The Aaron's Company, Inc.
Q2 2015 Earnings Call Transcript

Published: 24 Jul 2015

[Operator:]

Good morning. Welcome to the Aaron's, Inc. Second Quarter 2015 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. Participating this morning are John Robinson, Aaron's CEO; Gil Danielson, Aaron's CFO; Steve Michaels, Aaron's President; 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:]

Thank you, and good morning, everyone. Welcome to our conference call to discuss the Aaron's second quarter results issued today. All related materials 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. These factors include matters such as changes in general economic conditions, competition, pricing, customer demand, legal and regulatory proceedings, customer privacy and informational security, risks related to the company's recent Progressive acquisition, risks related to its new strategy, and other issues, including those discussed in the company's SEC filings. Forward-looking statements that may be discussed today include Aaron's projected results for future periods, Aaron's new strategy, the future effects of the Progressive acquisition and other matters include as 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. I will now turn the call over to Aaron's CEO, John Robinson. John?

[John W. Robinson:]

Thank you, Garet. Good morning, everyone. Thanks for joining us today. We appreciate your interest in Aaron's. I'm pleased to report solid results for the second quarter of 2015. As you recall, Aaron's acquired Progressive Leasing on April 14 of last year. Results for the second quarter of 2014 include Progressive from that day. Against that backdrop, consolidated revenue and EBITDA increased 16% and 109%, respectively, in the quarter. Net earnings were $40.5 million, up significantly from last year's $8.5 million and diluted earnings per share were $0.56 versus $0.12 the previous year. On a non-GAAP basis, EPS increased 65% to $0.61 from $0.37. Our consolidated customer count was up 9% to $1.53 million which means we're reaching more customers than ever with our lease-to-own transactions. On many levels, the second quarter demonstrated the progress we are making and why I'm so excited about the future. The core business reported its second consecutive quarter of improved earnings. Progressive achieved solid top-line growth with a higher profit margin. We continue to make progress integrating the two businesses and are achieving greater efficiency across the organization. Our financial profile is strong. We ended the quarter with $91 million in cash and have reduced our debt by $111 million from the end of 2014. We are raising our EBITDA and EPS outlook for 2015 to reflect the success of our profitability initiatives in the core business and stronger trends in Progressive. Overall, we think Aaron's is well positioned to grow revenue and drive double-digit EBITDA growth for the next several years as we execute our plans. Steve, Ryan and Gil will discuss segment and financial details in a moment. But before that, I want to share some highlights and observations. Revenue in the core business remains challenging. Same-store revenues were below our expectations. Core profit margin in the quarter increased, driven by pricing and inventory and expense reduction initiatives. While we are pleased with our improvement in profitability, we're disappointed with our core revenue performance in the quarter, and we'll continue to focus on execution to improve top-line performance. As of June, e-commerce is operating in all the markets we serve, and the initial results are encouraging. Thus far, more than 60% of our e-commerce customers are new to Aaron's. Given the early success of the program, we'll continue to invest to grow the channel. Progressive continues to exceed our expectations. Revenues and margins improved significantly. Our product is clearly resonating, as evidenced by a significant increase in invoice dollars per active door and our robust pipeline for new retail partners. While we believe we have the industry-leading virtual lease-to-own solution in the market, we continue to invest in the people and technology to drive more innovation so that we can serve more customers and drive more revenues for our retail partners. I will now turn it over to Aaron's President, Steve Michaels, to talk in more detail about the core business. Steve?

[Steven A. Michaels:]

