Upbound Group, Inc.
Q2 2010 Earnings Call Transcript

Published: 27 Jul 2010

[Executives:]

David Carpenter - VP, IR Mark Speese - Chairman & CEO Mitch Fadel - President & COO Robert Davis - EVP-Finance & CFO

[Analysts:]

David Burtzlaff Budd Bugatch Arvind Bhatia Laura Champine John Baugh Mike Grondahl John Rowan

[Operator:]

Good morning and thank you for holding. Welcome to Rent-A-Center's second quarter 2010 earnings release conference call. At this time, all participants are in a listen-only mode. Following today's presentation, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded on Tuesday, July 27, 2010. Your speakers today are Mark Speese, Chairman and Chief Executive Officer of Rent-A-Center; Mitch Fadel, President and Chief Operating Officer; Robert Davis, Chief Financial Officer; and David Carpenter, Vice President of Investor Relations. I would now like to turn the conference over to Mr. Carpenter. Please go ahead, sir.

[David Carpenter:]

Thank you, Jackie. Good morning everyone and thank you for joining us. You should have received a copy of the earnings release, distributed after the market closed yesterday that outlines our operational and financial results that were made in the second quarter. If for some reason you did not receive a copy of the release, you can download it from our website at investor.rentacenter.com. In addition, certain financial and statistical information will be discussed during the conference call, will also be provided on the same website. Also in accordance with SEC rules concerning non-GAAP financial measures, the reconciliation of EBITDA is provided in our earnings press release under the statement of earnings highlight. Finally, I must remind you that some of the statements made in this call, such as forecasts, growth in revenues, earnings, operating margins, cash flow and profitability and other business or trend information are forward-looking statements. These matters are, of course, subject to many factors that could cause actual results to differ materially from our expectations reflected in the forward-looking statements. These factors are described in the earnings release issued yesterday as well as our most recent quarterly report on form 10-Q for the quarter ended March 31, 2010. Rent-A-Center undertakes no obligation to publicly update or revise any forward-looking statements. And now I would like to turn the conference call over to Mark. Mark?

[Mark Speese:]

Thank you, David. Good morning everyone, and thank you for joining us on our second quarter earnings call. As you read in the press release, the company announced strong earnings for the second quarter, ending June 30, as well as the introduction of our first ever cash dividend and an increase in our share repurchase authorization to $600 million. Let me share a little about each of these and then I will ask Mitch and Robert to provide some additional details. With regard to our business in general, despite the slow economic recovery, the overall tone remains fairly positive. Now what I mean by that is that our traffic, as measured by the number of deliveries made per week, continues to run at or above last year's numbers, where we saw strong double-digit increases. The demand for our products and services remains strong, and in fact we believe that more consumers are coming to appreciate the ease and flexibility of our transaction. Now while our rental and fee revenue was slightly less than expected, that was caused by both some price declines, driven by continued deflation in some products, resulting in lower weekly rental payments, and some promotional activity on our part, as well as a slight increase in our weekly delinquency numbers, resulting in lower revenue collected than expected. A slight increase in delinquency did not affect the loss read in the second quarter, but rather has led to more returns of products, more pickups that would otherwise have been expected. Certainly, consumers remain under pressure and discretionary spending is limited, yet we continue to see good demand for our products on the front-end. Of course, at the same time, we continue to make excellent strives in our expensive agents. Our gross profit margins have improved, be it in depreciation or our margins on sales products and our operating expenses have been reduced due to many of the controlled initiatives that have been implemented over the last year that we've spoken. All of that gives us comfort in reaching the low end of our annual guidance, now at $2.65 and $2.80 per share, up from the $2.60 and $2.80. So all in all, a good operating quarter for us and again mention, Robert will provide a little bit more color on that in a moment. Now let me talk for a moment about our efforts to increase shareholder value. As always our first objective is to invest in the business for the future. In that vain you have heard us speak of a couple of initiatives that we are working on. One called ramp acceptance, which is our new model of a kiosk inside refill furniture stores, whereby the prospected customers denied credit financing from that retailer or the provider, we ramp acceptance, acquired products from the retailer and offer to the consumer under a rental purchase transaction. We now have over 100 of these kiosks inside various retailers, with dozens more in the works. Of course, the other big initiative we have spoken about is our entry into Mexico. We continue to aggressively prepare for an entry, expecting our first-handful of scores to be opened during the fourth quarter of this year. That said, and knowing that our third quarter earnings update which we'll provide in late October will also include the first outlook for 2011, we will, at that time, be providing a detailed overview of these and other business initiatives, including our strategic rationale, our expectations, the timing and the impact. We are very excited about these, and look forward to discussing them in detail with you at that time. Of course, the other exciting news announced in the earnings release is the Board's authorization of a quarterly cash dividend as well as an increase in our stock repurchase reauthorization to $600 million one additional $100 billion. Our strong recurring revenue net cash flow coupled with our strong balance sheet provides us with the financial flexibility, and we view these actions as a great way to return value to our shareholders. As I mentioned, the first quarterly dividend will be paid on August 26, all common shareholders of (inaudible) at the close of business on August 12. We expect any future share repurchases will continue do be done opportunistically in the open market as they have by and large in the past. So we remain cautiously optimistic. We know the demand for products and services is there. We believe our potential market is expanding. In fact, recent reports on credit scores now show approximately 35% of the individuals, up from approximately 27%, with credit scores of less than 650, which is considered sub-prime. First of all, unemployment remains high. The extension of benefits should also prove favorable, allowing consumers to retain or obtain the necessities of life. All the while we continue to do all that we can to enhance the customer's experience with us. I do want to thank all of our coworkers for their hard work and their commitment and I thank you for your support, as well. With that let me turn it over to Mitch to provide you with few more details on the operational details. Mitch?

