hhgregg’s Inc. F2Q09 Earnings Call Transcript

| About: hhgregg, Inc. (HGG)

hhgregg’s Inc. (NYSE:HGG)

F2Q09 Earnings Call

November 6, 2008; 09:00am ET

Executives

Jerry Throgmartin - Chairman, Chief Executive Officer

Dennis May - President, Chief Operating Officer

Don Van der Wiel - Chief Financial Officer

Andy Giesler - Director of Investor Relations

Analysts

Rick Nelson - Stephens Inc.

Brian Nagel - UBS

Brad Thomas - KeyBanc

David Magee - SunTrust Robinson Humphrey

Peter Keith - Piper Jaffray

Michael Lasser - Barclays

Anthony Lebiedzinski - Sidoti & Co

Scott Tilghman - Hudson Square Research

Operator

Good day and welcome to hhgregg’s second quarter earnings conference call for fiscal 2009. This call is being recorded. At this time all participants will be in a listen-only mode. I will now turn the conference over to Mr. Andy Giesler, Director of Investor Relations for hhgregg; please go ahead, sir.

Andy Giesler

Good morning everyone. With me today are Jerry Throgmartin, our Chairman and Chief Executive Officer; Dennis May, our President and Chief Operating Officer; and Don Van der Wiel, our Chief Financial Officer.

During today’s call, Jerry will make some opening comments; Dennis will provide highlights from our second quarter; and Don will conclude with a discussion of our liquidity and capital resources and an update of our earnings guidance. At the end of our prepared comments we will have until 10:00am Eastern Time to discuss any questions that you might have.

Let me take moment to reference the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. During this call, we will make forward-looking statements which are subject to significant risks and uncertainties, which include the future operating and financial performance of the company.

The company believes that the expectations reflected in its forward-looking statements are reasonable and can give no assurance that such expectations or any of its forward-looking statements will prove to be correct. We refer you to today’s earnings release, the MD&A section of our Form 10-Q and the “Risk Factors” section of our Form 10-K for additional discussions of these risks and uncertainties.

In addition, we will discuss net income and diluted earnings per share as adjusted to primarily exclude the impact of the loss from the early extinguishment of debt for the debt refinancing completed in connection with our initial public offering in July 2007, which are considered non-GAAP measures. We use these measures to highlight operating performance.

Please refer to our reconciliation of net income and diluted earnings per share as adjusted in the non-GAAP disclosure section on our Investor Relations website, which can be accessed through www.hhgregg.com.

With that, I would like to turn the call over to Jerry.

Jerry Throgmartin

Thanks Andy and good morning everyone. Macro economic trends presented stiff headwinds during our second fiscal quarter. Turmoil in the financial and credit markets coupled with growing unemployment compounded a tough economic climate already buffeted by the sub-prime mortgage crisis and a downturn in existing home sales. These factors among others have shaken the roots of consumer confidence, resulting in a slowdown in consumer spending.

Similar to other retailers, our customer traffic has worsened since the middle of September. To be clear, this trend has not been steady. It has been marked by significant volatility, not unlike that exhibited in the financial markets.

Anticipating strong headwinds for our appliance business during the second quarter, we developed and executed a plan to deliver stable gross margins and effectively leverage our SG&A expense, excluding the impact of certain growth investments. However, we maintained an aggressive advertising posture to maximize store traffic in existing markets as well as ensure our differentiated model as well as it was well introduced in our new markets.

These tough economic times are a tremendous test of the resiliency of a business model. As evidenced by our SG&A leverage this quarter, we have a very resilient model. The more important and frequently overlooked key to our resiliency is our highly variable labor expense structure.

Sales commissions, delivery commissions, manager bonuses, and executive compensation are highly variable. In fact, the majority of our total compensation, in turn which comprises approximately one-half of our SG&A expense on a normalized annual basis, is variable or at risk. Therefore, when comparable store sales fall, our SG&A expenses maintain their relative leverage as a percentage of sales quite well. These tough economic times are also a test of management team’s acumen for balancing short-term working capital management but long-term growth opportunities.

During the second quarter, we closely managed our inventory levels and working capital while adding six new stores. As of September 30, 2008, we had reduced our average inventory per store to $1.5 million as compared to $1.8 million as of September 30, 2007, all while maintaining a stable gross margin compared with the comparable prior year period.

We were able to maintain store growth because our economic model is highly efficient. Over the past five fiscal years, our working capital has averaged 2.6% of net sales; our capital expenditures have averaged 2.2% of net sales; and our inventory has averaged seven inventory turns per year.

When coupled with our strong store level returns, the business has generated significant cash flow that has been used to fund our growth and de-lever our balance sheet. This year is not expected to be an exception. We currently expect our projected 20% unit growth for fiscal 2009 will be funded in its entirety from free cash flow. Stated another way, we do not expect to be drawn on our revolving credit facility as of our fiscal year end March 31, 2009.

