease Ownership

Thanks, John. Total revenues for the quarter were $485 million, down 5.4% due to a 3.6% decline in lease revenues and fees, a reduction in store count, and a 14% drop in non-retail sales. The drop in non-retail sales was primarily due to the reduction of franchised store count. Our franchisees had positive comps in the second quarter, and reduced inventory levels per store. Comparable store revenues for company stores improved on both the sequential and year-over-year basis.

In the quarter, same-store revenues were down 1.2% and down 0.3%, excluding Texas. This marks the fourth consecutive quarter of same-store revenue improvements. Texas had a pronounced negative impact on our comparable store trends in the second half of 2015. And we're pleased to see improvement in both our Texas and non-Texas stores in the second quarter. Customer counts were down slightly on a same-store basis and flat, excluding Texas. EBITDA for the core business was $46.5 million for the second quarter.

As a percent of revenues, adjusted EBITDA was 9.8% versus 10.5% in the second quarter of last year, primarily due to deleverage of the expense structure. Merchandise write-offs were 3.7% versus 3.6% in a year-ago quarter, reducing the year-over-year GAAP we've experienced in the last several quarters.

While I'm pleased with our improvements in same-store revenues and write-offs during the quarter, we have a great deal of work to do to get the business where it needs to be. Given our revenue pressure, we're moving to achieve greater efficiency in our expense structure, including a full review of our store base. As we focus on driving profitable growth, we are concentrating our efforts on a couple areas of particular emphasis.

One of our near-term goals is to identify and reduce performance variability across the company. This is all about improving execution and operating consistency. We're narrowing our organizational focus to concentrate on those activities that can make the most impact. We're simplifying our goals, streamlining communications, and building better analytics to capitalize on opportunities within our business.

Additionally, we've realigned our teams to strengthen coordination between the store support centers, stores and our e-commerce organizations. We're focused on prioritizing lower cost, higher-margin initiatives, where the execution is immediately within our control. We're taking a more analytic approach to our marketing and merchandising efforts, that should ultimately benefit our customer acquisition and pricing initiatives.

Our goal is to more effectively attract, convert and service new customers, strengthen our relationship with the existing customers, and reengage with our lapsed customers. I'm optimistic that with the right attention and effort, we can deliver improved results.

I'll now turn the call over to Ryan, for an update on Progressive.

Ryan Woodley - Chief Executive Officer, Progressive Leasing, Aaron's, Inc.

Thanks, Douglas. Progressive had an outstanding second quarter. Among other positive metrics, invoice growth accelerated in the quarter, up 14.3% versus 10.9% in Q1 of this year. That's a very positive sign for the business as we continue to harvest our pipeline on new and existing doors. Strong invoice growth, in turn, drove strong revenue growth, which was up 17% versus the year-ago quarter to $299 million.

Growth in active doors accelerated for the third consecutive quarter, up 19% versus the second quarter of 2015. We ended the second quarter with approximately 13,900 active doors. We achieved door growth in each of our retailer verticals. These new doors put natural pressure on average invoice volume per door for the quarter, which was down 3.6% compared with the same quarter last year.

Recall that new door activity drives invoice volume, which, in turn, drives revenue and EBITDA growth. EBITDA increased 16% in the second quarter to $42 million. Our EBITDA margin was 14% of revenues, comparable with the year-ago period. We're very happy with that performance. We've remained price-disciplined, and the team has done an extraordinary amount of work over the last year to tighten execution across our various functions. And as the financials demonstrate, those efforts are paying off.

Merchandise write-offs were down 160 basis points versus the year-ago quarter, and down 90 basis points year-to-date. Bad debt expense was 9.5% of revenue versus 9.8% in the second quarter of 2015. This is the second consecutive quarter of year-over-year improvement in these metrics.

In previous calls, we've discussed the fact that we have an ongoing pilot in approximately 100 Walmart stores. We've been pleased with the executions of pilot and the results to-date. They've met or exceeded the expectations we established for the program. And we were honored to be awarded Emerging Vendor of the Year by Walmart at their Annual Services Conference.