[Mitch Fadel:]

Thanks Mark and good morning everyone. We are pleased with our results in the quarter as our store and total revenue were within guidance ranges. Additionally, we exceeded our earnings guidance of $0.72 per share of earnings by continuing to execute on our expense management initiatives and by continuing to improve our inventory management. Now it's important to understand here that even though our revenue per agreement is down slightly and that caused the slight rental income softness for the quarter, the overall margin per agreement is higher. In other words, there is more deflation in our inventory costs, especially in electronics, than there is in the rental rates and terms. As we passed some of the deflation on to the customer to remain competitive, we are using some of it to increase inventory margins. A little less revenue per agreement, but more gross dollars per agreement is still a very healthy combination. Same-store sales were positive 0.1% and albeit a very small number, it's our first positive comp since seven quarters. Customer traffic and demand remained solid, and the number of units rented on each agreement held steady during the quarter. We're continuing our targeted marketing and advertising, focusing on strong values for the consumer, and we continue to believe, as Mark mentioned, the tightening of consumer credits made transactions more viable for an increasing number of consumers. Now, with regard to collections, as Mark was talking about, our weekly delinquency average for the quarter was up slightly as the consumer remains under pressure. The good news here is that our customer skipped installments as a percent of store revenue for the second quarter, came in at 2.2%, tied for the lowest second quarter in the last five years. Due to the positive impact of our new inventory management system our held-for-rent inventory level ended the quarter at 26.5%, slightly above our historical range, but certainly not a level that concerns us. Our new centralized program is getting more merchandise into the stores quicker than we need to manage our orders. We certainly have fewer products out of stock now as the program is working. And we will continue to tweak the system. We still see what the normal range of held-for-rent merchandise that exist with the more proactive ordering system. Some history with this new system will allow us to continue to refine the way it works both in assortment and inventory productivity. In financial services, we are seeing positives for operating income as that business continues to perform well. Unfortunately, due to legislative changes in three states, we decided to close our 39 kiosks in Washington, Colorado and Arizona. These closures won't have a material impact on the future revenue and earnings. And additionally, we will be opening another 30 kiosks or so between now and year-end in States that currently have favorable legislation. And we remain confident in our ability to grow that business in those selected states. In summary, we will continue driving customer traffic to valued competition by purchasing high quality products and good price points and targeting our marketing and advertising accordingly. We also continue to focus on maintaining control of delinquency and losses, while managing our inventories through our new centralized system, all with the overall goal of driving revenue and increasing our margins and profitability. I would also like to thank our 18000 co-workers for their excellent execution, and with that I will turn it over to Robert.

[Robert Davis:]