While we’ve been focused on running our business efficiently and effectively as possible in a short term, we believe that there very well could be a long-term silver lining in this challenging economic climate. Many competitors do not have as resilient a business model as we do. Due to the difficult economic environment, we now can foresee opportunities for long-term market share and unit growth that could not have been envisioned even one year ago.

We intend to closely monitor growth opportunities as they arise and make prudent adjustments to our operating and expansion plans to drive shareholder value for the long term. To clarify, we will not overextend ourselves or compromise our execution for the sake of aggressive unit growth.

Before I turn the call over to Dennis to discuss our operating results for the second quarter, I want to acknowledge the dedication and effort of all of our associates who continue to make us a compelling alternative to low-serve big box competitors.

I’ll now turn the call over to Dennis to discuss our operating results for the second quarter.

Dennis May

Thanks Jerry and good morning everyone. Before I discuss our second quarter operating results, I want to thank all of our associates for their tremendous efforts and exceptional execution during these difficult times. During the second quarter, our team maintained stable gross margins, levered SG&A, excluding certain growth investments, and increased inventory productivity; all while opening six new stores. Thank you all for your outstanding dedication and commitment.

I would now like to turn your attention to a discussion of our second quarter operating performance. During the second quarter, our comparable stores sales decreased by 8.8%, on top of an 8.9% increase during the second quarter last year. This was comprised of a 15.2% decline in appliances; a 0.6% decrease in the video category; and an 11.9% decrease in our other category which primarily consists of audio, personal electronics, notebook computers, mattresses, and furniture and accessories.

The 15.2% comparable store sales decrease in the appliance category during the second quarter came on top of a 5.7% increase last year. The decrease primarily reflected double-digit comparable store sales declines of entry level and lower mid priced point major appliance products.

High efficiency front-load laundry and three-door refrigeration performed better than the company average and contributed higher average selling prices for the entire appliance category. The weaker store sales performance of the appliance category relative to the video category and the other category contributed to an approximate three-percentage point decline in the appliance category share of our consolidated sales mix.

We expect, as in past downturns, that the appliance unit shipments will rebound with the economy, returning to its long-term historical pattern of low single digit unit growth. When this rebound occurs, we expect the appliance share of our consolidated sales mix will be expected to return in line with historical norms.

The 0.6 comparable store sales decrease in video during the second quarter lapped a 7.5% increase from the prior year. The decrease in the video sales performance was comprised of continued double digit decreases in projection and tube TVs, partially offset by strong double digit comparable store sales growth in large flat panel LCD televisions in screen sizes 45 inch and up. We continue to enjoy triple digit sales growth in 120-hertz LCD televisions.

During the second quarter, more than 90% of our television sales were in LCD and plasma flat panel television, with micro display making up the majority of the remainder. The 11.9% decrease in comparable store sales in the other category followed a 24% increase in the comparable prior year period. The comparable store sales decrease in the other product category was driven largely by decreased sales of mattresses and personal electronics.

Gross profit margin expressed as gross profit as a percentage of net sales was virtually flat for the second quarter compared with the prior year, despite an unfavorable out-of-period adjustment of 20 basis points.

The increase in the gross profit margin realized in the appliance category during the second quarter, reflecting our emphasis of driving our higher margin, high efficiency business and limiting our mix of lower margin entry level appliance volume, more than offset a 35 basis point decline in our consolidated gross profit margin, due to the appliance categories previously discussed; reduced contribution to the consolidated net sales mix.

In the video category, our more heavily featured mix of 10 ADP and 120 hertz flat screen televisions and larger screen sizes than the industry average, largely offset declines in industry wide ASP on equivalent screen sizes resulting in a moderate decline in our second quarter video category margin. Small shifts in sales mix within the other category had a modest positive impact on the consolidated gross profit margin during the quarter.

SG&A expense, as a percentage of net sales, increased 54 basis points when compared to the prior year. The increase was primarily due to growth investments totaling 64 basis points, largely comprised of store pre-opening expenses associated with six new store openings, as well as distribution and management infrastructure investments in Florida. These growth investments and the de-leveraging effect of our comparable store sales decline was contained by effective cost controls over general and administrative expense, a reduction in bonus expense and an insurance reserve adjustment.

Net advertising expense, as a percentage of net sales increased 95 basis points when compared with the prior year comparable period. The increase was largely driven by the de-leveraging effect of our comparable store sales decline, coupled with the heavy advertising spend associated with the launch of the new Florida market.

Let me take a minute to explain how we go about advertising in new markets. We enter each new demographic market area with a target share for the marketplace and typically add locations quickly in these areas to leverage our marketing investment.