Thank you, John. As you mentioned, our core business earnings increased on a year-over-year basis, continuing the trend we reported in the first quarter of 2015. EBITDA was $53.8 million for the second quarter, up from $49.2 million last year, excluding last year's special charges. As a percentage of revenues, EBITDA margin improved 125 basis points to 10.5%. Overall, we're executing well on our profit initiatives. We're not satisfied with our top line progress, but are optimistic that our investments in e-commerce and pricing will deliver improvements. We'll continue to manage the business for EBITDA as these initiatives take hold. The gross profit margin increased 50 basis points in the quarter from a combination of inventory reductions and price increases. We've been working hard to optimize inventory, and as of the end of June, inventory not on lease was down 19% compared to June of 2014. We will continue to look for opportunities for inventory efficiencies in select product categories. Our cost reductions are also fully on track for 2015 and have enabled us to leverage operating expenses on a sluggish top line. Same-store revenues for the second quarter were slightly below plan, and write-offs were 3.6%, 70 basis points higher than the year-ago quarter. A portion of that was driven by closures of underperforming stores and the activity required to address accounts associated with these stores. We previously announced our intention to further optimize our store base in the first half of 2015. As of the time of this call, through a combination of store closings, refranchising and store swaps, we've consolidated 49 Aaron's corporate store locations. We expect to realize the operational efficiencies of these moves throughout the second half of 2015 and into 2016. Turning to our growth initiatives, we're excited about e-commerce and are optimistic about the results we're seeing from our price increases. We are currently able to transact online in all the U.S. markets we serve. We continue to be excited about the insights we are gaining from this channel and are learning daily how to adjust our offering to meet changing consumer preferences. As in our preliminary tests, we are continuing to find that the customers are choosing higher ticket items, and also appear to have better risk profiles. Since e-commerce is in the ramp-up phase, the benefits of its customer profile and performance are not fully reflected in Q2. We're hopeful the channel will start to contribute more meaningfully in the back half of 2015 and into 2016. We're pleased with the results from the price increases we implemented last year and the first part of 2015. It's early, given our lease cycle, but the initiative is driving higher average ticket that is beginning to show up in gross margin. We expect margin improvement to build over time as more leases reflect the new pricing. As we learn more about the smartphone category, we have decided to extend our pilot and delay our system-wide launch. Progressive has had success in the category for a number of years, and we are working on leveraging their decisioning technology to help ensure our success in the category. A launch is still a part of our plan, but is now more likely to be a 2016 event instead of the fall of 2015. We'll continue to test and analyze feedback from the pilot as we want to make sure our rollout is conducted in a disciplined fashion that helps us grow not only revenues but also profitability. While we're confident that the delay is the appropriate decision, it will impact our same-store revenue outlook for the second half of 2015. We anticipate sequentially improving quarterly trends, but most likely will not reach the negative 1% level we previously expected. That said, due to the profitability initiatives mentioned, we have raised our core EBITDA expectations. I'll now turn it over to Ryan for an update on Progressive Leasing. Ryan?

[Ryan Woodley:]

Thanks, Steve. During the second quarter, Progressive generated revenues of $256 million, up 71% over the year-ago quarter. At the end of June, Progressive had 473,000 customers, up 58% over the prior year. Growth continues to come from a diverse base and was driven by a strong increase in invoice volume per active door. Looking at the key components of revenue, second quarter invoice volume was $179 million, up 31% from the second quarter of 2014. Invoice volume is the dollar value of merchandize that we purchase from retailers and subsequently lease to consumers. Active doors, those with at least one Progressive transaction during the period, increased 3% in the quarter to 11,749. Invoice volume per active door rose 28% over the same period last year to 15,264. There are a couple of takeaways. First, growth in doors is based on the timing of retailers we're working with which introduces some variability to the metric. We continue to feel confident in the appeal of our offering and new retailers in our pipeline reflect this. Second, the growth in invoice volume per active door underscores that our product is getting better and that our process is working more efficiently at the doors we've onboarded. The combination of a robust pipeline and improving volume per active door makes us very confident in the growth outlook for the business. Second quarter EBITDA was $36 million or 14% of revenues. Slower growth in invoice volume drove that to some degree. As we said in the past, periods where we have slower growth in invoice volume generally come with a higher margin given more seasoned leases and fewer 90-day buyouts. We also benefited from increasing leverage on fixed operating expenses. Importantly, we're achieving strong rates of growth while maintaining consistent lease portfolio performance. Write-offs were 6.1%, a 10 basis point improvement over last year. The 17 customer service hubs that we finished launching in Q1 contributed to that, and we're encouraged by the results we're seeing there. I'll now turn it over to Gil, who'll give a more detailed overview of the combined financial results. Gil?

[Gilbert L. Danielson:]