Thank you, Mitch. I will spend a few moments updating you on our financial highlights during this quarter, as well as, updated guidance for the balances of the year. After which we will open the call for questions. I would like to mention, that much of the information I provide, whether it is historical results or forecasted results, will be presented on a reoccurring and comparable basis. So, at that, with press release, total revenues were $671.5 million during the second quarter of 2010, down $8.1 million as compared to the second quarter of last year. As the Press Release alluded to, however, taking into account our debenture of prepaid telecommunications energy theory last fall, total revenues actually increased during the period with the same store sales increasing the 0.1%. Margins continues to improve, both on the product side, as well as, on the operating profit side. We have seen a 50 basis point improvement in the cost of rental fees margins during the quarter, which along with continued strength and our strict expense management initiative had led to an operating profit margin of 12.3% in the third quarter, an improvement of 150 base points over the prior year. Net earnings and diluted earnings per share were $47.8 million and $0.72 respectively, increases of 17.2% and 18% respectively. Our second quarter EBIDTA came in at just over $100 million. A 9.5% increase from the prior year, while EBIDTA margin increased 140 basis point from the period to 14.9%, our highest quarterly EBIDTA margin in the last three years. We continue to post strong results in both EBIDTA and margins and both are improving over historical results. Our strong EBIDTA results continue to translate into solid return and capital generation, as we posted positive cash flow during the quarter and ended over $74 million in cash on hand. During the quarter, we utilized our cash to reduce our outstanding indebtedness by approximately $14 million between mandatory and optional prepays. Calculation our increased EBIDTA and lower overall indebtedness have reduced our leverage to the lowest point in the last six years, to 1.52 times. Our current leverage, along with strength and cash flow, provide us with more than adequate flexibility with regard to capital allocation. As Mark mentioned, we will first and foremost continue to invest in the business. However, our continued effort to return shareholder value and as a result of our continued belief in long-term prospects and value of the company, during second quarter we purchased over 268,000 shares of our common stock for approximately $68 million. Our goal of enhancing shareholder values further evidence of our announcement this quarter of our first ever cash dividends, as well as $100 million increase in the board authorized share repurchase program. In terms of guidance, we anticipate for the third quarter of 2010, total revenue to range between $648 million to $663 million with same store sales expect to be approximately flat. Moving now to the share, we are guiding the third quarter to a range between $0.52 and $0.58. The annual guidance for 2010 was a total revenue to fall in the range of 2.7 out of 6, and $2.736 billion, and same store sales expected to be approximately flat. The diluted earnings per share are now expected to range between $265 million and $280 million, as we have increased the lower end of our previous guidance. In terms of EBITDA and free cash flow, the company still expects EBIDTA to range between $375 million and $395 million, and the free cash flow for the year to be in a range of $120 million and $140 million. I would also say the current values exclude any potential benefits associated with potential future stock repurchases or dividends, changes in our pertaining business or acquisitions or dispositions completed after the date of the press release. With that update, we would now be happy to take questions. Jackie, if you would now compile the Q&A roster.

[Operator:]

(Operator Instructions) Your first question comes from the line of David Burtzlaff. Your line is now open.

[David Burtzlaff:]

Good morning. A few questions. Mitch, on the inventory, you talked about being at 26.5% idle for the quarter. So is that something you are still just in the works and trying to figure out, or is that something with businesses is if it slowed down at all?

[Mitch Fadel:]

Maybe a little bit on business slowing down in the summer. That is a seasonal number, anyhow, but I think more so, is that it’s a more proactive system, and it is filling needs of the source faster than when 3000 different managers order their own inventory. So, I am not sure if it will stay around 26.5. That may be a little high because of the seasonality and I still think, we’ll see even with this system, we will see it higher in the summer than in the other quarters. I am not sure exactly where it’s going to level up. We are happy with the way the program is working. We are tweaking it a little bit, as with any new system, but I think it’s just the fact that it’s more proactive as when our managers ordered. 20% to 24% used to be the range we be inventory would be in depending on the quarter and the seasonality. And that may move, we have not really give a new range yet, but we want to see how the new system performs over the next couple of quarters as we tweak it. But in general, it is just because it is a more proactive ordering system than when all 3000 managers ordered for themselves.

[David Burtzlaff:]

Okay. And then, Robert, free cash flow in a normal year, is that around $175 million?

[Robert Davis:]

That is closer to a couple hundred million.

[David Burtzlaff:]

Okay.

[Robert Davis:]

I have given a range of $120 million to $140 million this year, but we will be paying excess taxes this year as the return of benefits in prior years associated with both appreciation, so our tax allocation this year is roughly around $170 million more normalized in future periods and we would expect it to be more closely aligned with $200 million.

[David Burtzlaff:]

Okay. And then finally, on the payday side of the business, can you quantify how positive that was this quarter?

[Mitch Fadel:]

Yes, we can. Bear with me just for a second. Mark mentioned store operating income was positive for the quarter just over $1 million. Now one thing you may have noticed in our release, the amortization was tangible, a little higher than it had been historically, so there is 39 kiosks that we shut down. We did take a charge in the quarter of $1.5 million in good will and $1.5 million in assets and loan reserves for shutting those stores down. So, there was a charge in the quarter for financial services business, but not material number and overall, it was positive in store operating income level, about $1 million.

[David Burtzlaff:]

So the million includes about the $3 million charge?

[Robert Davis:]

Not the good will piece. About half of it.

[David Burtzlaff:]

Okay.

[Robert Davis:]

So, store operating income, if you break that down, a 2 million for the quarter without that charge.

[David Burtzlaff:]

Now was that above your expectations?

[Mitch Fadel:]

Slightly.