We plan to add three more locations in existing Florida demographic markets by March 31, 2009, which should help better leverage our advertising costs as a percentage of net sales in those markets. As we look to the back half of the year, we will closely monitor and manage the efficiency of our advertising spend.

As with our advertising expense ratio, the de-leveraging impact of the third central distribution center and the divisional management infrastructure of our SG&A ratio will correct itself as we add additional new stores in Florida. Our third central distribution center as of today, currently serves ten stores spread over central and northern Florida. By comparison, our other two central distribution centers currently support a total of 97 stores in eight states, producing far more productive leverage ratios.

The Florida CDC has been scaled to effectively and efficiently support approximately 30 store locations. We expect to see appreciable improvement in the third CDC’s expense ratio, as we plan to have 13 stores in Florida by March 31, 2009.

Over the past couple of quarters, we’ve gotten several questions about our new store performance in Florida. It is well documented; the Florida economy has been hit harder by the downturn in the economy than most other states. While we have experienced strong grand opening performance in Florida, it does not now appear that Florida stores will enjoy the historical level of first-year sales productivity that we have experienced in the past. However, we continue to believe the Florida market will be a good long-term investment for our company.

Rather than achieving 95% of mature sales volume in the first year, with low single digit comparable store sales increases in subsequent years as we have historically experienced with our new stores, we expect Florida stores will not achieve maturity as fast but will achieve higher than average comparable store sales growth when the Florida economy rebounds.

We are focused on the upcoming holiday season and we are excited about the values that we’ll be able to offer our customers. We have assembled a very compelling mix of product, financing, and service-related offerings. Facing what appears to be a difficult retail season, we are pleased that flat panel televisions, laptop computers, GPS and digital picture frames are once again on the consumers top ten wish list.

We’ve adapted our holiday hiring expectations accordingly. Having said that, we are passionate about dedicated to delivering the best customer purchase experience with the most highly trained and most knowledgeable sales force in the industry.

We intend to manage our inventory levels and assortment closely during the holiday season. Confident in our ability to nimbly manage our plan-to-sell and direct-to-sales force in such a way to offer tremendous values to the customer while maximizing our gross profit margins. This confidence is bounded upon our track record of being able to adjust our holiday plan-to-sell weekly, if needed.

We demonstrated this ability as recently as two holiday seasons ago, with the plasma television supply imbalance. This imbalance had a significant negative impact on our competitors’ gross margin results. In stark contrast to our competitors, we actually improved our gross margin that holiday season when compared with the prior-year holiday season.

With that, I would like to turn the call over to Don to discuss our liquidity and capital resources and an update of our fiscal 2009 earnings guidance; Don.

Don Van der Wiel

Thanks Dennis and good morning everyone. We ended the second quarter of fiscal 2009 with $700,000 of cash, compared to $1.6 million in the prior-year comparable quarter. As of September 30, 2008, we had $25 million of borrowings under our line of credit and $3.7 million in outstanding letters of credit drawn on our revolving credit facility, leaving us a net borrowing availability of approximately $71.3 million, which does not expire until July 2012.

By comparison, as of September 30, 2007, we had $15.7 million under our line of credit and $3 million in outstanding letters of credit drawn on our revolving credit facility. As of yesterday, we had $39.4 million of cash borrowings and $4.1 million in outstanding letters of credit drawn on our revolving credit facility, leaving us with a net availability of approximately $56.5 million. The increase in cash borrowings since September 30, 2008 related to a seasonal build in inventory.

As Jerry mentioned, we’ve made substantial progress in reducing our inventory levels and improving inventory productivity since June 30. Notably, we achieved the improvements without any negative impact on consolidated gross margins during the second quarter.

The addition of four more stores in the Florida market since June 30 continues to improve inventory productivity in that distribution hub. Consequently, we currently expect a consolidated inventory turnover will improve the historical levels by the end of the fiscal year, as we expect to have 13 stores open in Florida which should help achieve inventory productivity levels there, more typical of a mature distribution hub.

We are extremely comfortable with the adequacy of our existing revolving credit facility to support all of our seasonal funding needs. Our revolving credit facility is a traditional asset-backed lending facility with no financial covenants until we reach a trigger point within $8.5 million of our borrowing capacity, which we do not expect to come close to approximating.

Despite closely managing our margins, SG&A expenses and inventory during this period to ensure a solid working capital position, the economic uncertainty resulting from the turmoil in the financial markets and growing unemployment contributed to a significant drop in customer traffic during the last two weeks of September. It is still difficult to accurately gauge this economic uncertainty and its impact on customer traffic. Accordingly, we are revising our previous guidance with a widened range of projected results for fiscal 2009.

Based on a comparable store sales decline of between 10% and 17% for the second half of the fiscal year, diluted net income per share for fiscal 2009 would range between $0.75 and $0.90, as compared with previous diluted net income per share guidance of $1.13 and $1.20. This would result in comparable store sales decline of 8% to 12% for fiscal 2009, as compared with the low single digit comparable store sales decline under prior guidance.

