Michael Poppe – Chief Financial Officer
Timothy Frank – President, Chief Executive Officer
David McGee – Sun Trust Robinson Humphrey
Rick Nelson – Stephens Inc.
Conn's Inc. (CONN) F2Q10 (Qtr. End 7/31/09) Earnings Call August 27, 2009 11:00 AM ET
Welcome to the Conn's Inc. conference call to discuss earnings for the second quarter ended July 31, 2009. (Operator Instructions) Your speakers today are Mr. Timothy Frank, the company's President and CEO and Mr. Michael Poppe, the company's Chief Financial Officer. I would now like to turn the conference over to Mr. Poppe.
Good morning everyone and thank you for joining us. I'm speaking to you today from Conn's corporate offices in Belmont, Texas. You should have received a copy of our earnings release dated August 27, 2009 distributed before the market opened this morning, which describes our earnings and other financial information for the quarter ended July 31, 2009. If for some reason you did not receive a copy of the release, you can download it from our website at conns.com.
I must remind you that some of the statements made in this call are forward-looking statements with the meaning of the Securities and Exchange Act of 1934. These forward-looking statements represent the company's present expectations or beliefs concerning future events. The company cautions that such statements are necessarily based on certain assumptions which are subject to risks and uncertainties which could cause actual results to differ materially from those indicated today.
I would now like to turn the call over to today's host, Tim Frank, Conn's President and CEO.
Good morning and thank you for joining us today. Mike and I are going to speak to our sales, financial performance and the current status of our credit and financing operations.
In the face of the challenging market, we believe we gained market share, maintained control of the credit portfolio performance and continued to focus on removing costs from the business model. I continue to be very excited about the long term growth opportunities for our business and believe we are well positioned for renewed sustainable growth.
We faced increasingly challenging economic conditions but have a long track record of success through a variety of economic cycles and have consistently delivered increasing sales and profitability since our founding.
We believe our unique value proposition and excellent customer service differentiate us from our competitors and we expect to continue to capture share in our markets. We increased market share in our key categories of electronics, appliances and furniture and mattresses despite the current challenging economic environment as evidenced by our sales performance relative to published industry information.
According to the U.S. Census advanced retail sales report, revenues for consumer electronic and appliance retailers during the three months ended July 31, 2009 were down 13.8% while our revenues declined only eight tenths of one percent in those categories. In fact, our LCD unit sales during the second quarter increased 32% over the prior year and plasma units increased 120% as we offer our customers a great selection of top brands and expanded our line up this year.
Our furniture and mattress business has continued to exceed industry performance. Again, according to the U.S. Census, sales for furniture retailers during the three months ended July 31, 2009 were down 13.3% while our business was up 10.7%. We told you on the last earnings conference call that we were focused on capturing market share and we delivered on that promise.
Net sales for the quarter were essentially flat, down two tenths of a percent as same store sales declined 5.2%. Revenue growth from appliances, furniture and mattresses was offset by revenue declines in consumer electronics and lawn and garden.
The track category was flat during the quarter which is an improvement over the prior quarter trend as we expanded our selection in computers, added net books and improved our in-store displays and increased our promotional activities.
Our appliance revenues grew on a 5.7% increase in refrigeration sales and a 26.8% increase in air conditioning sales as laundry sales were down 6% and cooking sales were down 8.7%. We expect to continue to counter the national trend of significantly lower appliance sales through aggressive promotional activities. Additionally, we expect to benefit from the $300 million Federal Energy Star incentive program.
We grew our furniture and mattress revenue after remodeling many of our stores, improving our in-store display of these products and creating a more inviting environment in which to shop in addition to expanding our brand selection.
Consumer electronics revenue declined by 4.2% despite a 28% increase in total television units sold due to a 25.7% decline in average selling prices.
The lawn and garden category continues to be a challenge due to the drought conditions we've been experiencing in many of our markets. Our service maintenance agreement sales were down during the quarter as we completed a review of the program and our training in response to the ongoing Texas Attorney General investigation.
We expect that as a result of the enhancements made after our review and the overall improved execution by our service organization, sales and service maintenance agreements will trend towards our historical performance levels over time. We believe sales growth will be driven by aggressive promotional activity, our consumer credit advantage and a more effective merchandizing layout in our remodeled stores.