Unfortunately, Walmart has decided not to pursue the pilot further at this time. As evidenced by the award, we've built a great partnership with the team there and hope to continue to build on that relationship and revisit the opportunity in the future.

As our existing retailer base and the acceleration in door growth indicates, we've been successful in onboarding thousands of large and small retailers. Q2 was another exceptional quarter of strong additions to the pipeline, as well as rollouts of national and regional retailers. I'm excited about the door growth we delivered in the quarter, the opportunity remaining in our existing pipeline and the market potential that exists beyond the conversations we're having today. Based on the strong performance of the lease portfolio and pipeline conversion year-to-date, we've raised our outlook for 2016.

I'll now turn it over to Steve to discuss e-commerce and the financial details. Steve?

Steven A. Michaels - Chief Financial Officer and President of Strategic Operations

Thanks, Ryan. E-commerce, as a percent of lease revenues, was 4% in Q2 versus 3.6% in Q1. We're pleased with the channel and we remain on track to reach a mid-single digit contribution to lease revenues in 2016. We continue to acquire new customers through this channel and we're working hard to provide a seamless lease-to-own experience.

Now, I'll turn to the financial details for the second quarter and six months. Revenues for the second quarter and six months of 2016 were $789.4 million and $1.644 billion, up 2.6% and 3.3% respectively over the same periods a year ago. The increase was driven by Progressive revenues, which were up 16.7% and 19.2% respectively over the second quarter and six months of 2015. Net earnings for the second quarter were $38.5 million versus $40.5 million a year ago. Net earnings for the six months were $88.2 million versus $89.8 million in the prior year.

Net earnings for the three-months and six-month periods include a loss of $2.3 million and $5.2 million respectively for Dent-A-Med, which was acquired in October 2015. Dent-A-Med has performed in line with our expectations in 2016. Net earnings for the second quarter, on a non-GAAP basis, were $43.3 million, compared to $44.7 million for the same period in 2015. Net earnings for the six months, on a non-GAAP basis, were $95.3 million, compared with $98.1 million for the same period in 2015.

Earnings per share, assuming dilution for the second quarter of 2016, were $0.53, compared with $0.56 for the same period a year ago. And earnings per share, assuming dilution for the six months ended June 30, were $1.20, compared with a $1.23. Diluted EPS, on a non-GAAP basis for the second quarter, was $0.59 in 2016 and $0.61 in 2015. Diluted EPS, on a non-GAAP basis for the six months, was $1.30 in 2016 and $1.35 in 2015.

The year-over-year decline is due to the inclusion of Dent-A-Med's results in 2016. Non-GAAP net earnings and diluted earnings per share in 2016, exclude the effect of amortization expense from the acquisition of Progressive, a gain on the sale of the company's headquarters building, retirement and severance charges, and impairment charge related to the HomeSmart asset sale. In 2015, non-GAAP results exclude the effects of Progressive amortization. The sale of the assets of our HomeSmart division was completed in the second quarter. We've recognized an additional charge of $1 million and received $35 million in cash during the quarter.

Adjusted EBITDA for the company, which excludes all the special charges and adjustments just mentioned, was $88.2 million for the second quarter of this year, compared to $89.8 million for the same period last year. Adjusted EBITDA for the six months was $192.2 million versus $193.5 million a year ago. At June 30, 2016, the company had $242 million of cash on hand, compared to $15 million of cash at the end of 2015. Cash generated was a result of cash flow from operations, as well as a $120-million tax refund received in February.

Our total debt was reduced $113 million during the six months. And at the end of June, we had new outstanding balance on our $225-million revolving credit facility. Consolidated customer account increased 6% to 1,571,000 at June 30, 2016, up from 1,488,000 a year ago.

In our outlook, diluted earnings per share is presented both on a GAAP and on a non-GAAP basis, excluding Progressive related intangible amortization and any future one-time or unusual items. Adjusted EBITDA also excludes any future one-time or unusual items.

The company has updated its outlook for the 2016 year to reflect the sale of the assets of HomeSmart and current trends in the business.