Thanks, Ryan. Revenues for the second quarter were $769 million, up 16.1% over the $662.5 million for the second quarter of 2014. Revenues for the first six months were $1.591 billion compared to $1.248 billion last year, a 27.5% increase. Net earnings for the second quarter were $40.5 million versus $8.5 million a year ago. Diluted earnings per share were $0.56 compared to $0.12 last year. For the first half of the year, net earnings were $89.8 million compared to $46.8 million last year. Diluted earnings per share were $1.23 compared to $0.54 a year ago. Net earnings for the second quarter on a non-GAAP basis, which excludes amortization expense related to the Progressive acquisition and certain other special charges in 2014, were $44.7 million compared to $27.2 million for the same period in 2014. For the quarter, non-GAAP earnings per share, assuming dilution were $0.51 per share compared to $0.37 last year. For the first half, non-GAAP net earnings were $98.1 million compared to $66.7 million for the same period in 2014, up 47%, and diluted earnings per share were $1.35 compared to $0.92 a year ago. EBITDA for the company was up substantially in 2015 to $89.8 million for the second quarter compared to $43 million for the same period last year and $193.5 million for the six months of 2015 compared to $119.3 million for 2014 for the same period. Although revenues for both Aaron's sales on lease ownership and HomeSmart declined in the second quarter and first half compared to the previous-year periods, EBITDA for these components of the core business grew to $53.8 million for the quarter and $129.2 million for the six months ended June 30. As a percentage of total revenues, EBITDA was 10.5% for the second quarter and 11.9% for the first six months compared to 5.5% and 9.4% for the same periods a year ago. We are effectively managing the core business with cost and inventory reductions, which is resulting in positive cash flow generation and higher EBITDA levels. Same-store revenues in the second quarter for company-operated stores in the core business decreased 4.4% compared to the same period last year, and customer counts on a same-store basis for company-operated stores were down 3.7% in the second quarter compared to last year second quarter. Aaron's franchisees collectively had revenues of $237.1 million in the second quarter and $497.9 million for the first half of 2015, decreases of 2.3% and 3.1%, respectively, comparable to 2014 periods. Same-store revenues for the quarter for franchise stores decreased 1.6%, and customer counts were down 2.2%. Revenues, again and customers of franchisees are not revenues and customers of Aaron's, Inc. Progressive, once again, exceeded expectations with revenues of $255.9 million and $507.6 million for the quarter and first six months, respectively. EBITDA for the second quarter of this year was $36 million and $64.3 million for the first six months. EBITDA for Progressive as a percentage of revenues was 14% in the second quarter and 12.7% versus first half of the year. At the end of the second quarter, the company had $91.1 million of cash on hand compared to $3.5 million of cash at the end of 2014. Approximately $220 million in cash was generated from operations during the first half of the year. And at the end of June, no debt was outstanding under our $225 million revolving credit facility. We are increasing our previously announced full-year 2015 guidance to reflect strong results in the quarter. No change is being made in the previously published revenue guidance. For the core business, we now expect EBITDA in the range of $205 million to $220 million for the year compared with the previous guidance of $200 million to $220 million. For Progressive, we expect EBITDA in the range of $120 million to $130 million compared with the previous guidance of $105 million to $115 million. On a consolidated basis, we expect EBITDA for the year in the range of $325 million to $350 million, again, compared with the previous guidance of $305 million to $335 million. We are increasing our GAAP diluted earnings per share guidance for the year to a range of $1.92 to $2.12 and non-GAAP diluted earnings per share to a range of $2.15 to $2.35. These are the financial highlights for the quarter. I'll now turn the call back over to John.

[John W. Robinson:]

Thank you, Gil. We achieved a solid second quarter that highlights many of our strengths. I'd like to thank all of our associates in the Aaron's family. We appreciate your hard work and dedication to providing the best customer experience every day. I have great confidence in what we can accomplish together. Thank you for all of your efforts to make Aaron's such a success. We'll now turn it over to callers for questions.

[Operator:]

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

[Bradley B. Thomas:]

Thanks. Good morning, everyone, and congratulations on a great quarter here.

[John W. Robinson:]

Thanks, Brad.

[Bradley B. Thomas:]

I have a number of questions, but why don't I just focus in on comps in the core Aaron's business? I guess, first of all, could you give us some color on the price increases that you put into place and how you think those have affected comps?

[Steven A. Michaels:]

Yeah, Brad. This is Steve. So the price increases effectively – the 2015 set of – or the increase that we did really didn't take effect until April and throughout our Advo circulars and our advertising, as well as the in-store pricing, so obviously it's early in the – as it works through the portfolio of leases. And I'm not sure how – it had a small impact on top-line revenue in the second quarter. We definitely saw average revenue per agreement that was delivered. During the three months' period – tick up as we would expect to see. But, as far as working its way through the $1.5 million or so agreements that we have, it's a small impact.

[Bradley B. Thomas:]

Got you. And then, in terms of the customer count, when we look at the comp customer count down at 3.7%, that was better than the decline of the last two quarters. What are you seeing in terms of overall traffic and any change in interest in the product as a result of the price increases? Anything else on the traffic you could comment on would be helpful.

[Steven A. Michaels:]

Yeah. I mean, we're seeing some – so as the quarter progressed, April, I think mostly calendar-influenced, was soft compared to the previous year's April. And then, in what we call new customer deliveries for May and June, we're basically flat versus the previous year. So we expect to see some impact related to the price cards and the pricing in the stores, but it has not – like I said, as the quarter progressed, we saw – we are happy with the results.

[Bradley B. Thomas:]

Great. And then, just lastly on this topic, if I could ask about e-commerce and how the initial feedback from customers have been who have been able to get approval on the website.

