The Aaron's Company, Inc.
Q3 2015 Earnings Call Transcript

Published: 30 Oct 2015

[Operator:]

Good morning. Welcome to the Aaron's, Inc. Third Quarter 2015 Earnings Conference Call. All participants will be in a 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, sir (sic) [ma'am] (00

[Garet Hayes:]

Thank you, and good morning, everyone. Welcome to our conference call to discuss Aaron's third 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, 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 strategy, the future effects of the Progressive acquisition 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. 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. While consolidated revenue was up 10%, and we achieved a low single-digit increase in EBITDA, the third quarter was challenging for both our core and Progressive businesses. Revenue growth continued to be negative in the core business, particularly in areas that are levered to oil markets. Despite a 3% decline in revenues, core EBITDA increased approximately 6% in the quarter compared to last year's adjusted EBITDA. Our price, inventory and expense initiatives generated favorable core EBITDA performance, despite continued revenue softness. e-commerce, while still small, is performing very well since its June launch, and we're moving forward on an improved smartphone release for the holiday period. Overall, we're continuing to manage the core business to maximize EBITDA, as we focus on our initiatives to drive revenue in this segment. Progressive revenues increased 47% in the quarter, driven by strong growth in invoice volume year-to-date. Our pipeline of new retailers remains strong, but the pace of converting new opportunities into invoice volume was below our projections in the third quarter. That said, we added new retail partners to the platform during the quarter and increased the number of opportunities in our pipeline. As we've said before, the timing of on-boarding new retailers typically moves on the retailer's schedule and can be lumpy. Progressive's gross margin improved versus the third quarter last year. Our operating expenses were higher than planned in the quarter, due primarily to an increase in bad debt expense and write-offs related to the issues covered in our press release this morning. Our February, March and April 2015 lease pools have performed worse than expected due to the temporary interruption of certain third-party data use in our decisioning algorithm. Due to this data loss, our lease pools in these months are experiencing higher write-offs than we expected. It is important to note that despite elevated write-offs relative to our expectations, we believe each of these pools will still be profitable. Lease pools originated subsequent to April 2015 are performing back in line with our expectations. We also introduced new software code into our lease management system in the second and third quarters, which resulted in a number of accounts not being identified as being delinquent and affected our ability to begin prompt collection activities. We believe these issues have been corrected and are not material to our financial statements. I'm disappointed that we had these issues, but I'm pleased our team identified and fixed them. While our internal controls helped us detect these issues, we are implementing additional processes to further enhance our control environment. On October 15, we closed on the previously announced acquisition of Dent-A-Med. We are excited about using the Approve.Me platform to offer Dent-A-Med's credit program alongside our industry-leading lease program. We believe that Progressive Leasing and Dent-A-Med together with the flexibility of our Approve.Me application system creates the most customer-friendly revenue-enhancing solution for our retail partners. Despite a disappointing quarter, we continue to believe Aaron's is well positioned to drive attractive top line and EBITDA growth for the next several years. I'll now turn it over to Steve to discuss our third quarter core business results in more detail. Steve?

[Steven A. Michaels:]

Thanks, John. Core revenues declined 3.1% on a year-over-year basis to $501.7 million. Our comparable store revenues were down 4.1% and our same-store customer count was down 2.8%. Revenues were significantly impacted by stores with high exposure to oil and gas exploration and production. The State of Texas represents approximately 18% of our same-store revenues, and stores across the state are experiencing negative impacts. Excluding Texas from the same-store revenue calculation would have resulted in a comp of negative 2.7%, 140 basis points better than the overall comp and a 110 basis point sequential improvement from the negative 3.8% experienced in Q2 of 2015 when excluding Texas from that calculation. Gross margin was 55.7%, a decline of 14 basis points from the year-ago period. The gross margin benefits from our pricing initiatives were somewhat muted by the third quarter first payment promotions, as well as a six-month Same as Cash promotion we offered in February and March to celebrate Aaron's an 60th anniversary. We believe the Q3 margin impact from the extended Same as Cash promotion was approximately 40 basis points. And looking forward, we expect our price and inventory initiatives to continue to support gross margin improvement. Core EBITDA was $43.7 million in the third quarter, up 5.6% from adjusted EBITDA in the year-ago quarter. As a percentage of revenues, EBITDA improved 70 basis points to 8.7% as cost improvements continue to offset a difficult revenue environment. Operating expenses fell in dollar terms and as a percent of revenues in the third quarter, which offset the slight decline in gross margin performance. Our cost reductions are on track, and we expect our expense program to continue to benefit earnings for the balance of 2015 and into 2016. Merchandise write-offs were 4.1%, up 20 basis points from the year-ago quarter. That's a sequential improvement from the 70 basis point rise we saw in Q2. Our third quarter write-offs are higher than we would like and we continue to take steps to improve performance. Our idle inventory is in good shape as we enter the fourth quarter, down to $341 million or approximately 7% lower than year-ago levels. The idle inventory in our stores at quarter end, stood at $168 million, down 17% versus last year. And inventory held in our fulfillment centers was up 5%, as we began to bring in stock to support our holiday season merchandising and inventory plans. Turning to our growth initiatives, as John mentioned, we are launching our smartphone program this week in time to support the holiday season. Last quarter, we announced a delay in our launch plans as we study the category from a device and risk standpoint and learn from Progressive. We decided to launch a two-phased approach beginning with a device-only strategy. We've worked hard to put appropriate risk mitigation technology and procedures in place, and we have introduced a tighter assortment of current generation phones. We will offer highly competitive lease rates, and are excited to be rolling out an attractive value offering for our current and future customers. The second phase of our launch plan will be a partnership with a national carrier, which we expect to implement some time in the first half of 2016. This will further enhance our offering, as well as provide additional margin opportunities. We will be conservative on our inventory positions as we move into this category and will stay abreast of industry developments. Our e-commerce business continues to perform well. Q3 was the first full quarter of system-wide functionality and e-comm agreements represented approximately 4.25% of total agreements delivered during the quarter. Over 60% of the customers are new to Aaron's and they continue to lease higher ticket items and demonstrate slightly better risk profiles. We'll continue to invest in the channel and expect a more meaningful contribution in 2016. Overall, we are happy with the progress of our cost and efficiency initiatives, and our ability to deliver improved EBITDA margins in the face of this challenging revenue environment. We will continue to focus on our growth initiatives, as we look to deliver sequentially improving same-store revenues. I'll turn it over to Ryan to discuss Progressive.

