hhgregg Incorporated (NYSE:HGG)
Q3 2016 Earnings Conference Call
January 28, 2016 9:00 am ET
Dennis May - President, Chief Executive Officer
Robert Riesbeck - Chief Financial Officer
Lance Peterson - Director, Finance and Investor Relations
Greg Melich - Evercore ISI
Michael Goldsmith - UBS
Dolph Warburton - Jefferies
Anthony Chukumba - BB&T Capital Markets
Good day ladies and gentlemen, and welcome to the hhgregg Third Quarter 2016 Earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will follow at that time. If anyone should require assistance during the conference, please press star, then zero on your touchtone telephone.
I would now like to introduce your host for today’s conference, Mr. Lance Peterson, Director, Finance and Investor Relations. Sir, you may begin.
Good morning everyone and thank you for joining us. Joining me on our call this morning are Dennis May, our President and Chief Executive Officer, and Bob Riesbeck, our Chief Financial Officer.
During today’s call, Dennis will discuss the current state of our transformation, our business, and the status of our key fiscal 2016 initiatives. Bob will follow with details on our operating results for the third quarter ended December 31, 2015. After our prepared comments, we will have until 10 am Eastern time to answer your questions.
During this call, we will make forward-looking statements which are subject to significant risks and uncertainties, and include the future operating and financial performance of the company. The company believes the expectations reflected in its forward-looking statements are reasonable but can give no assurance such expectations or any of its forward-looking statements will prove to be correct. We refer you to today’s earnings release and our current Form 10-K for additional information of these risks and uncertainties.
In addition, we will discuss EBITDA, adjusted EBITDA, net loss as adjusted, and net loss per diluted share, as adjusted, which are non-GAAP measurements we use to assess our financial performance. Please refer to our reconciliation in the non-GAAP disclosure section on our investor relations website, which can be access at hhgregg.com.
With that, I’d like to turn the call over to Dennis.
Thank you, Lance. I would like to first thank everyone at hhgregg who went above and beyond with their efforts during the holiday period. I was very pleased with the enthusiasm and energy I saw at each store I visited over the past several months. It was this level of effort which has generated several key wins for us.
We generated $4.3 million of adjusted EBITDA during the quarter, and through nine months are $4 million ahead of where we were last year. We exceeded our plan on cost savings during the quarter and now have realized $48.9 million of savings year-to-date. This is a great testament to our entire team, who continue to be more efficient. We also grew our furniture business 15.5%, which beat our expectations, and we continue to strengthen our balance sheet.
Moving to our financial objectives for the year, our most important financial objective was to generate positive EBITDA for the year. We feel we will deliver on this goal. Through the third quarter, we have generated $3.4 million of positive EBITDA, which as I mentioned earlier is roughly $4 million more EBITDA year-to-date compared to the same period last year. For the fourth quarter, we plan to generate positive EBITDA, which compares to the negative $11 million of EBITDA for the fourth quarter of last year.
Another financial objective is to realize $50 million of cost savings for the year. We continue to have solid execution on managing our cost structure to align with our expected sales levels and have become a more efficient company. In the third quarter, we realized $21.7 million of savings related to this objective. As I mentioned earlier, this now gives us $48.9 million of savings fiscal year-to-date. With our year-to-date performance, we are confident that we will now exceed our target of $50 million of cost savings in fiscal year 2016. We expect to have this same effort on cost savings in fiscal 2017 and look forward to providing you the details on our fourth quarter call.
Most pleasing is that while we reduced our costs, we continue to see increasing customer satisfaction scores in our three most important customer-facing areas: stores, online, and in-home delivery, and strong conversion rates.
With regard to sales, we had a disappointing quarter in revenue driven by our biggest category, appliances. The most significant factor in our third quarter performance in appliances was in the area of promotional offerings on delivery. Simply, our competitors were advertising free delivery, and we were not. We believe this resulted in low appliance traffic and sales. Our approach to a full-service delivery model for one low price is still advantageous, but this was lost on customers who reacted to advertisements.
We have changed our approach here. On a go-forward basis, we plan to match or beat our competitors with our promotional offerings, which includes introducing free instant delivery to our customers starting in February. We feel this will allow us to compete more in the areas we excel: broadest product selection, best price, and ultimately best-in-class service and delivery.
We are currently at a negative 7.3% comp fiscal year-to-date. During the fourth quarter, our focus will continue to be where it has been all year: appliances, 4K TVs, furniture, and online sales.
This past quarter further reaffirmed our commitment to this transformation. Retail is in a constant change and we must continue to drive our key strategic initiatives to continue to change with the industry and drive growth. Our top strategic initiative is to grow our revenue. Appliances is our largest sales category and we expect to get back on track after a difficult third quarter. I provided color on the reasons for our appliance performance at the beginning of my prepared comments.
One other quick note for appliances - one of our primary appliance growth initiatives continues to be through our Fine Lines departments. Our stores with the Fine Lines do 2x the appliance sales, and these Fine Lines locations have had a positive comp on the quarter. In October, we announced that we were planning to double the number of locations with Fine Lines by the end of fiscal 2017. We currently have 11 stores with Fine Lines.