The company currently expects to achieve the following: for the core business, total revenues of approximately $1.95 billion to $2.05 billion, compared with the previous outlook of $2.05 billion to $2.15 billion; lease revenues for 2016 in the range of $1.5 billion to $1.6 billion, compared with the previous outlook of $1.55 billion to $1.65 billion; quarterly same-store revenues of approximately negative 3% to flat for the remainder of 2016; adjusted EBITDA in the range of $195 million to $215 million, compared with the previous outlook of $210 million to $230 million. For the Progressive business, EBITDA in the range of $135 million to $145 million, compared with the previous outlook of $125 million to $135 million.

On the consolidated results, the outlook calls for revenues for 2016 in the range of $3.15 billion to $3.35 billion, compared with the previous outlook of $3.25 billion to $3.45 billion, this excludes the revenues of franchisees. Adjusted EBITDA in the range of $325 million to $355 million, compared with the previous outlook of $330 million to $360 million. GAAP diluted earnings per share in the range of $1.92 to $2.12, compared with the previous outlook of $2.03 to $2.23, and non-GAAP diluted earnings per share in the range of $2.13 to $2.33, compared with the previous outlook to $2.20 to $2.40.

The change in non-GAAP EPS outlook is comprised of $0.04 to $0.05 due to the EBITDA update and $0.02 to $0.03 related to changes in the tax rate estimates from the original outlook. The above outlook does not include the impact of any store consolidations or closures resulting from the review of our store base.

I'll now turn the call back over to John.

John W. Robinson - President, CEO & Non-Independent Director

Thanks, Steve. We're pleased to have achieved consolidated revenue growth with strong margins in the quarter. Progressive continues to deliver outstanding financial performance and growth on an increasingly large revenue base. The core business remains challenging, but I'm confident that we have the right leadership team in place to maximize EBITDA, while returning the core business to profitable growth. Lastly, our balance sheet is in great shape and continues to improve, which gives us a lot of flexibility to drive shareholder value.

As always, I want to thank all of our associates and franchisees in the Aaron's family for your efforts during the quarter. We appreciate your commitment to taking care of our customers and all you do to make Aaron's such a success.

Operator, if you could please now open the call for Q&A.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. The first question comes from Brad Thomas of KeyBanc. Please go ahead.

Bradley B. Thomas - KeyBanc Capital Markets, Inc.

Yeah. Hey. Good morning, guys, and thanks for taking the question.

John W. Robinson - President, CEO & Non-Independent Director

Sure. Good morning.

Bradley B. Thomas - KeyBanc Capital Markets, Inc.

I wanted to first ask about Progressive and the average invoice volume per door. Ryan, I think you talked about that coming down as a result of newer doors that may be a different type of retailer that you're working with, and a younger door for you. But any more color around kind of average invoice per door, particularly as it relates to what your approval rates look like in legacy doors, and what your maybe initial open-to-buy approval level is for existing doors? Any color around those metrics would be helpful?

Ryan Woodley - Chief Executive Officer, Progressive Leasing, Aaron's, Inc.

You know that it's really those two factors that you mentioned off the bat. Number one, the introduction of a lot of new doors to the platform that haven't had a chance yet to ramp and productivity; and number two, a healthy shift in the mix. It really signals an evolution of the business into other verticals that have smaller tickets in addition to our historical strength in furniture and bedding. And so, those two factors, new doors and just a shift in the mix. Approval rates are in line and doing well. It's really those two factors.

Bradley B. Thomas - KeyBanc Capital Markets, Inc.

Great, thank you. And then a follow-up on the comment about Walmart. Certainly encouraging to hear how the pilot performed and the award that you got. Obviously disappointing to not have it rolled out more broadly. I guess as you all think about the opportunity with national accounts that clearly could be a so significant for the Progressive business, what are the biggest areas of pushback, given the strong performance of the pilots? And how can you better-overcome those pushback with future opportunities?

Ryan Woodley - Chief Executive Officer, Progressive Leasing, Aaron's, Inc.