[Steven A. Michaels:]

Yeah. We're very excited about the e-commerce initiatives and our ability to be fully transactional in all the markets that we serve. We're seeing some really good acceptance – June was actually the first time that we advertised the fact that we had a transactional website. We were on TV for the first 10 or 12 days of June with that message. And we're seeing – we saw huge site traffic related after that message went out and had a corresponding number of web agreements. As I mentioned, we're seeing a slightly younger customer, skewing a little bit more female. The average ticket is higher than the in-store agreement. And so far, even though the lion's share of the deals have happened in the last, call it, 45 to 50 days, we're seeing good performance in that pool. So, we saw about last 7,000 agreement deliveries in June from our e-commerce activity, and we're seeing a sizeable comp in July against that number. So, we continue to be very excited. We spent a lot of our time really what we consider to be opening up the top of the funnel and making sure more and more of our customers and those that aren't our customers can transact with us. And now that we've – now that we have capabilities everywhere, we're concentrating on the user experience and the conversion funnel, the bottom part of the funnel. So, we expect to continue to make strides there.

[Bradley B. Thomas:]

Got you. And so if I just do some quick math, 7,000 agreements on about 1 million – a little over 1 million customers that you have, it's just under 1%. Is that a way to think about maybe the potential lift that we might see from e-commerce going forward?

[Steven A. Michaels:]

Yeah. I mean, we expect that to grow, and as those agreements kind of layer into the base, we've said before we think it can grow to 8% to 10% over time. But it's going to be a small lift, although we do expect it to have an impact in the back half of the year, but it's going to be small in 2015.

[Bradley B. Thomas:]

Got you. Thank you all so much and I'll turn over to someone else.

[Operator:]

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

[J. R. Bizzell:]

Yeah. Good morning, guys and congrats on another great quarter.

[Steven A. Michaels:]

Thank you.

[J. R. Bizzell:]

John, I was wondering if you could kind of delve into, I know you talked about a little bit, but kind of the combination Progressive and Aaron's, and what you're seeing on the potential gains of synergies there and is it progressing as expected?

[John W. Robinson:]

Sure. So, I'd say a couple of different areas, the first being e-commerce. That was certainly a big initiative for us, right after the merger to get that up and running using the Progressive kind of front-end technology to get the transaction approved and executed, and that's gone extremely well. We were ahead of plan as far as I'm concerned in terms of where we are with access to customers across all our states; the process is working really well. We're doing really meaningful volumes as Steve talked about. I mean, we do believe this will be a significant part of our business. And if you look at it just in June, it's a significant piece of what our future is going to be for sure. So, from that perspective, I would say, that's a very, very positive result of the merger already and it's not only benefiting the company but also our franchisees, which is very exciting for us. Second, I would say the back-end process for Progressive in terms of picking up product returns is being more effective in that part of our kind of ecosystem; that is going really well. So we have 17 hubs rolled out in kind of major markets where Progressive had real density of customers and that has really been a joint effort between Aaron's and Progressive. The employees are all Progressive. We took a lot of employees from Aaron's over to Progressive who knew that process, and that's gone extremely well. We are very pleased with the results of that. We talked about it in the first quarter a little bit. We saw that get even better in the second quarter, which we would expect given that the first quarter is kind of when we finished getting those rolled out. But we're not going to quantify it, but we're really pleased with the investment we've made there and the potential for that to benefit both sides of the business.

[J. R. Bizzell:]

Great. And switching gears here a little bit, and, Ryan, this one may be for you, kind of invoice volume down a little bit sequentially. I know you referenced that, but just wondering if there's some seasonality. Was there some things you're looking at? And then kind of how you all are thinking about that invoice volume as we work throughout the remainder of the year.

[Ryan Woodley:]

Sure. So, just to clarify, invoice volume was up 31% year-over-year for the quarter, which we feel good about. Obviously, down in growth rate from the prior quarter just given large numbers taken hold. But we feel pretty good about where we sit today. For active doors, as we mentioned the stat in the prepared comments, we saw an increase of 28% year-over-year for the quarter, which we're very pleased with. And as we look to what sits in our pipeline and is effectively the roadmap for future growth, we feel really good about where we're at. And so growth will continue to come for us from a broad base of retailers across several different industries and across both small, medium and large-sized retailers, which we're really excited about. One of the virtues of the model is that we have the benefit of working with some really great retail partners who are growing their businesses. And as their base of business grows, we benefit from that same trend.

[J. R. Bizzell:]

Great. And kind of building on that, the revenue was impressive for the quarter. Can you kind of break out where you're seeing that growth being driven and kind of maybe on a percentage basis kind of break it out? Is it new customer, existing customer, and kind of quantify it that way?