[Ryan Woodley:]

Thanks, Steve. Progressive's revenues for the third quarter were $266 million, up 47% versus the year ago quarter. Invoice volume was up 18% to $187 million versus the third quarter of 2014. The gain in invoice volume was driven by strong growth and volume per active door, which reached $15,451, a 16% increase over last year. Active doors in the quarter were $12,132 up 1.5% relative to last year. While we have seen strong growth among our existing regional and national accounts and added new retailers to the platform, we've not executed on our pipeline for new national accounts according to the timeline we expected. Given the size of the existing base of over 12,000 active doors, accelerating future growth will be realized to a significant extent by the rollout of larger national retailers. While we've not seen opportunities move through the pipeline at the pace we anticipated, we did not see any opportunities drop from the pipeline. In fact, the invoice potential of opportunities in our pipeline increased during the quarter. Furthermore, since the start of the third quarter, we have begun the launch of three national retailers each of which has the potential to be among our future top 10 accounts. And we're currently testing with two additional national retailers. Gross margin in the quarter was 40.6% up 100 basis points from the year ago quarter. The increase in gross margin was driven in part by slower growth relative to last year as the portfolio become weighted toward more seasoned leases. The percent of eligible accounts that took advantage of the 90-day purchase option in the third quarter was flat relative to Q3 of 2014. EBITDA was $18.3 million for the quarter. As a percent of revenues EBITDA was 6.9% in the third quarter compared with 10.3% in the prior year. Year-to-date EBITDA margin as of September 30 was 10.7%, up 80 basis points from 9.9% last year. While the decrease in Q3 EBITDA margin relative to the year ago period was due in part to one-time transaction expenses related to the acquisition of Dent-A-Med and investments in operations infrastructure, the primary driver of margin missing expectations are the operational issues John referred to earlier. These issues increased our bad debt expense and write-offs relative to last year and relative to our expectations. Bad debt expense was 14.5% of revenue in the quarter compared to 12.1% last year and write-offs were 8.5% of revenue compared to 7.5% in Q3 of 2014. As John mentioned, a portion of leases originated during February, March and April have performed worse than expected due to the temporary loss of data used in our decisioning algorithm. We estimate the loss of this data impacted the approval decisions on approximately 8% to 9% of applications over a 10-week period. The data was ultimately restored in the decisioning algorithm and we now have a redundant source for that input. As previously mentioned, we expect the impacted lease pools to be profitable, though below the levels we originally anticipated. We also released new software code into our lease management system in the second and third quarters, which resulted in certain accounts not being identified as delinquent and delayed collections activities on these accounts. We estimate that these issues impacted collections activity on less than 4% of accounts during the quarter. We believe the software defects have been resolved and resulted in an estimated $4 million increase to bad debt expense and merchandise write-offs in the third quarter, including $3.2 million related to the second quarter. These are pre-tax amounts that are not material to either period. As previously announced, we closed the acquisition of Dent-A-Med on October 15. We have already begun dialogue with several retailers about the opportunity to use Dent-A-Med in connection with our Approve.Me platform to provide a single seamless credit and lease application for all customers. We are also engaged in dialogue with retailers interested in taking advantage of the open architecture of Approve.Me to work with other primary and secondary lenders, as we are doing in the initial doors we launched on the platform. While it's still early, we remain excited about the opportunity to deploy both Dent-A-Med and Approve.Me to help our retail partners derive more revenue. 