[David Burtzlaff - Stephens, Inc.:]

Okay. So you are seeing pickup and demand. And the stores that are closing you said are Washington, Arizona…

[Mitch Fadel:]

And Colorado.

[David Burtzlaff:]

And Colorado. Okay. Thank you very much.

[Operator:]

Your next question comes from the line of Budd Bugatch. Your line is now open.

[Budd Bugatch:]

Good morning and congratulations on the quarter. Can you talk a little about the dividend policy, how you are looking at in the future? How should we think about in terms of a payout ratio or other metrics you may, the Board may consider for dividend policy?

[Mark Speese:]

Yes. Bud, this is Mark. Well, at this point, obviously the Board authorized the initiation of the dividend for the first time. And as you can calculate, it equates to about 1%, $0.06 per share. It is our expectation to continue doing that in the future. Now in terms of how that may move in the future, no decision has been made at this point. Obviously we'll continue to evaluate or reevaluate it, if you will, based on the other uses of cash and/or performance of the company and so forth. As I said, the expectation, of course, is still investing in the business. And again, in that vain, we will be able to give a lot. Our expectation is to share quite a bit more on this next call, next quarter in terms of some of these other initiatives; Mexico ramp acceptance of the ways. It will quantify some of that in terms of cash outlays, and growth ramp up and return on those investments and so forth. But then again, that will also all play into any future thoughts or conversations about dividends in terms of what may change on those in future periods.

[Budd Bugatch:]

Okay. Talk to us a little bit more about the issue of unemployment amongst your customers, how you are looking at that, maybe, get your crystal ball out and see when you think things may improve or at what rate they may improve?

[Mark Speese:]

Well, quite candidly, the crystal ball is pretty cloudy when it comes to the unemployment environment. And I say that, it's pretty hard to quantify what percentage of our customers may be on unemployment and receiving benefits were affected by. So when the benefits stop, of course, we know that the Congress has passed legislation extending those, so we view that optimistically. It is pretty hard to quantify what impact it’s going to have, but I think intuitively we all believe there’s certainly some segment of our customer base that was adversely affected by a lack of employment and/or reduction in benefits and so forth. When it really started a year ago, we started to see more regional impacts of the unemployment. In couple of states it went up pretty aggressively early on. We don't see much of that anymore. So it has kind of settled in. Right? I mean, unemployment hasn’t really worsened. It hasn't improved, but it hasn't worsened and so the results that we are seeing today is pretty consistent throughout the country. They are not regional differences much like we might have seen a year or year-and-a-half ago. Not to say that some stores are under pressure, but it’s, I guess, more consistent, I would say, throughout the country. Hopefully, things will continue to take place and incentivize businesses to grow because that’s what’s going to, that will lead to job creation and it’s hard to predict that, and also the benefits being extended. Well, certainly that’s a positive. We do view that at least in the near term, and that consumers might have lost all their benefits and income, obviously now that I had some and its like moving to comments whether that’s their ability to retain and rotate necessities. And I say that whether it’s a bed to sleep on, or a refrigerator, or whatever the case maybe, those are necessities and so we do view that optimistically. Consumers are, and I think we all know that, there is certainly some uncertainty, a lot of uncertainty in consumers' minds and they are under a lot of pressure still. And discretionary spending, I think across all businesses, has been not surprisingly, it's been basically non-existent. People are spending money, where, when and how they need to with not much beyond that, or should they at this point.

[Budd Bugatch:]

My last question is just talking about FinReg and obviously, it doesn't affect or at least in the near term are the RTO business but probably the payday lending business or the financial services segment. Can you talk a little bit about what you’re seeing so far in that and what your concerns are, what your views are?

[Mark Speese:]

Budd, you’re right. As it relates to the rent-to-own, it’s not covered because of the short initial terms. The definition of a covered release and that definition excludes leases with an initial term of 90 days or less, which is what the rent-to-own agreement offers. With regards to the financial services, you are correct and that is by definition covered. Now what impact that will have on the business in the future is frankly speculative at this point. I say that, albeit if the law has been passed, of course, they have not yet appointed a commission or an individual or bi-governing body that will have the oversight, and once that happens, they or that person will then start addressing all the instruments within that. And it will be left up to them in terms of what actions maybe put in place in the future. And so at this point it is purely speculative because none of that has taken place, and the card timing is also part of it. So, the only thing we can tell you is, yes, financial services by definition will fall under the CFPA or PB as they call it now. But why not, is there any actual impact that will have on the business, we don't know at this point, not until it’s addressed by that committee.

[Operator:]

Your next question comes from the line of Arvind Bhatia. Your line is now open.

