World Acceptance Corporation (WRLD) Q2 2013 Earnings Report, Transcript and Summary

Good morning, and welcome to the World Acceptance Corporation-Sponsored Second Quarter Press Release Conference Call. This call is being recorded. [Operator Instructions] Before we begin, the Corporation has requested that I make the following announcement. The comments made during this conference may contain certain forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act that represent the Corporation's expectations and beliefs concerning future events. Such forward-looking statements are about matters that are inherently subject to risk and uncertainties. Statements other than those of historical fact as well as those identified by the words anticipate, estimate, intend, plan, expect, believe, may, will and should or any variation of the forgoing and similar expressions are forward-looking statements. Factors that could cause actual results or performance to differ from the expectations expressed or implied in such forward-looking statements include the factors discussed in today’s earnings press release and in the Risk Factor section of the corporation's most recent Form 10-K and other reports filed with our -- or furnished to the SEC from time to time. The corporation does not undertake any obligation to update any forward-looking statements it makes. At this time it is my pleasure to turn the floor over to your host, Sandy McLean, CEO.

Thank you, Melanie. Because of certain circumstances and the concern for fair disclosure, the company decided to change its customary procedures and release my prepared remarks at the same time as the press release because some of you may not have seen them, I will read these remarks, and then we will be happy to answer any questions. Welcome to the World Acceptance Corporation's 2013 second quarter conference call. As usual, Mark and Kelly, our President and our CFO, are with me along with other members of our management team. I'll spend a few minutes reviewing the quarterly results, after which we will be happy to answer any questions. To begin with we are disappointed with the financial results for the quarter. However, we do not believe the reported results are fully indicative of the fundamental business performance of the company, and we do not believe that there has been a fundamental change to our business prospects. As has been disclosed in our financial statement footnotes since becoming a publically traded company, the company calculates interest revenue on its loans using the Rule of 78 and recognizes interest revenue used in the collection method, which is a cash method of recognizing the revenue. The company believes that the combination of these 2 methods does not differ materially from the effective interest method, which is an accrual method of recognizing the revenue. While we do see substantial fluctuations in the amount of cash collected on a month-to-month basis, depending on the number of days -- the number of business days in a month, these fluctuations generally level off during a given quarter. However, every so often as occurred this quarter the last 2 days of the quarter fell on a weekend. Last time this occurred was September 30, 2007, and the…

[Operator Instructions] We'll take our first question from Bob Ramsey with FBR.

I wanted to understand I guess this revenue shift issue just a little bit better. Is it just the revenues of $2 to $2.5 million that get moved into the fourth quarter? Or are provision associated with those revenues or other expense items allocated along the same basis as the revenues?

It's -- I mean, we estimate that number to be between $2 million and $2.5 million, and it's due to the timing of payments because of the 2 days at the end of the quarter. And the $2 million to $2.5 million is a net number of what will -- what is a recognizable number, and it has whatever type of provisions and reserves offset against that number.

Okay, great, so the right way then to think about this is that something like $0.10 to $0.15 got shifted out of this quarter’s earnings but into the fourth quarter’s earnings, and that’s I guess just simply a way to think about it.

I wish it were that simple. I mean, we believe that our financial statements are materially correct in accordance with GAAP. Otherwise we would have made the proper adjustment. We also know that between $2 million and $2.5 million in revenue was shifted from the second quarter due to the timing issue that we discussed, most of which should be recognized in the third quarter. However, due to other considerations and other offsetting items of a recurring-type nature, the financial impact is not overall material. However, we do believe that the impact we had on the yields warranted this additional disclosure. So normally we would not even be addressing these differences and so forth. And from an overall standpoint true net earnings is not necessarily materially incorrect, but there is no doubt that there will be a pickup in the third quarter as a result of this shift. I know that’s a little bit confusing, but that’s what took place and that is what put us in this position, that we wanted to go above and beyond the normal disclosure.

Okay, that is helpful. You also -- you mentioned a substantial increase in the credit facility that you guys have applied for. Do you have any sense of when the bank could give you an answer on that? And are you waiting on that approval before repurchasing any additional shares? Or is that just something you’re looking for as part of the plan to complete the authorization?