Great question. As you know, we've fortunately been successful in launching very large retailers in the past. We continued to see that success in Q2 of this year with the ongoing rollouts of some national retailers, which you saw driving door growth in the quarter. And we have more of those in our pipeline and there are those not yet in our pipeline that we hope to add in the future. I think, maybe the best way to generalize the way that conversation progresses is, an evolution on understanding the value proposition. And really just an ordering of priorities within the retailer.

Ultimately it comes down to where this project stacks up against other internal priorities at that retailer. But obviously we continue to believe that there's a tremendous opportunity for all retailers to provide this offering to credit-challenged folks who would love to shop in their stores but are currently unable to transact.

Bradley B. Thomas - KeyBanc Capital Markets, Inc.

Great. Thanks so much, Ryan.

Operator

The next question comes from John Baugh of Stifel. Please go ahead.

John Baugh - Stifel, Nicolaus & Co., Inc.

Thank you, good morning, John, Douglas, Ryan, Steve. Several questions. First can you, maybe Steve, just tell us in the back-half, by selling HomeSmart, what is the impact of revenue in the EBIT or EBITDA year over year for the back half?

Steven A. Michaels - Chief Financial Officer and President of Strategic Operations

Yeah. On the outlook side, we didn't really spell it out by segment. But as you know, we are thinking about flattish performance for HomeSmart versus 2015, and we owned it for five-and-a-half months – or, I'm sorry, four-and-a-half months of the year. And as you know, some of the revenue comes in that first quarter. So, it's similar to what the impact for 2015 would have been taking it out midway through the year.

John Baugh - Stifel, Nicolaus & Co., Inc.

Okay, super. And then maybe, Ryan, I saw on Progressive, the write-off, and that you mentioned the provision. What else – I presume there were other things that drove the margin strength within that unit. Or was that it?

Ryan Woodley - Chief Executive Officer, Progressive Leasing, Aaron's, Inc.

Good question, John. The biggest drivers were the improvement in write-offs and bad debt expense that you called out. It's really just systematic enhancements to the decisioning process. Our team there is doing a phenomenal job. And then through to the Op side of the business, the collection team is also doing a phenomenal job. Both of those are generating really strong lease portfolio performance, which kind of bleeds through the P&L. And obviously, that improvement in the quality of the lease portfolio results in a reduction in the impairment reserve, which is a component of those metrics. So, just good performance across the board that's resulting in strong lease portfolio performance.

John Baugh - Stifel, Nicolaus & Co., Inc.

Hey, are you now lapping, I don't know, infrastructure growth and started to leverage some of that? Or how do we think about that item going forward?

Ryan Woodley - Chief Executive Officer, Progressive Leasing, Aaron's, Inc.

Relative to last year, we're still investing in people and systems to support current and future growth, and I expect to continue to do that.

John Baugh - Stifel, Nicolaus & Co., Inc.

Okay. Steve, I think I missed it; you gave out some customer numbers. Did you give out corporate core and franchise customer accounts?

Steven A. Michaels - Chief Financial Officer and President of Strategic Operations

No. We gave the consolidated customer number of 1.571 million, up 6%. I don't have the segment customers in front of us, but we've given that in the past, so I'm happy to do that on a follow-up.

John Baugh - Stifel, Nicolaus & Co., Inc.

Okay. I will follow-up on that. And then, I'm sorry, what were the e-commerce comments again quickly?

Steven A. Michaels - Chief Financial Officer and President of Strategic Operations

Yes. So, e-comm represented 4% of lease revenues in the quarter, up sequentially from Q1 from 3.6% obviously; and Q2 of last year it was de minimis. And we continue to tweak and adjust the offer to improve it online and to help continue to partner driving customers and business into the stores through the e-comm channel.

John Baugh - Stifel, Nicolaus & Co., Inc.

Is there any cannibalization going on there? Are you able to look at that customer that's coming in and delineate from store traffic?

Steven A. Michaels - Chief Financial Officer and President of Strategic Operations

Yes. So we've said on numerous calls and it continues to be the case that about 60% of the e-comm activity is from customers who are new to Aaron's, never done business with Aaron's before. And then the remaining 40% is split between previous and existing with about 10% of the customers being existing Aaron's customers and the balance, the other 30%, being previous customers.