We've completed our store remodeling program and are implementing plans for opening three to five new stores by the end of the year in existing markets, allowing us to continue to leverage our existing infrastructure and advertising dollars, capitalize on opportunities to gain market share given the exit of certain competitors in these markets.
We're taking advantage of Circuit City's exit from the market place by taking market share through our existing store base and acquiring store locations in areas previously served by Circuit City. We've taken steps to improve the scalability of our business model as we prepare to launch renewed growth.
Our gross margin decreased during the quarter as compared to the prior year primarily as a result of the 220 basis point reduction and product gross margins as we focused on gaining market share. A change in the revenue mix with the decline in service maintenance agreement sales also contributed slightly to the declining gross margin.
Partially offsetting these declines was the benefit of a favorable change in the non cash fair value adjustment this quarter as compared to the prior year quarter.
SG&A expenses increased 90 basis points as a percent of revenues excluding the non cash fair value adjustments, as a result of the decline in same store sales and increased occupancy and compensation costs due to the seven stores opened since the beginning of the second quarter in the prior fiscal year.
We were able to reduce advertising expense without reduced coverage and benefited from lower fuel prices for our delivery and service fleets. We are committed to reducing our monthly expenses by $1 million and have identified many opportunities to remove cost from our business and are in the process of implementing them.
We expect the initial cost savings identified to be in place by the end of the third quarter and reduce our expense run rate by at least $500,000 per month. Some of the key items include the ability to continue to reduce advertising expense without reducing coverage, restructuring our sales training program to regionalize the training, eliminating expenses for travel and accommodations while improving content and performance standards, adjusting certain benefit plans while continuing to provide solid, competitive benefits to our associates, adjusting non sales staffing levels looking at performance, attrition and needs, and I believe there is still room for additional reductions.
Our inventory per store was flat at $1.3 million per store at the end of the current and prior year quarters. I should note that we have seen a reversal of the types of supply of television inventory we experienced in the first quarter. In fact, there is ample supply of product available which is providing us with some opportunistic buys, though as the manufacturers adjust production, these opportunities may be reduced in the future.
While we are not satisfied with our performance this quarter, we believe our credit portfolio results continue to compare very favorably against other consumer credit operations, especially in light of current economic conditions. The net charge off rate was 3.4% during the second quarter which is one tenth of one percent over our 12 month average and was up as compared to 3% in the first quarter and 2.8% in the second quarter of last year.
Additionally, 60 day delinquency was up seasonally to 7.6% versus 6.9% at April 30, 2009 and 7% at the same time last year. Both net charge offs and delinquency have been negatively impacted by the reduced use of cash and cash option credit programs which are given to our highest credit quality customers.
The percent of the portfolio re-aged was essentially flat as compared to the first quarter at 18.9%, though it was up from 15.9% at the same time last year. We have been pleased with our ability to maintain consistent performance relative to the percent of the total portfolio re-age during these times.
I would like to remind you that this increase was a result of our targeted program assisting customers impacted by Hurricane's Gustaf and Ike last September. The re-age programs have been effective in achieving our goal of assisting these customers and staying on track with their scheduled monthly payments when they experience hardships.
Our second quarter underwriting standards are more consistent with our historical practices after tightening them in the first quarter.
We proved that we can quickly adjust the use of our credit program to control the amount of capital used in the business. We'll continue to monitor our capital requirements and will adjust the credit penetration as necessary to support the long term success of the company.
With respect to the recent Texas Attorney General law suit, we continue to cooperate fully with the Attorney General's office. However, it is still too early to predict the ultimate resolution. We are proud of our 118 year history of delivering outstanding service to our customers and are committed to continuing to improve our service performance and have through several initiatives.
Looking forward, we are going to continue to grow our business through strong merchandising, consumer credit availability and excellent customer service. We are able to give customers the ability to purchase the products that they need when they need them, through our consumer credit at highly competitive prices, when others can not.
Guaranteed low prices, choice selection, in-stock guarantee, professional sales associates, next day delivery, flexible credit and in-house service, give us unique competitive advantages. This is consistent with our long history of providing outstanding customer service and being a leader in the communities we serve.
I'm now going to turn the program over to Mike Poppe, so that he can share additional financial information with you.