We, as announced, and as you know, we still have $25 million remaining under the previous authorization. We have to balance what we have in total availability and what we anticipate in loan growth, but at this point in time we believe that we will be repurchasing shares in the near future, regardless of what happens with the credit facility. The request -- we had a bankers' meeting within the last few weeks, and we made the request for the additional increase in our credit facility. And I believe that we will hear from them in the near term, but that -- they've all got to go their credit committees and so forth, and we do not have a firm commitment on the amount, but we believe the amount will be substantial.

Okay, great. And then last question, and I’ll move back out. But I know you guys mentioned that loan demand improved this quarter. Could you just talk a little bit about sort of what is driving that and what you're hearing and seeing from your customers and what’s driving sort of the slight uptick in loan growth?

Yes, unfortunately, that’s got a little bit of noise in it also. But, yes, we do and did in fact have -- our loan growth grew from 9.4% to 12.7%, which is a really very good improvement in our year-over-year growth rate. However, as a result of the shift in the peso that took place between March and the June quarter and then turned around and reversed between the June quarter and the September quarter, approximately 0.75%, somewhere between 0.75% and 1% of that change was due to the shifting and the timing of the movement in the exchange rate. In addition to that, because of the amount of payments that we did not receive in the second quarter because of the timing issue that we were -- we've been discussing and talking about, those payments came in the third -- in the beginning of the third quarter and are coming in as we speak. And so that accounted for what we believe is roughly 1%. So our true year-over-year growth rate we believe is somewhere right between 11.7% or 11.8% and 12%. And it's -- like I say, it's a little bit of noise here that -- which we weren't faced with, but we're trying to be as fair disclosure as we can. But it is definitely an improvement.

Okay, I mean, that's helpful. And I mean, what -- again, just sort of more big-picture fundamentals, what is sort of driving that improvement, and what are -- do -- are customers a little more comfortable borrowing, a little more apt to borrow? Or do you think it's more a reflection of some of the new stores added?

I'm going to let Mark address that.

Part of the improvement is the fact that the second fiscal quarter of last year wasn’t a very stellar quarter in terms of growth. So growth returned to a more normal level. It's still not exactly where we would like to have it. In addition, as Sandy mentioned, you get 3 quarters of pickup due to the exchange rate and some fractional percent based on payments that didn’t occur on the last 2 days of September. But you’re still looking at a 1.5% or so of internally improved growth, which may reflect partially that last year wasn’t great. But, yes, loan demand pick up a bit, but it's -- I believe looking at a 3.4% or whatever percent increase over the end of fiscal quarter one is probably rose-colored glasses. It's not that good.

We'll go next to John Hecht with Stephens Incorporated.

For the facility change, can you tell us approximately what the magnitude of potential change is? And are you asking for a change in your advance rate? Or is there some other factor we should think about what you’re basing the increase on?

Really, our business [indiscernible] get into that detail, but I can tell you it's much or more than what we requested and that -- what we announced in the second quarter. And, yes, there will be some slight change in terms as a result of this, but those details are being worked out.

And then I wonder, can you -- the accounting shift, it sounds like due to the more of the effective yield, can you tell us beyond the next quarter is there any changes we should expect for, I guess, the way we'd model it is on effective yield basis. Will there be any impact on that?

We're -- I mean, we would have made that transition now [ph], but there's a lot of things to consider, the things that we'll have to address when we make this change. I mean, theoretically, it should not be materially different on a year-to-year basis. But I don’t know of anything that you should be concerned with from a modeling basis over the near term. It's amazing to us that, I mean, I think we hadn't really thought about this 2-day end of -- the last 2 days ending on the end of a quarter. And it hadn’t happened but twice, 3 times over the last 10 years. For some unknown reason it's going to happen twice more in the next 3 quarters. So that’s even lends -- made our decision to fully implement the accrual, the full accrual method that much more important, so that we don’t have these potential fluctuations. But I hope I've answered your question, but, no, I don’t know of any significant modeling things out there.