The interesting thing about the previous customers is it's really weighted to a large period of inactivity. So about half of those haven't done business with us in over two years. So they're coming back to Aaron's through the e-comm channel. So clearly, there's a little bit of overlap, but we're excited about the idea to expand the trade area.

John Baugh - Stifel, Nicolaus & Co., Inc.

Great. And I guess, my last question for Douglas or John, on the core in the stores. You referenced you are going to look at expense structures. Any additional thoughts there, in light of the trends there? And were there trends in the quarter – through the quarter and/or into July – that have weakened incrementally? Or is it kind of stable, just at a lower rate? Thank you.

Douglas A. Lindsay - President, Aaron’s Sales & Lease Ownership

Yeah. This is Douglas. I'll just comment on that. Your segment question first. I think what we've seen is an improvement in our rate of decline. So, we're still low single-digits negative, but we're seeing stabilizing in that number, which is good. In terms of the deleverage on the expense structure, we're continuing to look at that, but we're looking at it across the organization. So, it's not just store costs that we're looking to get more efficient in. It's also our regional structure and throughout our store support centers. So, we'll continue to look at that and assess it, as well as our footprints and each of the markets we're in.

John Baugh - Stifel, Nicolaus & Co., Inc.

Thanks for answering my questions. Good luck.

John W. Robinson - President, CEO & Non-Independent Director

Thanks, John.

Operator

The next question comes from J. R. Bizzell of Stephens, Inc. Please go ahead.

J. R. Bizzell - Stephens, Inc.

Hi. Good morning, guys, and thanks for taking my questions. Maybe Ryan, first one for you. I know you spoke to kind of partnership updates a little bit. Maybe give us an idea of national retail partners that I know you all onboarded in 4Q, and in 1Q continued that. And maybe just an update on – I know you spoke to other wins being in the pipeline. Just wondering if those were in test phase? Are they about to start testing, or have you been in there for a while?

Ryan Woodley - Chief Executive Officer, Progressive Leasing, Aaron's, Inc.

Good question, J. R. I think we're just limited to saying that we're really happy with where the pipeline sits today. We've definitely seen an uptick in conversations across the board over the last 6 months to 12 months as more national retailers become aware of the offerings, they proposition for their customers. And that's in step with ongoing positive dialogue with regional retailer. The door growth that you saw in – well, Q4, Q1 and Q2 is really representative of a pretty broad base of growth across both those buckets, regional and national retailers.

J. R. Bizzell - Stephens, Inc.

Great. And staying with Progressive, but thinking about the losses and the debt – sorry, the bad debt expense. It continues to improve, like you said, the second straight quarter of improvement year over year. And just wondering if you could kind of help us think about what's really driving that? I know you spoke to collection team really outperforming. But also, I know you now have the ability to go collect that item, something you didn't have a couple of years ago. Just wondering where you are in that process, how you're thinking about losses on a go-forward basis, and where you think improvement or stabilization can come from on a go-forward basis?

Ryan Woodley - Chief Executive Officer, Progressive Leasing, Aaron's, Inc.

Yeah. Great point. When I referenced earlier the excellent performance from our operations and collections team, certainly included in that would be the performance of the customer service hubs which we have across the country. We're now at 22 hubs, and those teams are performing well and that's providing a nice lift in our write-off performance that we're benefiting from year-over-year. So, the teams have done a great job.

And as you know, that has to start with underwriting. So, our decisioning teams are doing a great job, getting us started on the right track with good decisioning upfront, good decisions upfront on the applications that we're collecting. And that flows through the execution towards the tail end with the operations team. They're all doing a phenomenal job.

J. R. Bizzell - Stephens, Inc.

Great. And then last one for me, and switching to the core a little bit. Could you give us an update on HomeSmart phones, what you're seeing there, how you're thinking about that in the back half of the year and as we move forward?