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 third quarter were $767.7 million, up 10% over the $698.4 million for the third quarter of 2014. Revenues for the first nine months were $2.36 billion compared to $1.95 billion last year, a 21% increase. Net earnings for the third quarter were $24.2 million versus $9.3 million a year ago. Diluted earnings per share were $0.33 compared to $0.13 last year. For the first nine months of the year, net earnings were $114 million compared to $56.1 million last year. Diluted earnings per share were $1.56 compared to $0.77 a year ago. Net earnings for the third quarter on a non-GAAP basis, which excludes amortization expense related to the Progressive acquisition and certain other special charges in 2014 were $28.6 million compared to $28.2 million for the same period in 2014. For the quarter, non-GAAP earnings per share, assuming dilution was $0.39 in both periods. For the nine months, non-GAAP net earnings were up 35% to $126.6 million compared to $93.6 million for the same period in 2014, and diluted earnings per share were $1.73 compared to $1.29 a year ago. EBITDA was up 40% in the third quarter of 2015 to $52 million compared to $44.4 million for the same period last year and up 56% to $255.5 million for the nine months of 2015 compared with $163.7 million for the same period a year ago. Although revenues for both Aaron's Sales & Lease Ownership and HomeSmart declined in the third quarter and nine months compared to the previous year periods, EBITDA for the core business grew to $43.7 million for the quarter and $172.9 million for the nine months ended September 30. As a percentage of total revenues, EBITDA was 8.7% for the quarter and 10.9% for the first nine months, compared to 5% and 8% for the same periods a year ago. We are effectively managing the core business with pricing initiatives and cost and inventory reductions, which is resulting in positive cash flow generation and higher EBITDA and earnings levels. Same-store revenues in the third quarter for company-operated stores in the core business decreased 4.1% compared to the same period last year, and customer counts on a same-store basis for company stores were down 2.8%. As previously mentioned, total revenues as well as same-store revenues in the quarter and through the year are being negatively impacted by oil state stores. Aaron's franchisees collectively had revenues of $235.9 million in the third quarter and $733.7 million for the nine months of 2015, decreases of 1.8% and 2.7% respectively from the comparable 2014 periods. Same-store revenues in the quarter for franchise stores improved sequentially to a decrease of 0.4% and customer counts were down 0.7%. Again revenues and customers of franchisees are not revenues and customers of Aaron's, Inc. Progressive revenues were $266 million and $773.6 million for the third quarter and first nine months respectively. EBITDA for the third quarter of 2015, as Ryan mentioned was $18.3 million and $82.6 million for the first nine months. EBITDA as a percentage of revenues was 6.9% in the third quarter, compared with 10.3% for the third quarter last year as we have discussed earlier in the call. At the end of the third quarter, the company had $66.9 million of cash on hand compared to $3.5 million of cash at the end of 2014. Approximately $213 million in cash was generated from operations during the first nine months of the year. And at the end of this September, no debt was outstanding under our $225 million revolving credit facility. We're adjusting Progressive's full year EBITDA guidance primarily to account for the issues experienced in the third quarter. Revenue guidance is unchanged, although we expect Progressive revenues to be at the low end of the range. For Progressive, we now expect EBITDA for the year in the range of a $103 million to a $108 million compared with the previous guidance of a $120 million to a $130 million. So, primary drivers of this change in guidance are, increased bad debt expense and write-offs due to the matters discussed earlier in the call. Lower than anticipated invoice growth in the second half of the year, and transaction cost related to the acquisition of Dent-A-Med. On a consolidated basis, we now expect EBITDA in a range of $308 million to $328 million compared with the previous guidance of $325 million to $350 million. We expect GAAP diluted earnings per share in the range of a $79 to a $99 and non-GAAP diluted earnings per share in the range of $2.2 to $2.22. These are the financial highlights for the quarter. I will now turn it back over to John.

[John W. Robinson:]

Thank you, Gil. Despite a difficult quarter, we remain optimistic about the business. While we are lowering guidance for the year, I want to note that our revised EBITDA guidance still exceeds the original range provided in February. Lastly, I would like to thank all associates in the Aaron's family, our franchisees and shareholders for all you do to make Aaron's such a great company. At this time, I would like to turn the call over to the operator for questions.

[Operator:]

Thank you. We will now begin the question and answer session. And our first question comes from Brad Thomas of KeyBanc Capital Markets. Please go ahead.

[Bradley B. Thomas:]

Thanks. Good morning, everybody. And maybe I could just dive in with some Progressive questions. With respect to issuance during the quarter of new leases, did the effects that you said it on the call here today, did they have any impact on the rate of issuances of new leases in the quarter?

[Ryan Woodley:]

No. No, Brad. The primary impact there and the primary opportunity for us is to execute on the pipeline.