Okay, but we will see the full effect of it in the current quarter when you report next?

No, the -- between now and the end of the year or effective April 1.

Okay, okay. And then the -- I wonder if you could talk about the mix shift, on small to -- versus large installment loans, and where you're seeing that going, and what does that tell you about customer behavior?

I don’t know that changes anything with customer behavior. We have always attempted to fit the proper size loan to the customer's needs and/or ability. I think the mix in shift has been kind of as a result of offering additional products that we didn’t previously offer in, for instance, the state of Texas. And as we have certainly not real recently, but Kentucky has been a great state, but it's not as good on a really small loan, but it's extremely profitable for larger loans. And in -- our latest state that we've gone into is Indiana. And Indiana is kind of like Kentucky. It does not have the rate structure to support those loans of less than a $1,000 but it's certainly is profitable for those larger loans. So I think as we enter new market and continue to offer these larger loan products, we will continue to see the trend that we've seen over the last couple of years. And that is a overall decline in your interest and fee income as a percent of average net loans. And we've been talking about this reduction in yield in every conference call, every quarter. However, along with that, you should expect to see a continuing slight decline in your loss ratios because you're -- the credit quality on the larger loan is generally better, and you would expect the loss ratios to be less. And that in fact is what takes place in our portfolio, and additionally it certainly helps your G&A expense structure as you move to a larger loan because it's much more costly to originate and service 10 $1,000 loans than it is to originate and service 1 $10,000 loan. So I think we will continue to see this gradual and slight change in mix, and I think we will continue to see the overall -- the same type of impact to our financial statements. But I still believe that we will continue to get excellent returns on assets and improving returns on equity as we continue our share repurchase program.

And the final question is, I wonder if you could talk about the acquisition pipeline. Is there any large franchises or portions of our large franchises that are out there that you might take a peek at?

There is always little things here and there, and I really hesitate -- I mean, no, not at this moment of time. We do not anticipate closing any significant transactions in the near future.

We'll go next to Bill Dezellem with Tieton Capital Management.

Would you discuss Mexico and talk to us about the areas that you see the most opportunity from this point forward, if there are any different than what you have seen historically? And I know several years ago you had a couple of hiccups there. Given that you’re still in the early phases of building out that country, what's your biggest challenge today in Mexico?

I mean, the biggest challenge today in Mexico is the same as it has been over the last 5 or 6 years, and that’s having really good, qualified people that we can promote to our higher levels of management. And if you look at our slide presentation we review this in investor presentations and stuff, the average tenure of a supervisor in Mexico I believe is between 3 -- 2, 3 -- maybe 3 years. The average tenure of a supervisor in the U.S. is like 7 or 8 years. When you consider we opened our very first 2 offices in September of ’06 and then really began opening more offices in fiscal ’08, nobody that we have down there has been with the company [Audio Gap] less than 2 or 3 years. So the main challenge in Mexico is to continue to develop more and more highly qualified people [Audio Gap]

[Audio Gap] qualified assistant branch managers are moving a county over, a town over, generally within a state. And they feel comfortable with that. It's when we open new states in the U.S. that we have -- that we become challenged somewhat from an employee standpoint in getting individuals to move. I’m sure you know a lot about our younger generation. They don’t necessarily go where we tell them anymore. They tell us where they're going to go. In Mexico, think of it as every new place that we open is generally like opening a new state because it's -- there are tremendous distances down there when we move from say Matamoros to Cancun or Juarez to Monterrey or wherever. So we're constantly having to retool new staffs and new areas. And you don’t get the luxury of being able to move people within certain geographic areas like inside South Carolina or Georgia that we do in the U.S. So, again, as Sandy stated clearly, our biggest challenge [Audio Gap] trained and experienced to do the job down there, and it will continue to be a challenge that we work through.

And is there more willingness on the part of employees in Mexico to move long distances than there is in the U.S.?

Probably -- absolutely no and maybe worse. I mean, people are very comfortable where they live and where they were raised and whatever in Mexico just as our younger generation in the U.S. tends not to stray far from where they're at. But again it's just a challenge. We work through it. It's part of management’s job.