[Arvind Bhatia:]

The first question is just trying to understand the trends throughout the second quarter, if there was any difference from month-to-month. And then perhaps post the quarter, which you are seeing so far in July, I heard some of the comments you made, Mark. But just wanted to understand, how things trended over the last few months? And then, I think you said you want to discuss most of your initiatives next quarter. So I wondered if you could touch on Mexico a little bit and give us the size of the market that you see, so we can at least start to think in terms of the overall big picture there.

[Mitch Fadel:]

I’ll start with the trend and then Mark can talk about some of those initiatives. During the quarter, as Mark pointed out, from a delivery standpoint throughout the quarter, we ended up above last year, so the demand was there. As we've said, the returns were a little higher and the revenue per agreement was a little low, and that’s why we are on the lower end of the revenue guidance. But then revenue per agreement being lower, as I mentioned, Arvind, it’s at higher margin, so that’s helping, I think Robert mentioned, the 50 basis points at the inventory margin level. So, little less revenue but a lot less cost in their product is a pretty good combination, in fact, a very good combination. But trends for the business evens out. So far through July has been about what we expected. The demand is still there, nothing surprising about July and there was nothing in our guidance going forward and no surprises. Demand is still there. Certainly we’re seeing the consumer under pressure. But the demand is holding up, as well, not only throughout pretty evenly throughout the second quarter, but into July, as well.

[Mark Speese:]

And then your question concerning Mexico, and again, as you alluded or I alluded in the next quarter's call, it is our expectation to get much more granular on that, and some of the other initiatives, again, what the rationale is behind the outage some of our core competency, how we’re going to go about approaching these markets, some of our long-term and short-term expectations in terms of ramp up, use of capital, impact and so forth. Mexico’s got 100 million people plus, and suffice it to say that, all the work that we've done at this point, as we look at the market in size and demographics and consumer, we believe that this model has got application. Suffice it to say, we still have a lot of earning to do and in fact even get them up and running. You’ve got to prove things out, which again we know we’ll be in a much better position next quarter. We may even have several after the settlement in the fourth quarter; probably have a couple of them opened in advance of that call. So we’ll be in a little bit better position to give more specific information, which is why we chose to say we would do it then, also. So a lot more to come. But rather than speculating, I’ll rather be able to give you the specifics on the next call, if you don't mind.

[Arvind Bhatia:]

Sure. And then one question for Robert. The salaries and other lines, better than expected. Just wonder if you could, may be get into a little bit more and talk about some of the costs areas where you have exceeded expectations, and where you think there is more room in the coming quarters?

[Robert Davis:]

Sure, Arvind. And I think, as you pointed out, the salaries and other lines, the other areas of the margin, well, the operating profit margins are improving in large part due to the benefits we are seeing and some of the cost initiatives. And so far this year, if you compare it to last year quarter-over-quarter, in that line alone, we have saved or decreased costs approximately 13 million in a couple of quarters. We do expect that number to go up in the third quarter, primarily due to seasonality and the number of business days. But overall for the year, we expect that trend that we have seen to somewhat continue. And the area you talked about before are related to areas all across the P&L, from fleet management to office and store supplies. We have kicked off a initiative here to really address the sourcing, indirect spend. Mitch talked about more of the product side and deflation we are seeing in those categories, but we are also taking a more proactive approach on some of the indirect spin item that is go into supporting the store operations, be it store operating forms, office supplies, all up and down the P&L. And we have already seen some of that benefit, but the longer term impacts, we are still in the middle of the project. We are going to include some of that here between now and the end of the year and be able to give more definitive guidance and color on that. Mark mentioned other initiative on the October call. One of those is what we are talking about here, not just growth on the store side, but also, some of the things that we have been doing on managing costs on the backside. So we will provide more color on that in the October quarter, as well.

[Operator:]

Your next question comes from the line of Laura Champine. Your line is now open.

[Laura Champine:]

Good morning, guys. I have got a follow-up question on the deflation comments that you made. When you said that it is healthy to have price per agreement down, because you are driving more, my interpretation was that you think you are driving more conversions or more traffic by having the lower price points. Did I read that right? And if so, how long are you willing to pass on lower prices or to take a little bit of a margin hit in order to try to drive traffic?