Net sales would grow between 6% and 13% for the second half of the fiscal year, which would result in net sales growth of between 9% and 13% for the fiscal year, as compared with 19% and 21% in the previous guidance. We still plan to open between 18 and 20 new stores during fiscal 2009, of which 16 have already opened. As of March 31, 2009, we expect to have between 108 and 110 stores operating in nine states.

Capital expenditures, net of sale and lease back proceeds, are still expected to range between $29 million and $31 million for fiscal 2009. We expect to finance these capital expenditures with cash from operations and do not expect to be drawn on our revolving credit facility as of March 31, 2009.

At this time, I’d like to turn the call back to the operator so that we may entertain any questions that you might have.

Question-and-Answer Session

Operator

(Operator Instructions) your first question comes from Rick Nelson - Stephens.

Rick Nelson - Stephens Inc.

Jerry or Dennis, can you talk about the Circuit City demise, the store closings that they’ve indicated; how you see that impacting the business near term and long term?

Jerry Throgmartin

Rick, this is Jerry. Historically, in situations like this, my experience has been that we did not see significant impact in the short term on either volume and/or margins as the meaningful inventory, the current inventory and the highest demand inventory has liquidated pretty quickly and that inventory really, we’ve not seen it discounted as much. So we don’t see that and because those stores in those markets are still doing some business, you don’t see a significant shift in volume.

Obviously, when major players exit a marketplace, there is share up for grabs and we feel good about our opportunity of getting our share of that business, especially in the categories that are meaningful categories to us and obviously, they are in a lot of categories that we’re either not in or that we don’t participate in a very big way.

So I think as we said, we think that the short term impact, we’ve pretty much included within our guidance and the long term impact is what are the growth opportunities for us and what does that mean for the possibility from enhanced growth opportunities for us.

As we’ve said before, we really are careful to focus on our business and the execution of our business rather than what’s going on with the others.

Rick Nelson - Stephens Inc.

What do you think as a reasonable share that you might be able to garner from those stores? How much product overlap is with hhgregg? I realize they’re in a lot of categories that you’re not.

Dennis May

Rick, this is Dennis here. It’s really very difficult to ascertain what portion of share is the opportunity. What I would say is basically there are 30 Circuit City stores that are closing, that overlap with our company. So, as you think about our existing chain, there’s 30 locations that they’re currently closing that overlap with us. So that’s one way to look at it.

What I would go on to say is that we are aggressively competing in the market to make sure that we get our unfair share of that market share and I think strategically, taking a step back as Jerry said, is the long range, long term focus for us is this continued execution. Certainly, this environment and what’s going on in this environment is only making us more important and more strategic with our suppliers. So, as they look who they want to support, to sell their products, to launch their innovation, they’ll improve product mix, enhance not only ours but their profitability.

As Jerry earlier, we feel like there’s some real opportunities for us that we didn’t envision even a year ago. So, certainly, I think that as we move forward, we’re going to be very aggressive about our execution levels to be sure that we maximize that opportunity.

Rick Nelson - Stephens Inc.

Thank you for that. I do want to ask you about the current environment. You mentioned that this has got more challenging late September, last two weeks. Is the comp guidance that you’ve provided, 10% to 17% decline, is that sort of the comps that you saw late September or are you assuming an even more challenging holiday period?

Dennis May

Rick, this is Dennis again. There’s a lot of volatility in the marketplace and Don touched on that. As we look at the business environment, it changes week-to-week. We feel like our guidance was very thoughtful and I think it properly reflects the volatility that we’re seeing in the marketplace currently.

Rick Nelson - Stephens Inc.

Finally on store openings, I realize you don’t have guidance for fiscal 2010 at this point, but how do you sort of weigh store openings? We’re hearing a lot of retailers pulling back on openings as rents continue to drop, yet you appear to have some opportunity with some competitors going away. Just like to get your thoughts there.

Dennis May

Rick, this is Dennis again here. It’s a real balancing act for us. Certainly we’re excited about the opportunities that are in front of us. The key for our company is to be very prudent and be good stewards of our growth.

As Jerry touched on earlier, we’re not going to sacrifice our execution for expansion. However, there are some significant opportunities in front of us with expansion and the key for us is to be good stewards, take advantage of those, aggressively negotiate where it makes sense and we look forward to coming back to everybody at the end of our fiscal and outlaying that guidance around expansion.

Rick Nelson - Stephens Inc.

And a question for Don on debt covenants; are there any issues there, as you see them, given the new guidance?