[Bradley B. Thomas:]

Got you. And then, as you think about your decision making engine and your standards, would you expect those to change in a tighter manner as a result of what you've seen in this quarter?

[Ryan Woodley:]

It's a good question. We make ongoing changes to the decisioning algorithm to adapt to the current environment. And our current approval rates are in line with where they were a year ago.

[Bradley B. Thomas:]

Got you. And would you expect them to change as you move into the fourth quarter?

[Ryan Woodley:]

No.

[Bradley B. Thomas:]

Okay. And then, again drilling into some of the effects that you've said it today, as we think about margins for the fourth quarter, what are the ramifications specifically on margins in the fourth quarter as a result of these issues?

[Ryan Woodley:]

Yeah. We remain bullish on where we'll end up for the year. The effect of the revised guidance implies roughly a 10% EBITDA margin on the year, which is up from last year, which is approximately 9.4%. So, we feel good about what we'll end up on the year and again relative to where we were year-to-date last year, we're up 80 basis points.

[Bradley B. Thomas:]

Got you. Okay. And then, Ryan I guess with the Dent-A-Med acquisition is that going to get rolled into the Progressive results and does it affect your guidance at all for the fourth quarter?

[Gilbert L. Danielson:]

It's Gil, I'll answer that. The Dent-A-Med's results will be in our consolidated financial statements for the 75 days that we have them in 2015. We are kind of still researching. We don't know if it will be a separate segment and when we report, it probably will be. We haven't reached that conclusion yet, but we will and – I mean, that will be included in the first quarter or in the fourth quarter of 10-Q.

[Bradley B. Thomas:]

But in terms of the guidance that you have today, it's not included in the Progressive segment results.

[Gilbert L. Danielson:]

It will be immaterial to the guidance.

[Bradley B. Thomas:]

Great. Just wanted to make sure. And then, just lastly before I turn it over to others, on the comments about the national accounts, could you give us a little bit more color maybe about the pilot programs that you have in place. And how long do you usually have pilot programs before they get green light and turn into something bigger?

[Ryan Woodley:]

Yeah, it's a fair question, Brad. As we've mentioned in the past that the timeline of that cycle varies by retailer, it varies by retailer and by retailer size. And we're working on those pilots. We're excited about them. But we don't have visibility into when those pilots – when or if those pilots will convert into full rollouts.

[Bradley B. Thomas:]

Got you, but there are Progressive offering in a couple of national accounts today, are those in stores today?

[Ryan Woodley:]

Correct.

[John W. Robinson:]

Yeah, Brad. John, I mean to be clear there is three additional national rollouts that happened in Q3. Those are different than pilots; those are system rolloutsat three national retailers and then in addition to that there are two pilots for the national retailers which are more limited in scope.

[Bradley B. Thomas:]

Perfect. I appreciate that.

[John W. Robinson:]

We feel good about the third quarter from that perspective.

[Bradley B. Thomas:]

Perfect. Perfect. Thank you for all the help and I'll turn it over to others.

[Operator:]

And our next question comes from J.R. Bizzell of Stephens. Please go ahead.

[J. R. Bizzell:]

Yeah. Good morning, and thanks for taking my questions. John, can you kind of build on that last comment you just made on three new launches in 3Q; did I hear that correctly?

[John W. Robinson:]

That's correct. I'll...

[J. R. Bizzell:]

Yeah. Go ahead.

[John W. Robinson:]

Yeah. That's correct. Those are initial launches, J.R. So that doesn't mean necessarily that on day one, we're deployed in every location for a given partner. But the effect of that is that we've marked the transition from a pilot to a full rollout with that partner. And so, we've begun with three separate partners, a full rollout.

[J. R. Bizzell:]

And is it too early to name those partners?

[John W. Robinson:]

Yes. We'll maintain the policy that we have in the past, which is to not comment specifically on retailers by name to the extent that they don't comment on the relationship with us publicly, so that's the current plan.

[J. R. Bizzell:]

So just kind of back of the envelope we're kind of thinking about this. We would expect maybe just to be beneficial more towards the FY 2016 year as you work through adding your product into their store basis.

[John W. Robinson:]

That's correct. For two reasons, one given the nature of the rollout in that it's not immediately on day one in every door in a system, and then two given the nature of revenue lagging invoice. So, we'll first get those doors up and running. We'll optimize the program in each of those doors, begin to generate invoice volume and then revenue will follow.

[J. R. Bizzell:]

Great. And then switching gears and maybe for you again, Ryan on kind of this data, what was the missing data? And then, kind of what happened there, maybe some more color around why it went away in February? And then, when did you – you kind of – the official date when you solved the problem?