John W. Robinson - President, CEO & Non-Independent Director

Yeah. Sure. So, as you know, we launched our national partnership with Cricket in June. The launch was a success, we continued to see penetration into our store base and delivery is increasing in that category. We're continuing to monitor it. I think the most important thing is we're being tight with our inventories and not trying to overbuy in the category and make sure that we're selling through what we have and understanding the real profit margins in the category. So, it's early in the Cricket relationship, but we've had good adoption, and we will continue to monitor the category. I think in terms of the rest of the year, it should be accretive to our same-store sales, but it's too early to say really how big that number might be.

J. R. Bizzell - Stephens, Inc.

Could you give us a number of what it was, and the percentage of revenue? Or was it even measurable in 2Q?

Ryan Woodley - Chief Executive Officer, Progressive Leasing, Aaron's, Inc.

Yeah. J. R., it was in the – between 50 basis points and 80 basis points in Q2, pretty small.

J. R. Bizzell - Stephens, Inc.

Great. Thanks for the detail. And thanks for taking my questions.

Operator

The next question comes from Budd Bugatch of Raymond James. Please go ahead.

David Joseph Vargas - Raymond James & Associates, Inc.

Good morning, this is David on for Budd. Thank you very much for taking my question. I was hoping in the Progressive channel, within the pipeline specifically, if you could talk about maybe the kind of retailers that are in the pipeline – size? And is the product offering different from the current makeup of Progressive?

Ryan Woodley - Chief Executive Officer, Progressive Leasing, Aaron's, Inc.

Good question. Ryan here. So, you would see in the pipeline examples of retailers that currently exist within our base of approximately 14,000 active doors. And as you know across that, while we have historical strength in our core furniture and bedding, within the last couple of years has expanded outside of that to include verticals like mobile phones, electronics, jewelry, appliances. And you'd see all of that if you look in our pipeline today.

David Joseph Vargas - Raymond James & Associates, Inc.

Got it, okay, thanks. And anything changing in terms of underwriting standards within Progressive? I know that some of your competitors were talking about getting a little bit tighter and a little bit more focused on underwriting standards. Are you changing anything significantly quarter over quarter? And also could you comment on the competitive environment in virtual lease-to-own? I know there's been some smaller players getting into the business that may not have sustainable business models over the long term?

Ryan Woodley - Chief Executive Officer, Progressive Leasing, Aaron's, Inc.

Yeah. Sure thing. First on the decisioning. So, we invest a lot in folks to run our decisioning systems. We have teams of data scientists and statisticians who are doing a phenomenal job in that area of the business. Their mandate really is to generate consistent enhancements to that system. So there's not really a step function so much as it is continuing improvement in that area which we saw again in Q2. And like I said, the team is doing a great job there.

The confidence that we get in those results is that they're supported by consistently positive metrics across the business. If you look at those origination statistics, but flow that through the rest of the business to look at early indicators of lease pool performance, delinquencies on down the line, operations on our customer service hubs, which we referenced earlier. Our estimates of mature pool performance, they all support the same positive message about the quality of the lease pool that we're currently managing. So the team is doing a great job there, very confident in their execution.

On competition, I think I'd say it remains pretty consistent with what we've seen in the recent quarters. For some time now, there have been several folks following on the lead to progress, I guess, on the virtual market and coming to market with similar business models. And that really hasn't changed in recent quarters. Our job and what I feel the team has executed well on is to remain very price-disciplined. And if you saw our average pricing over time, they would reflect that. As you know, the 90-day buyout option and the low customer pricing has been differentiating features of our offering since inception. So, we haven't really had to change that in response to competitive dynamics.

David Joseph Vargas - Raymond James & Associates, Inc.

Okay. Thanks. And then the last question on Progressive is really a point of clarification on Walmart. Are they stopping or taking Progressive out of the 100 stores, or is it just not expanding the pilot?

Ryan Woodley - Chief Executive Officer, Progressive Leasing, Aaron's, Inc.

Yeah. They've decided to discontinue the pilot.

David Joseph Vargas - Raymond James & Associates, Inc.