Don Van der Wiel

No Rick, absolutely not. We’re fortunate to have an asset backed lending facility, which is really very, very light on financial covenants. In fact, we have no financial covenants until we reach within $8.5 million of borrowing capacity and as I had mentioned, we absolutely do not envision coming close to that level of borrowing. So, thankfully we have no financial covenants whatsoever to be concerned with.

Operator

Your next question comes from Brian Nagel - UBS.

Brian Nagel - UBS

I wanted to follow up on the previous question with respect to real estate and potential given a weaker environment that you guys may opt or act more conservatively with your growth. What type of lead times do you have when you’re opening the store? As we looked through the fiscal 2009 openings, how much flexibility do you have to potentially pull back on those if you do choose to do that?

Dennis May

Well, our lead times can vary greatly Brian. If you kind of look at the company’s history, we have kind of ebbed back and forth between new constructions versus taking existing boxes. So we’ve got a strong history of flexibility around that.

History shows us during economic downturns like this that the most opportunities that are put out for you as a retailer are existing boxes, and those have much shorter lead times than building boxes out of the ground. The answer to your question is, if you’re building a box out of the ground, the lead-time is around nine months. If you’re rehabbing an existing box, you put the lead-time as around three to four months.

We have a tremendous amount of flexibility available to us. So, as we look into next year, our goal is to take advantage of, whether it be prime real estate locations, whether it be improved rental rates, whether it be an opportunity to take a quantity of stores, anything of those things are things that we would look at opportunistically.

Brian Nagel - UBS

To follow up on that, to what extent have you been able to, particularly in the Florida market, go to landlords and negotiate down rents given the market?

Dennis May

Well, we’re pretty good at negotiating, Brian. We’re not shy about that. However, for competitive reasons, I really can’t get into that. What I would say to your question is the current environment, the current economic conditions, certainly creates strain, it creates certain stress points, but it also as Jerry touched on earlier, it creates tremendous opportunities, it creates opportunities with your manufacturers, you strategically work with them. It creates opportunities around real estate. It also creates opportunities around just talent in the marketplace from a human capital perspective. So we are exploiting every one of those elements.

Brian Nagel - UBS

And one final question, Dennis. You mentioned in the prepared remarks that the units in Florida now are performing less than 95% target you had on your previous units. Can you give us a little more color how much below that 95% they are performing?

Dennis May

Well, what we said there Brian was the Florida economy is certainly getting hit harder than most other places and they’re not performing at that level. However, we expect them to be leveraging nicely for us by the end of our fiscal and really feel strongly. A little color I’d give is, though we can’t break out individual store performance, we are executing in Florida very well.

When we look at some of our core operational components around customer satisfaction, operational efficiencies, the quality of the management we have in the market, we are extremely pleased with the foundation that we are building in Florida and are highly confident that it’s going to be a great long-term investment. The opportunities around real estate that are out there right now are only going to make our Florida investment better for us long term.

Operator

Your next question comes from Brad Thomas - KeyBanc.

Brad Thomas - KeyBanc

Nice job on the gross margin during the quarter. I was just wondering if you could just talk a little bit more about how you’re thinking about gross margin during the holiday quarter, especially considering the slowdown that we’re seeing in sales and in the consumer and the potentially promotional holiday season that we may see from some competitors?

Dennis May

Great question Brad. Our history, as a company, we are a merchandising driven company; a combination of having 20 year plus veterans, driving our merchandising and combining that with our sales force, which is a directed sales force, really allows us to put together a plan to sell that we modify almost on a weekly basis. So, as we navigate through these challenging times, it really plays into our hand quite well. So our merchants work with our manufacturers and we’re constantly monitoring and managing our product mix and driving that mix towards the highest possible margins for our company.

Our history shows us that when opportunities are out there we can leverage opportunistic buys with the leverage that’s planned to sell and we can navigate through these challenges as well as anybody.

Again, if you kind of look at Christmas season 2006, I think that was a great example of how we were able to guide through that and if you look at our guidance, I think that how confident we are is implied in our guidance. So thank you for the compliment and we look to continue to perform well there.

Brad Thomas - KeyBanc

Okay and I recognize we obviously, have still a few weeks to go before we get to Black Friday, but we are starting to get pretty close. Are you, in your discussions with vendors, are you getting the sense that you may have some of those opportunities this year?

Dennis May

It is a soft environment; it creates opportunities on the purchasing side. The key thing for us is not only to look at opportunities with our suppliers but look at strategy. Just like a soft environment creates challenges for retailers, it creates challenges for manufacturers. So, as we put together our plan to sell, it’s really a strategic business plan that we put together with our suppliers to work through this plan to sell.

Christmas selling season is going to be competitive. The 20 plus years I’ve been doing this it’s always been competitive. The key thing for us is to focus on our execution, sell the right product, educate the customer and let our business model shine through.