[Ryan Woodley:]

As you might imagine, some of our other financial services businesses, a lot of the data we use in our decisioning comes from third-party vendors. We don't necessarily control or have perfect visibility into the decisions made by those vendors. But in this case, one vendor discontinued, including certain data elements and stream they provide us. Fortunately, we now have an independent (28

[J. R. Bizzell:]

And then last one on this, and I am guessing so it – since that vendor discontinued and you've clearly got a new vendor in place, what is different now and are you – I know you said, you're seeing trends kind of back to normalization there. Can you kind of give us some comfort around how you feel about it on a go-forward basis and this new data that you're going have running the model, in the algorithms on a go-forward basis?

[Ryan Woodley:]

Sure. As we've discussed in the past, the algorithm the decisioning algorithm takes advantage of the use of several sources and hundreds of inputs. In this case, we still do work with the existing vendor, we still do get data from that vendor, but we also have data conserved, to provide a redundant source for those particular elements. In this case we just hadn't previously decisioned the pooled leases that had that particular mix of data elements, so we couldn't accurately predict how they would perform at that time. The model, the decision algorithm has adopted to the replacement of those variables and we now feel confident in its ability to perform going forward. As evidenced by the pools that we've seen since April, which again are in line with our expectations.

[J. R. Bizzell:]

All right. Thanks for taking my questions.

[Operator:]

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

[John Baugh:]

Thank you. And good morning. So just sort of following up on this Progressive and the charge-offs and write-offs and the quality since April. Because I think everybody wants to know how much of this could be the consumer struggling. So you mentioned, for example, in your core business, Texas is lagging. I'm curious if that's having an impact on the Progressive business in Texas or Louisiana or Oklahoma or wherever. And I think, John, you've talked about in the past, how you can see fairly quickly within – because it's a 12-months term, within a couple, three months of how things are trending. So sort of how much time have we had since the new decision tree, since the collections or whatever the software issues have been, how much time have we had to look at numbers? We had adequate time to really assess whether we're back to the normal kind of charge-off write-offs?

[John W. Robinson:]

Okay. Thanks, John. So I'll start with the first – I think I'll try to break into a couple of different questions. But the first being what are our expectation for write-offs would have been maybe without these issues at Progressive, and we believe they would have been in line with last year's performance. So if you kind of exclude those from the mix for the third quarter, we felt like our write-offs would have been in line with last year. I think that's part of your question. We do see some deterioration in our customer performance across both businesses in the third quarter. We haven't seen a pickup from energy prices on the delivery side, lower energy prices and fuel prices for our customers. We haven't seen a pickup there nor from higher wages, which has been disappointing for us. And our collections performance has been slightly more challenging. So in terms of our curves since April, we have a good bit of visibility into those curves and feel our expectation is that they're going to be back in line, they are performing back in line with what we expected at the beginning of the year. So we feel as confident as we can about those. You don't know until a pool plays completely out, obviously, how it's going to perform. We have a lot of early indicators on that. So we feel confident about our full-year guidance and implied in that is a return to normal margins in Q4 for Progressive. And that's just where – but the information we have right now, that's what we feel comfortable saying.

[John Baugh:]

So, John, just so I'm clear, you said that you expect the write-offs to be in line with last year I think in the fourth quarter is what you said. And yet you've also said that collections are slightly more challenging. So I'm trying to square those two comments up if I heard it correctly.

[John W. Robinson:]

Yeah. I mean, collections performance, for example, in a lease pool aren't exclusively about your write-off rate. There are other factors that can determine the performance of a pool, which would include pricing, discounts with the retailers, 90-day performance. I don't know if I missed any, Ryan, but those are the other elements that can drive the performance of lease pools.

[John Baugh:]

Okay.

[John W. Robinson:]

These are – and based on that, so basically, John, we have all those different components in our lease pools. And when we model out, what we think future results on pools are going to be, all those factors are taken into account. So it's not exclusively about write-off rates.

[John Baugh:]

Got it. And then maybe Steve can address on the core side, I'd love some more color around the same-store revenue figure. I think corporate customer account number was down 2.8%. You've had pricing. I guess, I am trying to understand, then you mentioned a few promotions you've ran that may have had more of a margin impact. I'm just trying to get a better understanding, in the core business, what's going on between year-over-year pricing? Is that impacting customer traffic or I'm trying to square up, I guess, between traffic and price and price per transaction?

[Steven A. Michaels:]

Yeah. John, that's a great question. So, yeah, as John mentioned, we are seeing some stress on the consumer and not really the tailwinds from the macro drivers. And so, we did put in the price increases and we have seen an impact, as you would expect, in our revenue per agreement. And that has ticked up to basically mid-2013 level, so that's a positive when you think about from a monthly payment standpoint on an agreement base. We are finding that we're having to be promotional in order to win those agreements, and that is causing a little bit of a muted impact on the comp drive in that first month and it's a little bit of a lag on the revenue impact. So we continue to expect the price increases to turn through the lease portfolio and help drive margin improvement. I don't see a big change in our need to be promotional in the future periods in order to drive those agreements. And we hope that e-comm will continue to play a bigger role, but we are seeing some challenges. One thing we've also seen, even though we have an increase in revenue per agreement, our revenue per customer has stayed fairly flat and that's reflective of a slight downtick in agreements per customer. And so that's another data point on the challenges that the customer is facing.