Okay. All right. So out of the stores. All right, and then just flipping over to the core briefly. Can you talk about the macro environment? It seems like with still-low fuel prices and some wage inflation at the low end, that the core may be doing – should be doing a little bit better. Can you just talk about what the puts and takes are there with the customer and the macro?

John W. Robinson - President, CEO & Non-Independent Director

Hey, this is John. I'll give it a shot and, Douglas, feel free to add. I mean, we get asked this question a lot. We've been answering it for the last couple of years as these macro changes have happened. But really, the one thing we've seen from a macro perspective in our numbers has been the impact of the oil price decline in Texas that happened really this quarter, starting in last year. And other than that, we really haven't seen a big change in our customer base. That certainly hurt us last year and we think that's improving from a number of perspectives now. But really that would be kind of a view on employment. So, employment in those areas, obviously, declined and that hurt us. But generally, we haven't seen other macro factors like lower fuel prices necessarily helping our customer, other macro factors hurting our customers.

David Joseph Vargas - Raymond James & Associates, Inc.

Okay. And any comments or guidance on what the store closures trajectory might be? And any specifics on what you are doing to reduce the operating variability in the core?

John W. Robinson - President, CEO & Non-Independent Director

Well, and I'll take that through – we're working on a thorough review of our entire expense structure, as Douglas mentioned earlier. So that process is underway. And we aren't prepared yet to give kind of numbers on that or in any regard. But we're certainly taking a hard look across the organization to make sure that we have the right cost structure given the demand environment that we've been facing.

Douglas A. Lindsay - President, Aaron’s Sales & Lease Ownership

And in terms of variability in performance, I mean that's something we're working on every day. We're really trying to focus our operations organization and tightening out variability and lessening the distribution of performance variance within the organization. We're also narrowing our focus on the goals that we're trying to achieve. There's lots of levers we can pull in the business and we're just trying to narrow the focus on those levers and drive lesser variability across our units.

John W. Robinson - President, CEO & Non-Independent Director

And if there's any positives in the fact that our performance – what Douglas just said is that there is variability. So, with better execution we should see improvement, and that's something that – that's the reason we brought Douglas in, and we think we can move the needle there. And as Douglas said, pull that lever plus other ones. So, we're optimistic about it, but we're – it's a difficult environment, so it takes some time.

David Joseph Vargas - Raymond James & Associates, Inc.

Okay. And one last clarification, and forgive me if you said it. Can you remind me what write-offs and bad debt expense were for both Progressive and the core?

Ryan Woodley - Chief Executive Officer, Progressive Leasing, Aaron's, Inc.

Sure. So, I'll go first on Progressive. So, in the second quarter, bad debt expense was 9.5% of revenue versus 9.8% the year prior, and write-offs were 4.5% of revenue versus 6.1% in the year prior.

Steven A. Michaels - Chief Financial Officer and President of Strategic Operations

And on the core, the write-offs were 3.7% versus 3.6% in the year prior, and there is not a bad debt metric in the core.

David Joseph Vargas - Raymond James & Associates, Inc.

All right. Thanks for taking my questions.

Steven A. Michaels - Chief Financial Officer and President of Strategic Operations

Thank you.

Operator

And we have a question from David Magee of SunTrust. Please go ahead.

David G. Magee - SunTrust Robinson Humphrey, Inc.

Yes. Hi. Good morning, everybody.

John W. Robinson - President, CEO & Non-Independent Director

Good morning.

Ryan Woodley - Chief Executive Officer, Progressive Leasing, Aaron's, Inc.

Good morning.

Douglas A. Lindsay - President, Aaron’s Sales & Lease Ownership

Good morning.

David G. Magee - SunTrust Robinson Humphrey, Inc.

Ryan, congratulations on the good momentum at Progressive.

Ryan Woodley - Chief Executive Officer, Progressive Leasing, Aaron's, Inc.

Thank you.

David G. Magee - SunTrust Robinson Humphrey, Inc.

So I hate to circle back to the Walmart pilot part, but I'm just curious, though, what learnings do you take from this? It seems to me that maybe the virtual RTO solution is maybe a little more difficult to pull off when you have a lower customer service environment. Is that a fair read of things?