The consumer likes our model. They like the way we go to market. They like the service and the value that we have. We feel like we have a very compelling offer to bring to the consumer this holiday season and we’re very confident we’re going to be able to make the business as good as it can be.

Brad Thomas - KeyBanc

Okay and then just a follow-up on advertising. It sounds like you are still out there aggressively trying to gain share from competitors who are closing stores, aggressively trying to make your brand known in new markets that you’re entering, but if we are in an environment here where the consumer is perhaps, scared to go out and shop, could you maybe just talk a little bit about how you’re thinking about advertising and at what point maybe would you cut back a little back a little bit on some of the spending?

Dennis May

Well, I think as we said in our prepared comments, we are constantly evaluating our marketing. We’re constantly looking at the competitive landscape, constantly looking at the opportunity. I think again, within our guidance, we were pretty reflective of how we view advertising and I think we encompassed it in there.

The one comment I would say is just like there’s opportunities, the soft environment creates opportunities to buy inventory, to buy real estate; it also creates opportunities around buying advertising also. So we’re aggressively advertising in the marketplace, however, as we go in the back half, we’re going to really closely monitor the opportunity to generate traffic and spend appropriately.

Brad Thomas - KeyBanc

So is it fair to assume that perhaps if the comps started to trend towards the lower end of your range that you might consider pulling back on the advertising a bit?

Dennis May

We’re going to match advertising to the traffic opportunity Brad, to your point.

Operator

Your next question comes from David Magee - SunTrust Robinson Humphrey.

David Magee - SunTrust Robinson Humphrey

Just a couple of things; one is can you, I guess perhaps compare and contrast the price environment that you’re seeing today versus what you did see back in the holiday of 2006?

Dennis May

What I would say is in 2006 you had an imbalance of inventory created by a format war, but at the end of the day, it was an oversupply and today what you see is more of a compression, softness in the market time, of the marketplace created by a soft economy. The net result is the same. There’s inventory in the channel. That inventory in the channel creates opportunities, so it’s similar in that regard. We view it the same.

As you look at the competitive landscape, the promotions that we see going into this Christmas are really not much different than what we have seen day in and day out. The promotional landscape is competitive, but really relatively rational for our industry. So, as we approach this Christmas season, our plan to sell is very nimble. We’re able to shift focus and mix as need be, to maximize margins.

David Magee - SunTrust Robinson Humphrey

Dennis also, can you talk a little bit more about the appliance side. It seems to me that in this environment the opportunity would be more on the mid-level or even the lower end, just as these people are buying things, they’d be less interested in the bells and whistles of appliances. Can you just maybe add a little color to what your approach to that part of the business right now?

Dennis May

Well, certainly the consumer has been relatively soft in that business for some period of time. At the end of the day there are certain segments, the core competency of the appliance business is it’s a good business, okay. It’s just got a lot of headwind associated from two factors. You’ve got the housing factor and then you combine that with this really soft economy that we’re in right now, it creates that headwind for the appliance business.

The appliance business though has really strong power alley categories that continue to perform well. As we said, high efficiency laundry is a product the consumer likes. They want that product. Our business model shines for that product because they want somebody to stand in front of it and explain the features and benefits of it. The three-door refrigeration is a very desirable product.

You’re seeing a lot of consumers migrate towards those products and that’s what -- one of the things that’s driving the mix, because those product categories are categories the customer definitely wants.

David Magee - SunTrust Robinson Humphrey

Then just one last question; Don, this is perhaps for you. The inventory as a percent or the accounts payable as a percent of inventory seems like it’s down significantly year-over-year. Is that a reflection of just the credit availability out there in general or what’s happening with that?

Dennis May

Actually our terms with our suppliers are the same, they have not changed. As we look into this fall selling season, as we manage costs, we’re constantly focused on managing our vendor mix to maximize profitability. So I mean it’s just a balancing act that we constantly go through to really look at profitability, to look at cash flow, to look at all those different elements, but our terms with our suppliers have not changed at all.

Actually, the comment I would say is our relationships with our manufacturers just continue to get stronger every day. As this economy and this environment is challenging, as the competitive landscape out there continues to change, the support that we’re receiving from our manufacturers is only going up. So we’re very excited about that.

David Magee - SunTrust Robinson Humphrey

So the decline in that ratio would be just the composition of vendors themselves changing year-over-year?

Dennis May

Exactly. It’s just one brand versus another. It’s just a mix shift.

Don Van der Wiel

I’d probably add to that also that we’re very pleased to be in a position where we can take advantage of different merchandising opportunities and cash discounts. So we’re constantly trying to balance our merchandise margin opportunities with the terms that are associated with those purchases. We’re really pleased to be in a position to be able to maximize our performance and our profitability by taking advantage of great deals.

Operator

Your next question comes from Peter Keith - Piper Jaffray.