[John Baugh:]

That's interesting. And so just to be clear, so we sign up a customer on a promotion and we count them in the customer account. But if the promotion was no revenue in the first month, then we don't get the revenue, is that basically what's going on to some degree?

[Steven A. Michaels:]

That's exactly right. I mean, it maybe a $90 per month agreement that was signed up on a $25 type promotion and the $90 would not be due in full until the second month.

[John Baugh:]

Got it. Thank you. Good luck.

[Steven A. Michaels:]

Thank you. Operations

[Unknown Speaker:]

Good morning. This is David (37

[Ryan Woodley:]

It was just impacting write-offs and bad debt, David (37

[Unknown Speaker:]

Got it. Thanks. And then, Gil, if you could kind of square up for me the change in EBITDA guidance for Progressive and the items that are impacting. I mean, it looks you took guidance down about $20 million for the year at the midpoint. This quarter bad debt and write-offs was $3.2 million higher. Can you give color on lower transaction impact and some of the acquisition cost from Dent-A-Med?

[Gilbert L. Danielson:]

Yeah. I mean, this is the guidance for the year. And so we are guiding to the low end of new guidance, so that has an effect on EBITDA, which is part of the moving it downward. The bad debt expense and the things we talked about on the agreements, we will have higher bad debt expense for the year because we have incurred it in the third quarter. And then the Dent-A-Med expenses are not real large, I think around $3 million we anticipate that will cost in the year. So those are the main issues in there – big issues.

[Unknown Speaker:]

Got it. Okay. And then moving over to the core, any reason that the spread continues to widen between the franchise comps, franchisee comp sales, and what we're seeing in the core business? Any color on that?

[Steven A. Michaels:]

Yeah, that's a good question. The franchisees are performing well. One thing I would note is that they – because historically Texas has been such a strong market for us, there's very little exposure to Texas for the franchise system. And if you were to ex that out of the company comps, the spread narrows, but it is still a gap that we're concentrating on and we're working to improve performance across both – across the entire store system, but it's certainly an area of focus.

[Unknown Speaker:]

Okay. And e-commerce, how much revenue came from e-commerce this quarter? I know it's still early really, but any color on that.

[Steven A. Michaels:]

Yeah. I mean, it's a small number, Q3 was our first fully functional quarter, and it ramped sequentially as the months progressed, so the numbers were still very small from a revenue standpoint, pretty immaterial.

[Gilbert L. Danielson:]

Yeah, Dave, I think for the year, it certainly will be less than 1% for the year (40

[Unknown Speaker:]

And are the cell phones now in all of the stores or are you still rolling it out to the entire fleet?

[Steven A. Michaels:]

Yeah. So the phones have been rolled out over the last week or so. This is our first week, I guess, of transactional activity. They're in about 80% of the stores as we sit here today.

[Unknown Speaker:]

Okay, all right. Thanks to all for taking my questions.

[Steven A. Michaels:]

Thank you.

[Operator:]

And our next question comes from Laura Champine of Canaccord (sic) [Cantor Fitzgerald] (40

[Laura Champine:]

Good morning. I also wanted to follow-up on the write-off issue in Progressive. With loans that were generated in three months alone driving a 100-basis-point pick-up in your write-offs in the quarter, I'm just wondering what percentage of the total book is represented by those loans generated in that three-month period. And what was the data, because obviously it was very important data, that went missing? A follow-up on that is when did you find out it was not available to you anymore and why did you choose not to disclose that?

[Ryan Woodley:]

Thanks, Laura. I think there were three separate questions, what data was lost, what percent does it represent of the book, and when did we find out. And so I'll try and hit all three of those. For competitive reasons, we aren't disclosing the name of the vendor or the nature of the data elements, but they were obviously more valuable elements for us in the scheme of the universe of the hundreds of variables that we do use. In terms of what it represents of our lease portfolio today, it's currently a very small percentage given the fact that we have a 120-day charge-off policy and those leases were originated in January, February and March. And it was that 10-week period and I think I shared that over that 10-week period it impacted our decisioning on roughly 8% to 9% of those applications. We think that, in retrospect, those pools will perform approximately 200 basis points to 250 basis points lower than the previous year's pools as a result of the loss of that data. We discovered the issues – of course we knew we had lost the data and developed a plan to replace it in February and March and it was replaced in April. The impact to our financial statements was – we began to understand the impact to our financial statements in August when we discovered and began to remediate the software code issues.

[John W. Robinson:]

One clarification, those pools were originated in February, March and part of April, that was the 10-week period. I think you mistakenly said January. So it's February, March and part of April.

[Ryan Woodley:]

Yeah.