This quarter with our focus on gaining market share and maintaining credit portfolio performance, we delivered diluted earnings per share of $0.22 with no significant non cash fair value adjustments impacting this period's earnings.
We faced significantly more challenging economic conditions in our markets this quarter as we saw unemployment rates in Texas and Louisiana rise over 100 basis points during the quarter and increase roughly 300 basis points or 60% in each of those markets since July of last year.
Total revenue grew to $220 million, an eight tenths of a percent increase on a net sales decrease of two tenths of a percent, a 2.5% increase in finance charges and other and a favorable non cash fair value adjustment.
As Tim provided color to you already on the underlying changes in net sales, I will speak to the growth and finance charges and other for the quarter which was driven by higher average total managed portfolio balance and lower borrowing costs for our QSPE as the QSPE's debt balance outstanding has been reduced since the second quarter of last year.
The increases in finance charges and other were partially offset by higher net charge offs on receivables held by the QSPE and reduced retrospective profits earned under our credit insurance program as a result of continued higher claims by our credit customers due to the hurricane's experienced in September 2008.
We began retaining receivables on our balance sheet during the third quarter of the prior fiscal year and are required to record a provision for bad debts to reserve for future expected net credit losses on receivables held by us and not transferred to our QSPE.
During the three months ended July 31, 2009 we recorded a total provision for bad debts of $2.7 million as compared to $333,000 in the prior year. Approximately $2 million of the increase in the current quarter expense was directly related to increasing the bad debt reserve for the growth in receivables reported on our balance sheet.
Because we were not retaining receivables on our balance sheet during the second quarter of the prior fiscal year, and as a result had no debt outstanding, net interest expense was higher during the current fiscal year. To protect against rising interest rates over the next 24 months, the company entered into an interest rate swap to lock the interest rate on $10 million of its variable rate borrowings under the revolving credit facility.
This brings us to a total of $40 million of interest rate swaps converting variable rate borrowings to fixed rates.
Adjusted diluted earnings per share excluding the fair value impact in both periods were $0.22 in the current year as compared to $0.49 in the prior year. As mentioned previously, also affecting the EPS comparison was the increase in the reserve for bad debts on retained receivables which reduced net income approximately $1.3 million and diluted earnings per share by $0.06.
Turning to our liquidity and cash flow, the company ended QSPE's current financing facilities provide $570 million of total financing commitments with $560 million of those commitments being long term in nature. As a result of the reduction in the total portfolio balance since January 31, 2009 our QSPE was able to reduce its total debt outstanding by $82.5 million while we increased to total debt outstanding on our balance sheet by only $67.2 million.
Combining our free cash flow and the reduction in the customer receivables and related debt balances of the company in the QSPE, we increased our capital available for future growth by $15.3 million since January 31.
Given the current facts and circumstances, we believe the QSPE and the company have sufficient combined capital to fund our operations for approximately 18 months before considering renewals or expansions of existing facilities or other debt or equity capital raising opportunities and dependant upon sales growth and store opening plans.
Additionally, given our ability to control the extent to which we use our own credit programs to finance our customer's purchases, we could use the available capital more quickly than 18 months or make it last longer than 18 months. The sources of our capital as of July 31, include approximately $58.2 million of unused capacity under the company's ABL facility of which $38.3 million is available to be drawn at July 31 and the remainder will become available based on growth in the receivables portfolio held on our balance sheet and growth in eligible inventory.
$10 million available under our unsecured line of credit and among other sources, we have future cash flow from operations, third party consumer financing program, flexible inventory payment terms, the ability to sell or finance owned real estate, the ability to adjust capital investment programs and other operating and financing alternatives, including changing the amount of credit granted to our customers.
At July 31, 2009 $10 million remained outstanding under the QSPE's $100 million 364 day commitment which was paid off during August. We will continue to let the QSPE's portfolio balance decline until it reaches the level necessary to support the remaining $350 million of committed financing facilities.
As a result, we expect to see a commensurate amount of growth in the balances held on the balance sheet with that growth being funded by increased borrowings under the revolving bank facility on the balance sheet, cash flow from operations and other capital sources.
As a result of the slow down in sales and timing of receipts of inventory, our accounts payable funded less of our inventory at July 31. As there have been no significant changes in vendor payment terms, we expect this difference to reverse during the third quarter resulting in an improvement to the liquidity of approximately $10 million.