Peter Keith - Piper Jaffray

It was nice to see actually that you guys did well in some of the higher end TVs, particularly with LCD during the quarter; have you noticed a change in consumer TV preference over the last six weeks?

Dennis May

Not materially, Peter. I try to tell Jerry how good of a job I’m doing all the time, so I appreciate you pointing that out. However, we continue to focus on, we continue to outperform the industry in innovation. If you look at our mix of 10 ADP versus the industry, or our mix of 120 hertz versus the industry, our plan to sell and our sales force really allows us to perform at a pretty high level, because the consumer wants these products if they understand them.

As we look at our mix overall, our strategy going into the holiday selling season is going to be very consistent with what it has been. It’s a focus on more innovation, 10 ADP, 120 hertz and also larger screen sizes. One of the exciting things that you’ll see as we, not only fall selling season but going forward, is you’re going to see the 45 inch and up, and even 50 inch and up, screen sizes, 58 inch screen sizes, 65 inch screen sizes come into price points that the consumer can afford in good quantity.

So we’re excited about the screen size value equation that’s out there and we think that that’s going to continue to be a good thing long term. On a short-term basis, it’s going to be promotional, but again a much broader assortment in larger screen sizes.

Peter Keith - Piper Jaffray

Switching over to appliances, I was wondering if you’re continuing to see some price increases from the manufacturers and if you could give us kind of a sense of what percent increase that is and potentially how that might impact margins for that category?

Dennis May

Well, it’s always difficult to ascertain exactly what manufacturer is going to do what when. Our suppliers have come out and publicly have stated that they’ve taken some price increasing this year. They’ve also publicly stated that they intend on taking some price increases in January.

That being said, one important thing to get on the table is the price increases do not hurt our gross margins. Whenever the price from the manufacturer goes up, the retail selling price, the MAP price goes up commensurate with it. So if we’re making 30 points on a product, just making this up, when that price goes up with a price increase, we still make that 30 points at a higher retail if not better. So there’s not margin compression in that regard.

Your second question is how much of that pricing actually sticks? It’s always really difficult to look at that on a model-by-model basis. There was a marginal improvement in pricing through price increases. The majority of that really came through quality mix management and just a function of our plan to sell.

Peter Keith - Piper Jaffray

Then just a last question; it sounded like you had a benefit from the insurance reserve adjustment. Is that something you could quantify in dollars or basis points for us?

Don Van der Wiel

Yes. Quite frankly, it was about 18 basis points and really what it was was refinement in our estimates of that self insurance reserve.

Operator

Your next question comes from Michael Lasser - Barclays Capital.

Michael Lasser - Barclays

In the Q, you mentioned that the video category’s gross profit margin decreased moderately due to a shift in certain vendor support programs. What was that, and can you quantify the impact?

Dennis May

Well, for competitive reasons, we really can’t get into what those shifts were. What I would say is overall we continue to be very pleased with our margin management in all of our categories. The video business is a competitive category and we feel like we plan to sell and the way we go to market with it had really some strong performance around margins compared to the rest of the industry and we feel like we’re going to continue to leverage the advantages of our plan to sell moving forward.

Michael Lasser - Barclays

Were there instances over the last few months where vendors came to you and said we have excess inventory, would you be willing to take some of this inventory at a more attractive price?

Dennis May

Well that’s what our merchandising team kind of does every day, but at the end of it, what we really try to do is partner with our suppliers and certainly, this soft environment is creating challenging opportunities, that also creates a challenge for our manufacturers. So what we try to do is work very closely with them, find out what their needs are; we know what our needs are, and how do we match those up, because on a short term basis we certainly want to leverage every opportunity we can to maximize our profitability, but we also have a long term vision and a long term relationship with our suppliers and we’re in this together.

Michael Lasser - Barclays

When you talk to your sales associates, what are they hearing from customers about the motivation for coming in recently? Do you have a sense for what percent of folks are buying televisions in advance in the digital transition, such that you may experience a negative impact next year once we get past that deadline?

Dennis May

I think what we have always said is the FCC tuner mandate, which indicates that the customer will not be able to get an off-the-air analog signal past February of 2009. We feel like that is a factor in driving the TV business; it’s a marginal one. The reality is, if you look at flat panel television or digital television, there’s only about a 50% penetration rate with this product and when you poll consumers about products that they want to buy and products that are on their wish lists, flat panel TV has been and will continue to be at the top of that list.

There’s tremendous runway in front of the TV business when you just think about how low the household penetration is for this product. Roughly 50% of American households have one today, couple that with the fact that only about 11% have two, there is just so much runway in front of this product category, when you think about color television having a 98% to 99% household penetration.

So we really see the TV business as having a just great runway in front of it. There’s so much innovation, so much technology out there that on a long-term basis it’s going to just continue to make that a great business.

Michael Lasser - Barclays

Two more quick questions: one, are you seeing any changes in the rate at which you’re able to attach warranties in light of the environment?