Ryan Woodley - Chief Executive Officer, Progressive Leasing, Aaron's, Inc.

Obviously, you're getting my interpretation of the success of the pilot, but I think execution in the store was a bright spot. I think it was tremendously successful. And we evolved the product a bit to excel in that environment. And I think the team did a phenomenal job on execution there – both teams. We enjoyed a great working relationship with our counterparts at Walmart, and our team certainly did a phenomenal job, both in Salt Lake and in the field there in the pilot. It's certainly not a factor as far as we're concerned.

John W. Robinson - President, CEO & Non-Independent Director

One thing I would add to that, as Ryan mentioned, but we really did innovate our product because of the pilot, and I think it will serve us well with other retailers going forward and probably already has. And Walmart is a process-driven organization and that helped us improve. And those are dividends we'll be able to reap over the next few years, I believe.

David G. Magee - SunTrust Robinson Humphrey, Inc.

Do you think that this is something they can do themselves? Is that what they are thinking?

John W. Robinson - President, CEO & Non-Independent Director

We don't have a view on that. I think Walmart can – they're a big company, they could do a lot of things. I don't know if this would be an area of focus for them or not. I don't think that factor into it, but we don't have a lot of visibility into their full decision-making process. So, your guess is as good as ours on that.

David G. Magee - SunTrust Robinson Humphrey, Inc.

I see. On e-commerce, with the momentum there, it's obviously becoming more and more part of the overall business. How big you think that can get over the next couple of years? Do you expect the momentum to continue to be very strong through next year? And this is a business that can become closer to 10% of sales in core?

John W. Robinson - President, CEO & Non-Independent Director

Yeah. I mean we expect we're going to have to continue to innovate and evolve, just like the retail landscape is doing across all offerings. So, we expect they will grow. We want it to grow. We do truly look at it as an omni-channel approach, and that is what partnering with the stores. And so, it's just another avenue for our customers to get the product and then be serviced by our stores and our service network out there across the country. So, yeah, we've talked about a mid-single digit contributor in 2016, but we expect it to continue to grow in future years.

Douglas A. Lindsay - President, Aaron’s Sales & Lease Ownership

And David, that depends to some extent on kind of what our store footprint ends up looking like. So, over time, that's going to evolve as it is in another retailers. And I don't think we know enough about what that footprint is going to look like in conjunction with e-comm yet. So, it really is an evolution that we're trying to make and also do it profitably and smartly.

David G. Magee - SunTrust Robinson Humphrey, Inc.

Is that something that you're advertising aggressively right now? Or is that something you could do more of in the future?

Steven A. Michaels - Chief Financial Officer and President of Strategic Operations

So, I mean, we certainly tag our capabilities on e-comm via aarons.com in all of our advertising. We're doing a decent amount, an increased amount versus last year on digital spend as it relates to page search and display and social. But we don't have like a ramped up campaign right now on e-comm. We see every time, we just advertise generally, whether it be television or core campaigns, or even Addo (44:26), we can see the spikes on aarons.com traffic and we're working really hard to optimize conversion of those visits to aarons.com. So, that's a lever in the dial that we can test and learn and continue to get better at.

David G. Magee - SunTrust Robinson Humphrey, Inc.

Thanks, Steven. And just lastly, on the wage side, are you seeing much pressure right now in terms of wages in the stores?

Douglas A. Lindsay - President, Aaron’s Sales & Lease Ownership

Nothing material that we've seen. We're constantly looking at that and assessing our wage versus the market and what's going on out there. But nothing material to speak of.

David G. Magee - SunTrust Robinson Humphrey, Inc.

Great. Thanks, Doug. Good luck.

Douglas A. Lindsay - President, Aaron’s Sales & Lease Ownership

Thank you.

John W. Robinson - President, CEO & Non-Independent Director

Thank you, Dave.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to John Robinson, Aaron's CEO for any closing remarks.

John W. Robinson - President, CEO & Non-Independent Director

Thank you. And thank you for your participation on our earnings call today. We look forward to updating you on our next quarterly call. Thank you very much.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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