And then the next question relative to Mexico is with the change in leadership down there, how if it all does that either create challenge or opportunity for you all?

Our best source of information on that is our in-country manager, Javier Sauza, who was born in Monterrey. And his family has always been from there, and his indication to us is that the change in politics down there will have zero impact on our operations, but in terms of building a broader credit base or availability for credit to their citizens in Mexico, that neither party has any qualms with that.

We'll go next to John Rowan with Sidoti & Company.

Just trying to -- not to beat a dead horse here, but the revenue number that wasn’t included in the second quarter got pushed off in the third quarter. I just want to try to understand that relative to the provision expense, right? Because the provision expense if you look at revenues, even if you add back that $2.5 million, was up as a percentage year-over-year. Meanwhile, charge-offs were down year-over-year. I just want to understand do you view the increase in the provision expense more as a function of loan growth, the provision leading the revenue associated with it? I'm just trying to understand if there was a lot of dilution from what looks like a high provision expense.

Absolutely we view the provision and/or the allowance that’s on -- the allowance for loan losses on the balance sheet at the end of quarter, we view that as a function of the balances outstanding at the same period of time, and has -- generally does not have a direct correlation between the timing of the recognition of revenue associated with the payments collected. So over time we -- our historical charge-off ratios have remained in a fairly tight band of anywhere between 15% to 14%. They remain within those still fairly tight bands. They decline slightly over time but still they -- within that same range. Therefore you would expect, and as is the case, the allowance as a percentage of your net loans outstanding to also remain in a fairly tight band, and that has also been the case. So I think as long as we see the loan loss ratios to remain within this band of historical numbers, then you will continue to see the allowance at the end of any given period to remain as a percent of the net loans outstanding.

Exactly, so is it fair to say then that the increase in loans -- because obviously if there's no big change in the allowance ratio and charge-offs come down but provisional relative to comes up that there was additional dilution in the quarter simply because the rate of loan growth increased and you obviously have to provision upfront for those loans before you even start necessarily earning interest on them throughout the quarter?

Yes, that -- actually, I did not think about that because we don’t look at the 2, but you’re absolutely correct because roughly 1% of our growth in loans for the quarter was in fact associated with the noncollection of payments for that 2-day period. that would have had an impact on the provision. You are correct.

Okay, and then lastly on the Rule of 78, obviously, you say there's not much of a difference. If I go back and I look at some older correspondence, documents between World and the SEC, they had asked you previously to disclose the difference in the accrual method. And at that point I’m pretty sure you guys had responded that it was about a 1% -- would have been a 1% decline. Now I know that, that changes a little bit based on the growth rates of the loan portfolio, but is that still -- that 1% decline in pretax earnings, I should say, is that still a fair kind of run-rate to assume as far as just an incremental difference between the accounting methodology?

Well, let me respond by saying, generally speaking, a collection method is a much more conservative method of recognizing earnings than the accrual method. And therefore as the portfolio grows, the cumulative timing difference associated with these 2 methods has also grown over time. But in any given period the impact of these 2 methods has not been generally been material and once again it was the unusual circumstances of the current quarter that we felt needed additional disclosure so that people would have a better understanding of what was happening to yields than what appeared in our financial statements. So does that answer your question?

Sort of. I'd always thought that the Rule of 78s was probably a little additive to earnings in a growing -- in a rising loan environment and potentially a little dilutive to earnings in a declining loan environment. And obviously with the ramp-up in earnings, I just -- and based on like I said the old correspondence documents between you and the SEC, it did seem to be that there was a slight, a very minor difference in pretax earnings based on the accrual methodology. It's not going to make or break the model, but I just wanted to understand if it was still in the ballpark.

The impact of the rule of 78s is less than the impact of the collection versus the accrual method. But they kind of offset each other somewhat in the combination of the 2 procedures that we follow as opposed to the strict accrual method, over time during a specific period of time, is not that material. And if our documents said that, that 1% was a general number, I don't -- I can’t answer that question right now, but it certainly has not varied that much.