[Laura Champine:]

And how did you not make a decision to reduce the number of agreements improved – or I'm sorry, approved? So if the approval engine was lacking key data, why not cut back on approvals during that period until you got it sorted.

[Ryan Woodley:]

It's a fair question. A couple of things. The indicators we've historically used to measure early pool performance ultimately were less predictive for these pools than they have historically been because of the loss of the data. So based on the indicators that we had used, we thought that leases would perform better than they ultimately did. Since then, we've added additional metrics to enhance the visibility we have in the lease pool performance, including early lease pool performance.

[Laura Champine:]

And have you changed your thoughts on disclosing changes in your approval process to the investing public? So we've heard from you many, many times since this became an issue, which you knew about February through April. Any changes in your thoughts on visibility that we might get into alterations that you make to the approvals process or to your algorithm?

[Ryan Woodley:]

To be clear, at the time, the indications that we had were that they would not perform out of a band that we would expect it for performance. So there was not knowledge back then to disclose about an expected material departure from those ranges that we had previously anticipated. The benefits of decisioning algorithm are that it can be changed and it can adapt, and changes are made regularly to accomplish that. It wouldn't perhaps be appropriate for competitive reasons to disclose every time and the reasons for which we made changes to the decisioning algorithm. What we'll try and do is execute better going forward on delivering the bad debt expense and write-off levels that we expect for the business.

[Laura Champine:]

Thank you.

[Operator:]

And our next question comes from Anthony Chukumba of BB&T Capital Markets. Please go ahead.

[Anthony Chinonye Chukumba:]

Good morning and thanks for taking my questions. I just wanted to spend a little bit time on the smartphone roll-out. I guess, I'm just a little surprised, last quarter you were saying that you were pushing it back until next year, and now you're saying it's in the stores now. And obviously, we just saw your major competitor have a big blow-up with smartphone. So I guess I'm just wondering what gives you the confidence that you're not going to also have smartphone issues.

[Steven A. Michaels:]

Yeah. Thank you, Anthony. This is Steve. That's a good question. So we believe in the smartphone category, as we did back in the summer when we announced our delay. Our customers are asking for these devices and it continues to be the category that gets searched most often on aarons.com. So we wanted to study and were concerned about three main areas, and we wanted to make sure we had those addressed before we are comfortable launching. And those areas were the device lineup, risk mitigation, and service and refurbishing. And so we wanted to make sure that we could address those things very well. And so what we were able to do is come up with – or find and partner with a locking software solution, and our delay allowed us to launch these phones with the software loaded on all the phones to help from a risk mitigation standpoint. We also partnered with a third-party to handle our service and ensure a proper wiping and refurbishment on the phones, as they come back off of lease. We've got a tight and narrow device lineup of current generation phones that we feel good about. And we're going to be conservative in our inventory positions and continue to pay attention to the industry and make sure we're reacting and dunk it home.

[Anthony Chinonye Chukumba:]

Got it. Okay, that's helpful. And I guess, I was just trying to understand too, so you said that you're going to have some sort of national wireless carrier next year. So if I was to go in and lease one of these phones now, would it be unlocked? I guess I'm just trying to understand that like what's happening now and then what's going to happen, I guess, when you get this national carrier.

[Steven A. Michaels:]

Yeah, good question. So currently, yes, you come into the store and we have unlocked GSM-capable devices in the store. And we've asked the stores to partner with local stores to get the activation on from a prepaid standpoint, assist the customer in doing that. So that's the current strategy and it helped us from an execution standpoint to simplify it for our folks and let them concentrate on product knowledge and helping customers make the right decision. We are talking to carrier partners, and we do think that activation is a key component of the program, and we do intend to have a second phase in 2016 via a national partner carrier and that will help provide us some additional margin through the activation and refill of the airtime.

[Anthony Chinonye Chukumba:]

Okay. That's really helpful. Thanks for taking my questions.

[Steven A. Michaels:]

Thank you.

[Operator:]

And our next question comes from David Magee of SunTrust. Please go ahead.

[David Magee:]

Yeah, hi. Good morning, everybody.

[Ryan Woodley:]

Good morning.

[Gilbert L. Danielson:]

Dave.

[David Magee:]

Couple of questions on Progressive. Is one of the reasons why the big accounts have been slower to land related to new competitive efforts out there, maybe somebody with a somewhat differentiated product? Do you think from that perspective that would be causing the process to be slower?

[Ryan Woodley:]

Yeah. Good question, David. While we do see competition for the opportunities that we're referring to specifically here, the national opportunities, there's really a much smaller competitive set that would be relevant, just given the scale and resources required to execute on these national retail opportunities. So that, I would say, isn't as much a driver as the reasons that would be idiosyncratic to a given retailer. And that is different for each and every retailer that we have in our pipeline. And in many cases, it's IT prioritization; in other cases, it may be preparations they're making for a busy holiday season. It really varies from every retailer from their perspective. The reality is the model that we've always employed is a retailer-first model, and so it is never prudent to force our timeline on one that would otherwise work better for them. And so that's the timeline we cater to.