[Mitch Fadel:]

Well, it certainly is always a balance, Laura, how we price it against our competition relative to the margin. What I mean by being healthier, it is not so much that we want to have lower revenue per agreement. We would like to have higher revenue per agreement. We brought it down a little, especially in electronics, there has been so much deflation in TVs and computers. You have to bring it down some. And of course you can bring down term or price. And we tend to bring down term more than the rate, but to stay competitive, we do have to bring down the rate, as well. But we haven't brought the rate down as much as the cost deflation. That’s tough from the margins. The revenue per agreement is down just slightly, as you can see we are only up about 1%. If you think about an example this way just use wrong numbers. If you think about a monthly rate of $100, and you know our cost basis is about $25 every hundred. So, if a year ago it was $100 minus 25, today maybe it's 98 minus $22. So, we've got $75 gross margin, we've got $76 gross margin. Instead of 100 minus 25, we've got 98 minus 22. And that's what, I mean, by being healthy, where we're taking some of the cost deflation, passing it onto the customer and then using some of it to increase our margins. If we can keep it all for margins and leave the revenue pre agreement at 100, a 100 minus 22, in my example is even better, if you can drive enough business doing that. So, we've got a balance, but right now we're giving some of the cost inflation into our pricing, and traffic is there. So, we think that's driving enough traffic, not enough to offset from a revenue standpoint, a little drop, the difference between 100 and 98 from my example. But it's driving enough the record. We mentioned the deliveries are running ahead of last year, and we're doing it at a higher margin. So, we think that's a good combination. As we can move on back up, we certainly will. The deflation has been so fast in electronics and computers that it is hard to leave the rate upward. As you can see in the revenue, we have only dropped it a very slight bit. We are talking about real slight decrease in the revenue, but a nice increase in the margin.

[Laura Champine:]

The other point that you mentioned is that delinquency rates have picked up some. And I think that you commented the consumer is under pressure, but the consumer has been under pressure, and your delinquency rates have been great. Did something change? Did we hit a wall? Were there any execution issues in the quarter?

[Mitch Fadel:]

No, I don't think so. And again, the keyword there I think is 'slight' in terms of how much it went up. I mentioned our losses. The number that we get more specific on every quarter, our loss number is 2.2% for the quarter, tied for the lowest in the last five years. So, the loss number is still running great. It ran great in the second quarter. Again, it's a slight increase. Why now versus the fact that customer has been under pressure for quite a while now. I don't have an answer for you. I will say it's a very slight increase.

[Operator:]

Your next question comes from the line of John Baugh. Your line is now open.

[John Baugh:]

Thank you, and terrific margin quarter there. I want to go back to the inventory level, because at 26 and change is certainly above and I know it's a seasonally high quarter for you. But I am curious, if you're going to carry a higher inventory help for rent number, my suspicious or assumption is that you're seeing some kind of revenue, positive revenue impact from that. Is it too early to tell, with the new system, in other words, that's the trade off, if that happens? But I assume you need that to happen if you are talking about carrying a higher percentage of inventory on the floor.

[Mitch Fadel:]

I certainly agree with that, John. If the new system, by being more proactive is going to put more inventory in the stores, as it has here in the very early first few months of the system, then we need to do more revenue to pay for that. If we don't, then if it is not paying off in more revenue, you have to tweak the system to slow it down a little bit, right? So if we normalize a couple of percent higher than we used to, then we would expect to see in the revenue over time and if not less by tweak its automated system. You can't have more inventory without revenue. You can't for the first quarter on the system like we are now right now. But over time you wouldn't want to live with a couple higher percent inventory if you weren't doing anymore revenue.

[John Baugh:]

Okay. And then….

[Mitch Fadel:]

The other way you have heard me say this before John, you have followed us a long time. You always say, well, ideally you have 100 or 165 pieces of vital inventory at a given time. Well, right now we have got about 180 and that is really the difference. I mean, those are real numbers. So, as we have got 15, 18 more pieces per store. At this point it becomes a question of the 18 that we have, we believe the system is buying products and putting minimums in there that the store didn't otherwise. And so by default, it is going to go up. Now as we get experience, we will see maybe which ones we didn't need as much of and does that take it back down to the 160. I think the other thing is important, we don't really know at this point what the real number should be. We said it was always 160, 165, and that was based on how we always did it, which was relying on 3,000 buyers. Well, today, now with the analytics and predicting side of it, as we get more history and actual results, that will then lead us to where we think that numbers should be. And again, I don't know where it will settle, 170, 160, 180, but if you got, again, the right products and the right quantities, then the actions should also translate into what the goals are in the first place, more revenue.

[John Baugh:]

Okay. And then if we went down the worst case path for payday and you were force to shut all the stores down, would the charge, and I calculated about $0.75 million per store, that you incurred here between goodwill and asset write-down. Would that be similar for the remaining 300 odd places where you have it, or would that defer? And then what, if any cash impact from closing these stores favorably or negatively?