Additionally, as a result of our QSPE's pay down of $100 million 364 day financing facility, it had excess collateral of approximately $10 million at July 31 that will be converted to cash during the third quarter as the receivables are collected.
We previously indicated that at least a portion of the QSPE's $100 million 364 day facility would not be renewed. On August 13, the facility expired with no balance outstanding. During August, the QSPE did complete the renewal of its $200 million revolving facility and the facility continued to be annually renewable at the QSPE's option through September 2012.
As a result of the pay off of the expired facility by the QSPE, we would expect the growth in the balance of receivables and debt on balance sheet to begin to moderate as the cash flows from payments on receivables held by the QSPE become available to fund new receivables generated by us rather than being used to pay down debt balances.
Because of the more challenging economic conditions we are now facing in our markets, we have reduced our earnings guidance per diluted share excluding potential fair value adjustments to a range of $1.40 to $1.60. As noted in the release, this includes the impact of the higher estimated bad debt expense we will be required to record to build the reserves for future loss as we continue to grow the balance of retained receivables.
Much of this analysis and more is available on our Form 10Q for the quarter ended July 31, 2009 to be filed with the Securities and Exchange Commission later today.
That concludes our prepared remarks. We will open up the line for questions.
(Operator Instructions) Your first question comes from David McGee – Sun Trust Robinson Humphrey.
David McGee – Sun Trust Robinson Humphrey
Can you give us a little more color regarding the ASP pressure out there? Are you seeing it more on the larger TV's, the smaller TV's? And as a second part to that, how important will LED models be to your assortment this fall? Are they of size and price points that would matter to your customers right now?
Certainly on the LED front, and then I'll talk to the average selling price. LED is a very important new category as it really fits with our model of trying to mix the product, using our credit as buying power leverage for the consumer to get them into a higher quality product and larger screen size.
It certainly fits with our commission sales model. It fits with the fact that those TV's, being larger generally have to be delivered, and so it is a very important part of our business. There is a lot of competitive pressure there as there is across all of the TV segment right now, although I'm certainly not very excited about the fact that our average selling price, the overall class of product fell more than 25%.
Certainly we are not, and I am not willing to forfeit market share at this point. We feel it's very important to defend the market share and in fact expand market share. We do have to work smarter at getting our same store sales up. But certainly LED is very important to us. The average selling price of those TV's being down 25% again is not exciting, but we're going to defend our market share.
David McGee – Sun Trust Robinson Humphrey
How do you see this playing out over the next several quarters? Just based on your history in the sector, and prospects for hopefully better economic conditions and new products, but you still have this grab going on for market share. How do you see the next three quarters playing out with regard to the ASP? Certainly comparisons are easier. That's one positive.
Absolutely. Third quarter should be a good quarter for us because of the comp comparisons that were created by the two evacuations that we had to do last year. So we would expect the third quarter to be a strong quarter for us.
Fourth quarter as we came out of the hurricane's last year, we had a lot of sales. They were generated as a result of some of the hurricane activity. I would hope and would expect competition, Wal Mart, Best Buy really fighting it out over the lower screen size and those price points. It can be viewed two ways.
I view it as a tremendous opportunity. It really stirs the market up. It gets a lot more consumers out in the market. It's an exciting prospect. We've always been able to hold our own against whatever national or big box player there is out there and right now we're doing it. I don't want to get too granular, but when there's a $350 32 inch third tier brand out there, we're matching it with a brand name. So we're going head to head.
Now are we making a lot of margin when we do that? No. Are we losing margin? No. So we're not going to forfeit it. So I would say that the third and fourth quarters, the third for sure looks good. I would hope in the fourth quarter as I've seen some economic forecasts, the fourth quarter is going to a more positive quarter just in general for the United States.
The $300 million that's being distributed through the Energy Star program by the government and I think there's a lot of positives out there. Certainly Circuit City's exit creates some market share opportunity. And so I view the very heated competitive landscape right now price point wise, as being an exciting opportunity.
Historically we've always been able to take advantage of that and we should now as well. What we have to do is we have to streamline our cost structure. We have to be more tactical, more aggressive so that we can deliver a better bottom line number. And we understand that.