[David Magee:]

Is it possible that some of these big retailers are testing your product as well as your competition's product at the same time?

[Ryan Woodley:]

It may be possible. In many cases, that early in a stage, we're not aware of exactly what their plans are. Obviously, when we go from a pilot to a full roll-out, those tend to be exclusive.

[David Magee:]

And as you look at the pipeline, would you say that the anticipated margins will be similar to what you would have put in place in the last couple of years?

[Ryan Woodley:]

Yeah, yeah, yes.

[David Magee:]

And then with regard to competition again, I guess I understand that maybe it's gotten a little bit more fierce at the smaller retailer level perhaps from a price standpoint. Are you losing doors at that level and maybe that's a partial drag on your door number?

[Ryan Woodley:]

It's a good question. It's a large base as we've talked about, it's 12,000. We do an excellent job, I believe, of servicing and taking care of those retailers. It's a lot of territory to defend. And so it certainly doesn't mean that every quarter we defend all 12,000 of the doors because there are competitors, smaller competitors who are willing to do irrational things that we're not willing to do. In an effort to remain price disciplined, from time to time we will lose out an opportunity, but we'll do so consciously because we feel it's in the best long-term interest of the business. Our experience has been that some of those guys come back.

[David Magee:]

What's an example of an irrational thing that a smaller competitor might do?

[Ryan Woodley:]

Pricing that we know from 16 years of experience is not sustainable.

[David Magee:]

Is that buying a product from the retailer at a premium even? Would that be at all feasible?

[Ryan Woodley:]

We have seen that.

[David Magee:]

Okay, all right. Well, Good luck. Thank you.

[Steven A. Michaels:]

Thank you.

[Operator:]

And we have a follow-up question from J. R. Bizzell of Stephens. Please go ahead.

[J. R. Bizzell:]

Sorry, guys. I'm jumping back on real fast. But I wanted to clarify something, Ryan, and kind of how you all think. When you think national account, could you kind of give us an idea of what the approximate size you all consider a national account versus just a regular partner?

[Ryan Woodley:]

We don't have a strict definition for that would mean, but generally speaking it's hundreds of millions of retail sales volume with a large regional or coast-to-coast footprint.

[J. R. Bizzell:]

Right. So I guess digging on that, and you can stop me if it's too in depth, but is it safe to assume north of 300 stores, 400 stores in the footprint?

[Ryan Woodley:]

It can be, but we also have smaller retailers who do significant volume out of – retailers who do significant volume out of a smaller retail footprint – door account footprint.

[J. R. Bizzell:]

Excellent. Thanks for taking my follow-up.

[Operator:]

And our next question is a follow-up from Brad Thomas of KeyBanc Capital Markets. Please go ahead.

[Bradley B. Thomas:]

Thanks for getting me back on. Just a couple of other housekeeping questions, if I could. Just on these national accounts, could you comment on the margin profile, if you work with a larger customer, would the margin profile be similar or might it be different?

[Ryan Woodley:]

Yeah. We expect the opportunities that we are currently rolling out and have in our pipeline will be consistent with the profitability profile of our existing relationships.

[Bradley B. Thomas:]

Great. And then one more on Progressive. Obviously, the doors from a national account could be very exciting. But as you think about the revenue outlook for Progressive, if you didn't sign the national accounts, what do you think Progressive would grow at next year just continuing to build on the relationships that you have with the existing retailers?

[Ryan Woodley:]

We've said, I guess, many times now, we're confident in our pipeline, and we know that the opportunity in 2016 and beyond is to go out and execute on that pipeline, and that's our plan. Of course, we'll provide guidance later, but the opportunity for us and our responsibility at this point is to go out and execute on the large pipeline that's in front of us.

[John W. Robinson:]

And this is John, David (sic) [Brad] (55

[Bradley B. Thomas:]

Great, great. And then turning over to the smartphones; Gil, Steve, what are you assuming for the margin profile for smartphones?

[Ryan Woodley:]

Yeah, good question. So we've priced the phones and have analyzed kind of the roundtrip or lifecycle if you will. We do expect that there will be more breakage and damage than in a typical category, but we feel like we've priced for that. We're going to be aggressive in moving pre-lease phones through the system in order to not have obsolescence issues. But all of that has been taken into consideration in our pricing. So we feel that it's going to be a normal kind of electronics type margin profile.

[Bradley B. Thomas:]

Great. Well, thanks for taking my next round of questions and good luck to you all.

[Gilbert L. Danielson:]

Thank you.

[Ryan Woodley:]

Thank you.

[Operator:]

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

[John W. Robinson:]

We appreciate your interest in the company. We look forward to updating you after our fourth quarter results. Thank you.

[Operator:]

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