Dennis May

No, we are very pleased with our warranty penetration. Our extended warranty policies are a great value for the customer and even during tough economic times, it’s been very consistent and we continue to perform very well there.

Michael Lasser - Barclays

And the last question; on the mix of inventory, have the increases been different? Is most of the change in appliances versus video category; how does it compare?

Dennis May

Really again as Jerry touched on earlier, our average inventory per store has come down. It’s really similar across all categories. Our year over inventory is in line. We feel very good about our ability to manage our inventory through these economic times. So really it’s across all categories. We’re in good shape. We’re well positioned.

Operator

Your next question comes from Anthony Lebiedzinski - Sidoti & Co.

Anthony Lebiedzinski - Sidoti & Co

I have a couple of questions regarding your balance sheet. You had mentioned that you have really no covenants to speak of, as for now, for the revolver; what about your term loan, do you have any covenants there, could you comment on that?

Don Van der Wiel

Actually no financial covenants of note at all Anthony.

Anthony Lebiedzinski - Sidoti & Co

And then you mentioned that there is a trigger point of $8.5 million. I mean if we were to take hypothetically, a doomsday scenario that your availability would be less than $8.5 million, what would happen then?

Don Van der Wiel

Basically what happens then, we’d be subject to a leverage ratio, which would basically imply that we would have to be under a leverage ratio, which is defined within the loan agreements as indebtedness, as defined, divided by EBITDA as defined, would have to be less than 3:1. Currently, I’m very pleased to say that we are at 1.58 as of September 30.

So, as you can see, I can’t envision a stress test where that would come into play and I furthermore couldn’t envision a situation where we’d reach anywhere close to $8.5 million of our borrowing capacity.

Jerry Throgmartin

Yes, I think that before we got anywhere near close to that, at that point, your growth plans would be changed. If a doomsday scenario comes about in an economy, you’re obviously going to look at our liquidity, which is in excellent shape and very flexible, but part of our job in maximizing our opportunities and evaluating our opportunities is to make sure that we never get very close to the edge on that liquidity and before we got close to that edge, we would be talking about significant changes in our growth strategy.

Anthony Lebiedzinski - Sidoti & Co

And then as far as your ability to do sale leasebacks, how do you see that in this current environment; are you perhaps paying more for that or could you just maybe discuss that as well please?

Dennis May

Well, we’re very pleased with our ability to get the right locations. We’ve not had any issues, as it relates to any sale-leasebacks. Again, moving forward, it will be interesting to see how the mix breaks out between new buildings and existing buildings, but, as I sit here today, I really can’t see that far into the future, but we’ve not had any issues on sale leasebacks.

Operator

Your next question comes from Scott Tilghman - Hudson Square Research.

Scott Tilghman - Hudson Square Research

I just wanted to touch on two things: number one, on the credit side, not for you but consumers with the financing offers likely becoming more and more attractive heading into the holidays; number one, have you seen any shift in the approval rates for your customers there and then in addition to that, have you seen customers taking more advantage of it than they have been historically?

Dennis May

Scott, that’s a great question. Our approval rates have been very similar to prior years, so a very strong approval rate, but the same as basically last year and we’ve seen what we call extended financing, which is a compelling part of our service bundle; really represent about the same amount in the balance of ourselves as last year also. So it’s really no news to report there.

Financing, as you said, is going to be an important part of this holiday season, but it’s just part of really the price, promotion, financing, and then the service that we bring to the table and we’re going to be very compelling and very competitive.

Scott Tilghman - Hudson Square Research

So the second question I had for you is on the appliance business. Has there been a meaningful shift between the customer’s willingness to opt for a repair service rather than to make the new purchase, given that we have sort of that underlying replacement need, or is it still pretty much business as usual?

Dennis May

You have seen some moderate shifts between the amounts of duress in our business. We call it duress, meaning people that are fixing broken appliances versus just replacing. So there have been some moderate shifts, but not as significant as quite frankly as the manufacturers had predicted.

Scott Tilghman - Hudson Square Research

Okay and lastly, just you had talked before about some opportunistic buys with the manufacturers and I know one of the other regional players out there has talked about potentially taking advantage of some of the inventory liquidations from other competitors in the marketplace. Is that something you see yourselves able to do or is it more likely to come through the manufacturer?

Dennis May

We’ll always look at any option to maximize our business and maximize our profitability, but our focus is really to strategically align our self with our key manufacturers and work through the difficult times with them. The sun will come out tomorrow and those relationships with those suppliers are going to be paramount to hhgregg’s long-term growth strategies.

Operator

And that is all the time we have for questions today. We thank you all for your participation. We also thank you for your interest in hhgregg. We also look forward to speaking to you in February. Have a wonderful day. You may now disconnect.

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