[Mark Speese:]

I would estimate, right now, John that we've got about $7 million carrying cost on the assets, give or take a few pennies or few dollars one way or the other. I don't have the number specific will in any mind, but just nothing more specific that’s the comps going into it or how long it has been open. I’m estimating around $7 million of fixed asset if we have to go down to your point, the Armageddon route. Our loan value right now is around $25 million. One of the highest levels it has ever been. So, from that perspective it is healthy, we are growing and it is strong. But then it becomes a matter of what the collectibility on that business had to shut down. And so, that $25 million wouldn't all be written off until you collect some of that for quite sometime until you make a determination it is uncollectible. So, I would suspect maybe $10 million number all ends between the assets and maybe reserves on the losses. That is purely the Armageddon route that you referred to.

[John Baugh:]

So, that is the P&L number, 10 million? Robert? How about the cash guess? I guess it depend s on how much of those loans you ultimately collect?

[Robert Davis:]

Yes. It is 3 million or so that we might determine is uncollectible after we collect out on the loan balance. So we have got 25 million of working capital on the street, we are reflecting on as we speak. And to the extend we’re able to collect on that. If you shut it down, that would be the cash numbers. The numbers I am giving you, 10 minus 7 on fixed assets is 3 million or so cash.

[John Baugh:]

Okay. And then just quickly, I don't believe Canada has favorable regulatory environments for rent-to-own is Mexico different? Has something changed there? Just curious, I don't want to get into a discussion of Mexico, per say, but just what laws are down there?

[Mark Speese:]

The current environment is silent on the rental transactions, and we don't deal with them negatively or adversarial at this point, based on lot of research we have done. Canada at this point has, there has been an opinion or ruling or two on it, but that is not the case in Mexico.

[John Baugh:]

Are there other rent-to-own operators operating in Mexico today of any note?

[Mark Speese:]

Not rent-to-own as we define it here, no.

[Operator:]

Your next question comes from the line of Mike Grondahl. Your line is now open.

[Mike Grondahl:]

Thank you for taking my calls, guys. The first one is on EBIDTA margin. The last two years it really expanded nicely. Where do you think it can go? What other levers do you have to pull there?

[Mark Speese:]

Well, certainly what we talked about in prepared comments, we can’t help you increase this year over last, from a seasonality perspective the third quarter is expected to be down sequentially from the second quarter we are today. But up over the part of the year, based on the guidance that we have given, overall for 2010 as compared to 2009, we are expecting it to be up in the range of improvement over prior quarter that is we have spoken about, a hundred basis points or so. Beyond 2010 we will be providing more color on 2011 in a couple of months here after the third quarter release. That will take into consideration the impact of some of the initiatives wrap up and so forth. So, if you ramp up in terms of Mexico, we could expect some margin decline at the start phase, just depending how material remember that we’re looking to ramp up. We haven't made those decisions. I am just trying to let you know that what we have seen so far this year is a healthy increase. In 2011, we haven't given guidance on yet, but depending on the initiatives and what level you increase the initiatives, we will have an impact on the margins.

[Northland Capital Markets:]

Sure. And then, if you could just talk to a high level, you know the dividend announcement I think is very positive, increase in the buy back. What do you guys really want to accomplish here over the next couple years. Is it shrinking your equity base? Is it about capital allocation? I mean, just kind of some thoughts driving returning value to shareholders?

[Mark Speese:]

I would say, Mike, first and foremost we believe we can continue to do that by growing the enterprise and that speaks to the initiatives that we are talking about, be it Mexico or RAC acceptance or some of the other things. Beyond that, obviously you know we are a mature, healthy company certainly within the U.S. marketplace as we demonstrated time and again. We’ve strong balance sheet. We generate pretty significant free cash flow. We are comfortable with where the balance sheet is today based on what we did the last couple of years, as we paid debt down, as we did the amendment extend. That has given us, give some flexibility to what could other ways for returning value which is what led to the decision with the Board to both introduce the dividend, as well as increase the share repurchase. We are not sitting there with a mindset of how do we just buyback stock? I mean, we will look at that opportunistically. Where we make sense, we will certainly do that. But there are other ways that we want to return value to the shareholders, which is frankly drawing the enterprise and the introduction of the dividend, and maybe even the share repurchase becomes third to do that.

[Mike Grondahl:]

Got you. That's great. And then just lastly, debt to EBIDTA has fallen in the last three or four years significantly from maybe 4 to 4.5 times, down to 1.5 times. How do you think of about that metric going forward? I mean, what if this was a private business, what would that number be?

[Mark Speese:]

Well, I guess, thinking back historically our lenders ratios have been high a couple of times primarily as a byproduct of a large acquisition. Back in 1998, we were over 6 times leverage, we were able to grow the EBIDTA levels and maintain a healthy balance of paying down debt. And we got that lenders' ratios around 2 times per show maybe slightly under. In the fall of 2006, we leveraged back up to make a large acquisition of the number three players in the industry.

[Mike Grondahl:]

Right.