[John W. Robinson:]

Sure. We haven't disclosed the components of invoice or revenue growth. But what we have said in the past remains true this quarter, which is we saw it across all regions of the country. We saw it across our largest national accounts, as well as our smaller regional accounts. And where that gives us confidence is that we have a base of 12,000 doors that are generating a really stable core for the business to generate future invoice growth. So we're happy about that, and that's the objective, really. While growth in doors may be lumpy from time to time just because we're subject to the timing of the retail partners we work with, what we want to see is a consistently strong growth rate in the invoice volume period-over-period, which is fortunately what we saw in Q2 and what we've seen in the past, because that means we're doing a better job at the point of sale and proving the experience for both the retailer and the customer.

[J. R. Bizzell:]

Great. Thanks for taking my questions.

[Operator:]

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

[John A. Baugh:]

Thank you. Thanks for taking my questions, and nice cost control here. I wanted to jump into the inventory in the core. Is that happening just in the DCs? Is it happening at the store level? I appreciate the 19% down year-over-year number. Just curious how much more there possibly is there in that number.

[Gilbert L. Danielson:]

Yeah. John, it's happening in both the DCs and at the store level, so it is across the board. I think our DC inventory is probably down about 20% – or down $20 million, I'm sorry from where it was a year ago, and then the rest that would be in the store group at core. So it's across the board, which is our plan, and we're making good strong progress in that.

[John A. Baugh:]

Are we halfway through, three quarters of the way through, any rough guideline?

[Steven A. Michaels:]

This is Steve, John. I think just kind of broad brush strokes, we're probably three quarters of the way through. I mean, as John has mentioned in the past, the franchisees have always run with leaner inventories than the company stores. So we took a look at that and made some strides across all categories, driven the inventory through the stores. And now, we have some opportunities in select categories. But I think it's more of a scalpel now and not a machete, but we do have some opportunities. But if we were to round it out, I'd say three quarters of the way is probably a good way to look at it.

[John A. Baugh:]

Okay. Thank you. And then, Steve, while maybe I've got you, there has been over the last couple of quarters, if I'm not mistaken, a little bit of a divergence between the franchise customer count and your corporate stores. I was just curious, is that a function maybe of the price increases you've taken versus the fact they probably haven't? Or is there something else going on there? Would you expect those numbers to come more in line? Are you just driving profit maybe a little more aggressively, not pricing as aggressively still as franchisees? Any color there?

[Steven A. Michaels:]

Yeah. It's a great point. And so, I think part of it is due to – so when the corporate stores increased the pricing, most of the franchise stores were already on an increased tier from corporate. So there's probably more overlap now between corporate and franchise on the same pricing tier. Some franchisees took a step up as well at the same time that the company stores did. But I think that's part of it is that on the customer count side, we're kind of resetting to where they've been for a number of years, and I think that's resulting in what you're seeing in the customer count. And then, they're executing pretty well, too. I have to give credit there. And so, we look forward to that continuing and we look forward to the company stores improving our performance.

[John A. Baugh:]

And my last question is on the Progressive side. There was a reference to strong collections. I'd love some color around that and whether or not the ability to repossess is perhaps helping that figure. And then, a reference to leveraging fixed cost, just curious if that's something we're going to continue to see. You know the pipeline better than I, so just curious how your infrastructure matches up against the pipeline build you expect?

[John W. Robinson:]

Sure. So first on the collections question, we did see a benefit from the hubs, as John mentioned, in the second quarter to a greater degree. And then, the benefit that we saw in the first quarter, those trends have continued. We love the trend line, and we expect it to continue. And I think that's primarily what we're referring to in the way of collection metrics because that's helping drive sequential and year-over-year improvement in a write-off metric even in the face of such strong growth. Now, we expect write-offs to be up sequentially in Q3, consistent with the trend we saw last year. But the same will hold true in Q3, which held true in Q2, which is we'll experience a lift in that metric from the benefit of having those 17 hubs out there and operational. And then, on the operating leverage, yeah, just given the strong rate of growth and revenue for Progressive, we obviously won't scale some elements of operating expense in line with that rate of revenue growth like for – just to give you one example out of the corporate overhead. And so we're benefiting from that now. We'll continue to benefit from that. But as you know, it's a bit of a step function. So we'll step up a bit in Q3 as we build up the team to support Q4 volume, but generally we should experience over the course of the year increase in benefits from leverage on fixed operating expenses.

[John A. Baugh:]

Thank you for that color. Good luck.

[John W. Robinson:]

Thank you.

[Gilbert L. Danielson:]

Thanks.

[Operator:]

The next question comes from David Magee with SunTrust. Please go ahead.

[David Magee:]

Yeah. Hi, everybody, and good quarter.

[Steven A. Michaels:]

Thanks, David.

[David Magee:]

Some questions. I heard you say that the gross margin was up at the retail or up for the core part of the business, but it look like it was down overall. Is that just a function of the mix of having Progressive in there, or how are Progressive's gross margins year-over-year?