David McGee – Sun Trust Robinson Humphrey
Based on the current guidance you have for the balance of the year and bringing the receivables onto the balance sheet etc., what should we anticipate the debt to cap ratio to be roughly by year end?
Depending on what your expectations are for total growth, the growth in the portfolio is still going to continue to happen on balance sheet and we are at $130 million in debt on the balance sheet right now with stand off balance sheet that we know we paid down in August, then you could easily be in the 50% range give or take debt to equity.
Your next question comes from Rick Nelson – Stephens Inc.
Rick Nelson – Stephens Inc.
Can you comment on the up tick in charge offs and delinquencies and what your expectations are as we go into the back end of the year recognizing the economy seems to be getting much tougher.
Currently our delinquency trend and charge off trend is slightly higher than our average for the year. I think for the year it's at 3.3% and we're at 3.4% was our last reported numbers. I would expect that over the third and fourth quarters, certainly the third quarter we might have a slight increase in that trend.
We're taking several steps to reverse that. There's some seasonality associated with it incidentally in the third quarter, but the steps that we're taking, we've really significantly increased our outside collection presence and since these are secure ties to loans, that's certainly very helpful, the threat of repossession.
In addition, coupled with the fact of needing to maintain strong liquidity and capital, we have increased down payments in some of the lower store zones. It's a good process that we do from time to time both to conserve liquidity and also to aid in delinquency.
Now in addition to doing that, because we have to be responding to competitive landscape, we're also increasing upper end cash options, 36 month, 24 month cash options. What that does, it injects a higher credit score to the portfolio and improves the general health of the portfolio and it's interesting to note, we've done this many times in the past.
We have a long track record of doing this, and we understand how to do that, scale back in the portfolio, increase the quality of the portfolio. Now what it does is certainly, it does not improve the margin long term. It does improve the health of the portfolio. It does help us drive sales in a segment of the credit population that we like to drive sales.
And it helps us step up the product line into higher margin products. So we get a little bit of a trade off in the margin field between credit and product as we step, in the larger screen TV's and LED TV's.
Rick Nelson – Stephens Inc.
Can you comment on the comps, how they're tracking in the early going of the third quarter?
Right now, our comp sales as compared to the second quarter we're down about 1% from that which we just reported at the second quarter. I expect that trend to reverse significantly in September, again because of the lower comps. We have many initiatives that we're doing right now and the vendors are starting to heat things up as well.
So the vendors, they have a strategy that goes from okay, we're going to capture as much margin as we can to we're going to grow the business as fast as we can are now getting on the trend of trying to grow the business faster. So much more promotional with more protected margins I would say is what we would experience in the last half of the third quarter here.
Rick Nelson – Stephens Inc.
If I could ask you about extended warranties and how your sales processes might have changed there and the effect it may have had on the second quarter.
Our sales process, we've always done what's right and legal for our customers and we're passing out additional information. Essentially that's all that's really changed in our process. I feel that some of the media over the Attorney General event could have dampened that. But I'm not going to hang our performance on outside issues.
We need to improve our performance. We have plans in place to do that. I would say that I'm very pleased with what's been happening in our service division as we've increased customer service scores a full 10 points and on days out which for a service company generally are measured how far out are you before you can get to the customer.
We're one to two days out in what is generally considered the toughest part of the year for that type of business, in the summer, compressors fail. If you have a refrigerator that's failed, it generally takes service companies anywhere from five to ten days to get out there. We're one to two days out in all of our markets and in some cases; we get out there the same day.
So we've improved our performance and with that, and with the confidence of that I feel that number will and Mike talked about, start trending back again at some point. But we're working very closely with the AG. We're going to do what they ask us to do and certainly I think improving our performance is the very first step that we needed to take.
That concludes the Q&A session. At this time, I'd like to turn the call back to management for any additional or closing comments.
I'd like to wrap up the call. I want to thank each of our 3,200 loyal employees for their dedication and executing at the highest level every day. Thank you to all of our customers. We know that many of you represent the second and third generations of families who have been loyal Conn's customers for decades.
I will also want to make the statement that we will attack these issues with renewed focus and we are not going to fail. We're not going to fail you and we're not going to fail ourselves in getting this business back on track to its historical profit and growth performance.
Thank you for your interest in our company and thank you for your participation in the call today.