Operator Instructions] We'll go to next to Doug Smith [ph] with North Run Capital [ph].

I have one more on this revenue shift item. I think you mentioned in answer to the first question that there were some offsetting items that muted the impact this quarter. Is that right, and if so can you comment on what the offsetting items were?

Yes, I'll happy to. For instance, we generally do not go through the normal search for unrecorded liabilities and so forth at the end of every quarter, but do so at the end of -- only at the end of the fiscal year. And so there is a timing of the payments and so forth, and that has an impact on what’s happening. We also have a very conservative approach to the way that we record our claims reserve as far as our group insurance, and so there's a component of our incurred but unrecorded claims that has a timing impact that also contributes to this offset. We have a unearned insurance before our ancillary products. We record those unearneds in accordance with the -- in this case, it is in accordance with accrual method. However, there is not a specific reserve associated with those for claims that we have -- that have been actually claims made but have not been paid. And these are consistent practices that we've had over a long period of time, and generally the combination of these type of ongoing recurring items offset each other. And this quarter they did not offset each other as much, but the remaining difference was still not considered material enough to go through and make unusual adjustments. That helpful?

Yes. How much of the revenue impact of that $2 million, $2.5 million revenue shift do you think was offset by those items?

I don’t have a specific number, but it was I would say at least 50% or more. And I would like to say that there -- the timing of the recognition of the revenue that has been deferred will in fact be picked up in the next quarter or there beyond. It makes -- there's no guarantee that it'll all be picked up in the next quarter because there's no guarantee that a customer will make a -- 2 payments in any given month. So it could very well be that some of this timing will be picked up over the remaining duration of the loan or until he next renews or something else, but there's a -- but we certainly believe based on the loan volume in December that a great deal of this will be picked up in the following quarter.

That's helpful. I have 2 quick ones on the CFPB if you don’t mind. One is, do you expect to be named a large-market participant? And then two, is there any sense that there's -- the CFPB's doing a broader review of credit insurance following the actions against the credit card companies, such that the review would extend to the installment loan industry?

Do I -- do we expect to be named a large market participant? The answer to that is yes. Number one, we do not have any data to suggest that at this point in time. If you look at certain consumer finance companies like OneMain and Springleaf and so forth, we certainly are not anywhere in the same marketplace as far as their size. But if you do look at you know primary installment -- small loan, installment lending, then we certainly are one of the larger players. So I guess do we expect at some point in time for the bureau to take a look at where we -- and the answer to that I think, yes, ultimately we will. The answer to your question regarding ancillary products. I -- in the enforcement actions that they have taken to date, there have been no negative comments regarding the product itself. It's all been a criticism and a penalty in the way that they allege that these products were marketed and sold. So as I've stated on previous calls, there's a vast difference in the way that we market and sell these products than what was alleged by the CFPB in the Capital One and other type actions taken, so I hope that answers your question.

Yes, I was just wondering can you -- I was just wondering if those actions were isolated or do you think they're intending to do a broader review of those type of products.

I do not know.

[indiscernible] financial industry.

I mean, I certainly think that the bureau is responsible for all consumer transactions, so I think that certainly they will be taking a look at credit insurance just like they have collections agencies and student loans and everything else. So yes, will they at some point take a look at these products? I believe, yes, they will.

And just last, a quick one. There was an article yesterday about traditional commercial banks getting aggressive in the small dollar lending space because their core business is not growing. Is there any evidence of encroachment into your space by traditional banks?

No, and I don't -- I mean, we -- and part of our collection activities and ongoing servicing of loans encourages the customer to come into our lobbies and so that we can maintain a personal relationship with these individuals. I don't -- not believe that banks want the traffic in their offices that we have in our offices, and I don’t believe that they are geared to maintaining the type of relationships that we have that make offering these small loan products profitable. So I do not feel threatened in competition on our small loan products. I believe that there will be competition more for what we consider our larger loan products because there's been a tremendous disappearance in the marketplace of those companies, such as Beneficial and Household, Norwest Financial's consumer credit subsidiary. In the last couple of years, these companies have been completely shut down, and it's created a big void in the market. I believe that’s an opportunity for us. But at the same time I believe as other offers of credit such as traditional banks do get more aggressive, it will be in that area rather than the small loans.