[Gilbert L. Danielson:]

Yeah. I mean, it is a miss. I mean, obviously, Progressive has lower gross margins than the core business, so the core business is still two-thirds of our business, but we did improve the margins. But in the quarter, the Progressive would have the lower margin.

[David Magee:]

But was that stable year-over-year at Progressive?

[Ryan Woodley:]

We experienced an increase year-over-year in gross margins, and that's attributable to the trend that we discussed, I guess, in our prepared comments as we experienced slower growth and the average age of the lease on our books matures, that margin expands.

[David Magee:]

Okay. Thank you. Then on the – did I hear correctly that the number of doors grew about 3%?

[Ryan Woodley:]

Correct.

[David Magee:]

Can you remind us what that was at the first quarter end?

[Ryan Woodley:]

I don't have it. I don't have it at hand. But that metric, as I mentioned, it tends to be a bit lumpy just because that's the presence of a door on the system but doesn't necessarily speak to the volume of that door, which is really what the invoice volume per active door gets to. And what you see with the active door metric is just we'll onboard a 300-store chain and you'll see a nice lift in that. And then you'll experience growing productivity from those doors over time. So what we've experienced this quarter is similar to a trend we've experienced in the past where the door growth was lumpy but invoice growth was likewise strong.

[David Magee:]

I got you. And any additional color also just in terms of – as you're in the market with Progressive in your – I want to guess, maybe new competition out there, any color in terms of what's being well received and what maybe what retail sectors are the most receptive right now to your message?

[Ryan Woodley:]

We've seen good growth – it's a good question. We've seen good growth across verticals. Fortunately, the opportunity for us is still a mix of greenfield. While we're working with retailers, you don't currently have a tertiary or an RTO solution as well as retailers who are looking to partner with a different tertiary. And that's true at the head of the tail and the long end of the tail. In other words, we're still coming across very large retailers who have no tertiary solution and are considering it for the first time. And we're working with small retailers who've had a tertiary in the past and are looking for someone else to come fill that. And what we try to deliver for that retailer is the highest sustainable approval rate over time and the best customer experience. And we feel like that's the value proposition that we've been successful in delivering and that's where all our energy is going. So in terms of the retailer experience that's developing a compelling set of POP for in-store advertising, a strategy to bring customers into their door, and a very streamlined process, application process to reduce the time the customer spends at the point of sale, and that's where our energies have been focused.

[John W. Robinson:]

And I would add one thing. This is John. I think our – the interest from retailers continues to broaden, just giving some historical perspective. It really, as you know, developed largely out of furniture and mattress, and there's still a lot of interest in those sectors. But there's also a broadening appeal for other retailers in other verticals. So we're encouraged by that. And also, the size of retailers. So we think more and more large retailers are interested in this option. So we think that – when we talk about our pipeline, we think there's a great whitespace there still available.

[David Magee:]

Okay. Thank you, John. And on the e-commerce side, is it too early to tell what the keep rate might be there as that business develops?

[John W. Robinson:]

I guess, the answer is yes. I mean, like I said, the lion's share has come through in the last, call it, two months. But what we're seeing is a better renewal or collection performance, and the keep rate is not materially different than the in-store. We'll continue to monitor that. But right now, it's early in the game, but positive.

[David Magee:]

Okay. And just – and last question, on the introduction of phones, as you studied that, what has sort of caused you to postpone that a bit? What about that business? It's given you some pause.

[John W. Robinson:]

Yeah. It's a great question. We know it's a high-profile category and an in-demand category that we want to be in, but we want to make sure that it's profitable. And so we're evaluating technology solutions to help mitigate our risk not only with the decisioning technology from Progressive, but other third-party softwares. And so we just decided that we needed to learn a little bit more, and we decided to delay the launch.

[David Magee:]

Okay. Great. Thanks and good luck.

[John W. Robinson:]

Thank you.

[Steven A. Michaels:]

Thank you.

[Operator:]

The next question comes from Laura Champine with Cantor Fitzgerald. Please go ahead.

[Jason Smith:]

Good morning, guys. This is Jason Smith on for Laura. Thanks for taking my question.

[Gilbert L. Danielson:]

Hi, Jason.

[Jason Smith:]

If I could start off just kind of touching on the last question there, smartphones, with the pilot program, were you seeing – I mean, was it a matter of maybe charge-off rates for coming in a little bit higher than you expected, or was there something along those lines that was beyond what you were looking for?