[Robert Davis:]

We were around 4 times the leverage at that point. Again, throw growing that enterprise and making increases in EBITDA as well as managing the debt balance, we certainly are down below 2 times now at 1.5 as you indicated. We have said all along we are very comfortable at leverage 2 times or less. We are not afraid to lever back up for the right opportunity and the right reason. But as we sit here today and think about leverage going forward, just by the sheer nature of mandatory debt payments coming due, and our expectation of growing EBIDTA, that number will continue to decline. To the extent there is a large reason for us to take on initial debt to grow the business, than that obviously will be addressed at that point in time.

[Operator:]

(Operator Instructions) Your next question comes from the line of John Rowan. You are line is now open.

[John Rowan:]

Mark, you mentioned the kiosk that you are installing in retailers. Can you just remind me, is that only in furniture retailers or are you looking to expand that potentially beyond just that group?

[Mark Speese:]

Certainly today it is only furniture retailers. We are considering and exploring how it may be applied beyond the furniture, but today it is only in furniture.

[John Rowan:]

And just one more quick question. Where kind of in Mexico are the stores going to be located?

[Mark Speese:]

Well, initially we are spending most of our time along the border, I guess what would be considered the east side of the border, from Texas over that way. Ultimately, our expectations would be to go interior as well.

[John Rowan:]

And do you think there is a opportunity to put financial services in those stores as well?

[Mark Speese:]

Certainly at some point, we know there are variations or versions of payday lending, if you will, or financial service providers in that country today, both in brick and mortar and internet, and so, might we at some point add that, certainly that’s a consideration. It is not our expectation to do it initially.

[Operator:]

Your next question comes from the line of [Jordan Hamalic]. Your line is now open.

[Unidentified Analyst:]

Two things, one, where is the line in the sand now on inventory levels. In other words, the line was always in the low 20s before, now it is 26 with the new system. But where is the line in the sand, you’re seeing, you know what it's just too much; we have to reduce the inventory held for rent?

[Mitch Fadel:]

Well, we’re not sure yet. It’s really the first full quarter that all our stores have been on it, was this past quarter. We’re making some changes internally on the way it works in different product categories. I think we need another, at least one more quarter, maybe two, to know exactly where to draw the line in the sand as you put it. I think we’re going to need another quarter or two to determine that.

[Unidentified Analyst:]

Can you explain why again a new inventory system would make the number go up and not down?

[Mitch Fadel:]

Yes. Initially it’s because it's more proactive. When we have 3,000 managers ordering for themselves, we had more products out of stock. Reason we put the new system is because we felt like we could reduce those product out of stock and we have. And that would help our business overall. And as I mentioned earlier on the prior question was that, in doing that, you’d expect a revenue increase down the road, if we have less out of stock, you should expect revenue. If we don't get the revenue increases, it doesn't help our business and we'll have to cut back on the inventory. But the reason is, it’s more proactive is ordering weekly now living up to 3,000 managers into it.

[Unidentified Analyst:]

That makes sense. And second question, on the payday lending. If you have $25 million on the balance sheet, I mean these companies usually have a 20% loss to revenue numbers and you said you may only lose $3 million or $4 million. Are you already that’s the way assuming already net of a loss allowance, and you’re saying $3 million or of $4 million or is that inclusive of that number?

[Robert Davis:]

No. The $3 million or $4 million more, there’s already loss allowance on the balance sheet as well.

[Unidentified Analyst:]

Okay. So…

[Robert Davis:]

And discontinuing a business like that toward the losses would run higher than the normal day-to-day business. So that $3 million, ours currently would be in it maybe it will run 30% loss is in the wind number at this point.

[Unidentified Analyst:]

And what is the loss allowance at present again, or what is the gross number of 25 is a net number?

[Robert Davis:]

We’re running about a 20% loss rate, so the net number would be roughly $20 million.

[Unidentified Analyst:]

No, the net number would had 25 and the gross number would be 30, right? Is 25 the net or the gross number?

[Robert Davis:]

No, the 25 is the gross number. There is a $5 million allowance, roughly, against that $25 million, for a loss provision, if you will so...

[Unidentified Analyst:]

Okay. And then you’re saying that makes sense.

[Operator:]

There are no further questions at this time. I will now turn the call over to Mark Speese. Please go ahead, sir.

[Mark Speese:]

Ladies and gentlemen, thank you very much for your interest. Thank you for joining us today. Do know we have to remain focused on growing our business and returning value to our shareholders. And we do look forward to talking to you next quarter and providing you more insight on these other initiatives as well as our then current results. So thanks again, have a great day. We’ll look forward to speaking to you in the future.

[Operator:]

This concludes today's conference call. You may now disconnect.