We'll go next to John Rowan with Sidoti & Company.

Sorry for the follow-up, but, Sandy, if I’m not mistaken, I thought you said earlier in the call that the $2 million to $2.5 million was in that number. I just want to make sure I understand what was net and what was off-setting. Because I thought you said it was net.

No, no, I thought you were talking about that as opposed to allowance and so forth. That $2 million to $2.5 million is a revenue item that shifted between the second and third quarter. However, due to the other items, and it was very clearly stated in our disclosure as well as specifically in answer that gentlemen’s question, that there are other ongoing recurring type of items that did have an impact on that. Therefore, we believe our current financial statements are in accordance with GAAP.

Okay, but the net number is somewhere south of $2 million to $2.5 million, all right? Because there was...

Of net-net impact -- net-net impact to net earnings, yes, it is. The amount that's carrying forward is not, necessarily. And then, once again, those -- these are small amount that are certainly more significant as we have a reduction in our shares outstanding.

We'll go to next to Bill Dezellem with Tieton Capital Management.

I wanted to actually circle back to your point at Household and those type of firms. There've been several of those that have shut down. Does that philosophically create an area that you’re interested in? And I would suspect it would not be with your existing loan offices, but maybe starting an entirely new World number two, if you will, or business number two.

No, it is definitely business number one. I mean, it is specifically what we are doing in the state of Indiana, as I said, and in all states we offer those larger loan products. It's just -- and it's -- and we've maintained a fairly reasonable mix over a fairly large period of time of roughly 70% small loans and 30% larger loans, and that mix has now shifted to about 68-32, and that’s ignoring the World Class Buying Club product line, but, no, we certainly look at this. I mean, we will continue to always make as many small loans as we possibly can. Every application we take we underwrite it as to a person’s ability and willingness to repay. But we just think there's additional opportunity in other markets for these larger loan products, that because, as I said, while there are lower yields, there are other compensating items that make them still profitable.

And one other thing, Bill, just to point it on it. In Indiana, for example, we would not have been nearly as interested in Indiana had the Associates, the Households, the Beneficials, the Norwests, the whatever all been there. That left a big hole in the playing field, and when we met with the administrator and the director of the financial services entity down there, they were very clear that because of their rate structure, which requires a larger loan in order to be profitable, they have seen a significant decline in the number of licensed lenders in the state of Indiana over the past 4 or 5 years. So, yes, there are opportunities there, and we're exploring them at every possible moment.

And even though we are talking about some larger loan numbers, you still feel like the existing locations and the offices the way you have run them, that actually works with the Household and Beneficial-type loans.

In every state we operate we offer -- I mean, they're -- to us, they're all installment loans. But we do have kind of a internal classification, and it is not necessarily market segment or anything else, but it's a -- we know the loans of less than $1,000 or $1,500 or so forth versus those that are much larger, we offer both products in our existing offices. I mean, just about every single office has that array of product.

And we have no other questions at this time.

Thank you very much for your participation today. Melanie, I'll turn it over to you.

Thank you for your participation. Before concluding this morning's teleconference, the corporation has asked again to remind you that the comments made during this conference may contain certain forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act that represent the corporation's expectations and beliefs concerning future events. Such forward-looking statements are about matters that are inherently subject to risk and uncertainties. Statements other than those of historical fact as well as those that identified by the word anticipate, estimate, intend, plan, expect, belief, may, will and should or any variation of the forgoing and similar expressions are forward-looking statements. Factors that could cause actual result or performance to differ from the expectations expressed or implied in such forward-looking statements, include the factors discussed in today’s earnings press release and in the Risk Factor section of the corporation's most recent Form 10-K and other reports filed with or furnished to the SEC from time to time. The corporation does not undertake any obligation to update any forward-looking statements it makes. This concludes the World Acceptance Corporation quarterly teleconference.