[Gilbert L. Danielson:]

No. I have to say that – so the pilot was 100-store pilot and the charge-off rates – and it was new. I'll remind you that we just really rolled it out in kind of let's call it May, so the charge-off rates haven't really had a chance to come through to surprise us anyway. One thing I hadn't mentioned that I want to make sure I get out is that we've mutually decided with T-Mobile that we're not going to move forward. So we were happy that early in the process, we decided it wasn't a partnership that both parties wanted to move forward with. So we're continuing with our pilot on the device side and evaluating other carriers to roll out with. But we certainly – as I mentioned, it's a high-profile category. We hear a lot about the charge-off experience of others and are mindful of that, and we don't want to just grow the revenues. But as I mentioned, we want to grow and grow profitably.

[Jason Smith:]

Sure, got it. And if I can change direction here, with Progressive, you guys are still in growing doors. Obviously, invoice volume is growing pretty nicely. Is there any plans or any thoughts as to when you might need to add more hubs? Are you set with the 17 or is there anything – what would sort of drive the next leg up there?

[Ryan Woodley:]

That's a good question. We're sort of in a constant state of performing that analysis to determine whether and when we should open hubs in new markets. I think in the near-term, it's probably most likely that what we'll do is open additional hubs in existing markets where the existing hub is performing well and we know that there's enough inventory to go out and pick up that we can warrant. It's a second team in that location. But for the time being, the 17 markets are doing well. Some are doing very well and in those markets that are doing very well, the next move will probably be to open a second hub in that geography.

[Jason Smith:]

Okay. Got it. Great. Thank you.

[Operator:]

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

[Beryl Bugatch:]

Good morning. Thank you for taking my questions and also congratulations on good profit performance this quarter. I usually ask, I will again go for the cost of lease merchandise for Progressive, if you could disclose that or give us a quantification of that.

[Gilbert L. Danielson:]

Cost of lease merchandise, Budd? You mean the balance sheet?

[Beryl Bugatch:]

Yeah, for Progressive.

[Steven A. Michaels:]

Gross margin.

[Beryl Bugatch:]

Gross Margin.

[Gilbert L. Danielson:]

We just don't talk about that in particular, Budd. So, I mean, obviously Progressive certainly had a much higher EBITDA margin in the quarter than people were anticipating, and Ryan spoke to that. I do believe that as you look forward to the next few quarters that that percentage will come back down to more normalized level that we were projecting at the beginning of the year from an EBITDA percentage.

[Beryl Bugatch:]

Okay. What was the revenue impact initially or expected for the core from smartphones that you had put in your plan originally? Could you tell us what that was?

[Steven A. Michaels:]

Yeah. I don't know if we've talked about exactly what we have baked into the model, but it certainly would be in the neighborhood of 1% to 2% on the comps in Q4.

[Beryl Bugatch:]

Okay. Thank you, Steve. And when you're talking about the comps, is e-commerce going into the same-store comp for the core as well, or is that going to be – is that how you're going to account for same-store? Is that going to be part of that?

[Gilbert L. Danielson:]

That's correct.

[Steven A. Michaels:]

Yeah. That's a good question and it will. So we're assigning that e-commerce customer to a store. The customer does not need to ever come into that store unless they have a reason to, but the store is servicing that customer and getting the revenue credit for that customer.

[Beryl Bugatch:]

And how does that work for the franchisee? How does that...

[Steven A. Michaels:]

Yeah. So that's a good question and one clarification I wanted to make from a question from Brad earlier. So, the customer chooses – they put their zip code in and it surfaces the number – the stores that are within 30 miles of that customer online and the customer chooses what store they want to do business with. And if that's a franchise store, the franchisee gets that business. And so, the clarification that I wanted to make was the 7,000 agreements that we created in June, about a third of those were franchise. So the ratio was a little bit off on the original question versus the 1 million customers that we have corporately.

[Beryl Bugatch:]

Got you. And you talk, I think, about the robust door growth that I think you're expecting or it's your process trying to get. Can you give us a feel of maybe what the goal is or how you get there? I think, John, you talked a little bit about different types of retailers, any other different types of – any expectation as to when we might see some of that? I know it's lumpy right now.

[John W. Robinson:]

Yeah. I'll take a shot and then Ryan can correct where I get off the track. But we don't give guidance on expected number of doors, so we've given our revenue guidance. And as we've discussed, we have given you that. So in terms of growth, we definitely expect door growth at the second half of the year, it's lumpy though. But I mean, the reality of it is, particularly when you talk to multi-store retailers, kind of larger retailers, there is a longer sales cycle, more diligence and just more prep work that goes in upfront. So there's that aspect that we just don't control the timing to a large extent. So it's kind of imprudent for us to try to guide you to which quarter, when the timing is. We just try to be a good partner to the retailer and proceed on their schedule. And so, that's kind of the plan. But we do see as good of a pipeline as we've ever had and the hope for us is to go execute and get these stores. I mean, pipeline is not meaningful until we get it up and running and we're producing invoice volume out of these doors. So, we feel really good about it, but there's an element that we just can't control the timing. In terms of the type of retailers, we continue to see more adoption of the product and more interest in the product across some different types of retailers who have leasable products from electronics to jewelry, categories that in the past haven't been as large, but we expect will be in the future. Q – [05LYT5-E Budd Bugatch]>

[Ryan Woodley:]

Well, we...

[Beryl Bugatch:]

...how do you think about that?

[Ryan Woodley:]

We feel pretty good about our front-end decisioning and we – if you think about our business, we were pretty successful before we have the integration on the back-end with Aaron's. So we feel good about our ability to go into different verticals and be successful. There'll be some learnings for sure, if we get into verticals that aren't perhaps product that we sell out of our stores, but there's other ways that we can release those items and benefit from the pickup. So, having the hubs gives us a lot of opportunity, no matter what the product type, whether we put it back to an Aaron's store or some other method on the back end. So, we feel okay about that.

[Beryl Bugatch:]

Okay. And two other quick questions, one, the universal application. I hear tell that some of that's going on now. How are you – what's your progress with that seamless application?

[Ryan Woodley:]

Yeah. I mean, it's something that we spend time developing for some of our key partners, and we're in some key partners with that. We don't talk individually about that, but we think it's a great tool for the retailer. It's a great – it improves the customer experience of the customer. And so, it's something that we hope will get more kind of a tailwind in the market coming into 2015 – the back half of 2015 into 2016. But it's something that definitely we think is fantastic for retailers. It really simplifies the process at the point-of-sale.

[Beryl Bugatch:]

Sure. And I thought you're also doing some consolidation of your campus in Salt Lake for Progressive. How is that going? Is that done – was it then supposed to be done about now?

[Ryan Woodley:]

Good memory. So, we're moving into that facility next month if everything goes according to plan, which will be a great thing for the team there. We're currently spread across three buildings in Utah, and we'll all be under the same roof for the first time in a long time. So it will be a great thing for the business, and that'll correspond to maybe a slight uptick in SG&A for the period, but nothing meaningful.

[Beryl Bugatch:]

Great. Thank you. Good luck on the balance of the year. Thank you very much.

[Gilbert L. Danielson:]

Thank you, Budd.

[Operator:]

The next question comes from Anthony Chukumba with BB&T Capital Markets. Please go ahead.

[Anthony Chukumba:]

Good morning. Thanks for taking my question. I just had a quick question on the balance sheet and share repurchases. Obviously, you had a very strong free cash flow and it looks like your cash balance went up significantly while you also paid down a bunch of debt. Are you currently precluded from buying back stock by your debt agreements?

[Gilbert L. Danielson:]

No. We are not, we have – we can certainly do that if we decided that would be the appropriate course of action. We are generating cash this year as we anticipated when we started the year as primary to the core business. I just kind of have a follow-up on – I think John asked about inventory reduction. One of the real strengths of our cash flow generation in the first half of the year is that we did take substantial amount of inventory, our fulfillment centers, about 17% or $28 million and another $44 million out of our core. So we're definitely ahead on the inventory reduction, and that's been a big positive on the inventory, on the cash flow generation. But, no, we're not precluded. As we said, we do have cash on hand. We have plenty of capacity under our revolving credit facility. We could kind of – as we stated before, we're just going to see how the year progresses before we decide whether or not we really need to change our thought process in any way as far as capital management.

[John W. Robinson:]

Yeah. I think the way – just a follow-on to that. This is John. The way we think about capital allocation is obviously trying to invest our capital in opportunities that generate a higher return on capital than our cost of capital, and so obviously organic growth being at the top of that list. And then – and we're working hard to generate that in both sides of the business, and we see particular strength there for Progressive. I want to make sure – one of the benefits of the transaction for Progressive with Aaron's was the ability to have dry powder and a large balance sheet to go into larger retailers and be able to support that. And so we feel like that's important for us to have that powder to do that. And then, also we feel like we're in a very unique position given the – if you think of it as real estate at the point-of-sale, the fact that we have this presence at the point-of-sale with so many retailers, we think that's a really valuable thing. I mean, we want to give ourselves the ability to be strategic around growing the offerings at the point-of-sale. So we feel like that could be an opportunity that we could build organically or through acquisition over time. And so we want to make sure we have dry powder to that because we think – for that, because we think that will be something that we can really add value for shareholders. And then you come down the list, we think share repurchases would come after that. But honestly, right now, we got enough opportunity on the first two that we think we need to keep the dry powder on our balance sheet.

[Anthony Chukumba:]

That's helpful. Thank you.

[Operator:]

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

[John W. Robinson:]

We appreciate you all being on the call. Thank you for your interest in Aaron's, and we look forward to updating you on our progress on our next quarterly call. Thank you.

[Operator:]

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