Next is our ecommerce platform. Our ecommerce sales also continue to be a core component of our growth. We are pleased with the 10.4% sales growth fiscal year-to-date. We continue to recognize the importance of this investment, specifically in the mobile capabilities and our expanded aisle offering. We expect our mobile experience to allow both easy buying and efficient product research platforms. We expect our expanded aisle to provide even greater selection to our customers. We feel we can still get better on both of these, which we believe will further help our sales performance online as well as in-store. Supported by our success to date, we expect to continue to invest in our entire ecommerce engine.
Within the consumer electronics category, although there was an industry softness in the quarter, we were pleased with the continued momentum and traction of 4K TVs. Fifty-nine percent of our TV sales were 4K TVs, which is up from the 50% we generated in the second quarter. We will continue to focus on large screen premium video, which is where we can best compete and win.
Our home products category continues to be our best growth performer. As I mentioned earlier, we grew furniture 15.5% during the quarter. What excites me is home products is our most immature category and we are just getting started. Accordingly, we continue to expand our offering within furniture and have constantly been testing store layouts to optimize sales performance for all categories. We are getting closer to having what we believe is the best product layout within our stores. This includes more furniture near the front of the store, so our customers can more easily see our assortment of furniture offerings immediately upon entering.
The stores with more furniture at the front of the stores are generating incremental sales and strong ROIs. We currently have 28 stores which have been reset, and plan to reset 100 additional locations by the end of fiscal 2017. As part of this focus on home products category, we will invest in driving more awareness to our customer base about the expanded offerings we have for furniture for the great room.
Our second company initiative is reshaping and reducing our marketing spend. As we indicated last quarter, we did not decrease the advertising spend on a percentage as much as we did in the first two quarters due to the holiday season. Fiscal year-to-date, we have decreased our gross advertising spend by $18.2 million. We are pleased with this level of savings, but as I’ve said all year, we not only want to spend less dollars, we want those dollars to be more effective.
Through this approach, we are pleased to continue to see better effectiveness of our advertising spend. During the fourth quarter and into fiscal 2017, we will continue to rationalize our advertising spend and rebalance our investments into the most effective mediums for us.
Our third strategic initiative is right-sizing our G&A structure, and Bob will give you an update on our third quarter performance for this initiative shortly. I have been very pleased with our ability to reduce costs, as I mentioned earlier, without any impact to our customer experience. I believe the third quarter results were a minor setback in our transformational efforts, and we know that we have a lot of work still in front of us, but looking at the first nine months as a whole, we are very pleased with the progress we have made and the improved profitability of the company.
I would now like to turn the call over to Bob, who will provide you more insight into our financial performance for the quarter. Bob?
Thanks Dennis, and good morning everyone. As we previously reported, during the quarter we generated net sales of $593.2 million, which was 10.9% from the third quarter of last year. We also experienced a 10.8% decrease in comparable store sales for the quarter, which was driven primarily by all categories except home products. The appliances and consumer electronics categories, representing 89% of our revenue base, were both under pressure in the third quarter. We believe this was due to the challenging consumer environment, particularly the electronics sector, and from significant competitive pressures in appliances. Our appliance category was down 10.4% in the third quarter. Our consumer electronics category was down 7.9% in the third quarter. Our home products category, however, increased 3.3% in the third quarter, primarily due to a 15.5% increase in furniture, partially offset by a decline in bedding.
During the quarter, our gross profit margin declined 83 basis points to 26.1% from 27% in the prior third fiscal quarter. This decrease was primarily due to lower margin rates in each of the categories except home products, partially offset by a favorable product sales mix to categories with higher gross profit margin rates. The decrease in gross margin rates was primarily driven by greater competition and higher promotional environment during the holiday period. For us, this came from both our investment in pricing and enhanced financing terms.
As Dennis mentioned earlier, we will continue to adjust our mix on pricing, marketing, financing and delivery options to the consumer to best drive long-term value for the company. As Dennis also mentioned earlier, we continue to manage our cost structure closely to align with our expected sales levers and to maximize our EBITDA.
The planned combined effect of reducing our marketing spend and right-sizing our G&A structure is expected to have a $50 million impact on this fiscal year. Year-to-date, we remain on track to exceed this goal. During the third quarter, we realized $21.7 million of savings, and for the first nine months we have realized $48.9 million of savings on this $50 million initiative. This has partially been offset by increased fees with our financing programs. Although we did generate $4.8 million of advertising savings in the third quarter, as we mentioned in our last call, it was not to the same degree of savings as we saw in the first six months during the holiday period occurring during the quarter. This approximately 12% decrease in net advertising expense for the third quarter was due to reductions in print media along with rebalancing our spend among more effective but less costly advertising mediums.
The decrease in SG&A has been primarily driven by cost savings in operations, logistics and corporate overhead. We recognized an $8.6 million decrease in wages due to our continuing effort to drive efficiencies in our labor structure, and a $4.3 million decrease in delivery services due to efficiencies in deliver routing and lower fuel prices. These decreases were partially offset by approximately $1 million of additional fees associated with higher cost customer financing options and higher private label credit card penetration.
During the quarter, we continued to feature extended terms on our proprietary and non-recourse hhgregg credit card. This benefited our total credit penetration increase to 46.2% in the third fiscal quarter, which was an increase from 41.1% experienced in the third quarter of last year.
Our cost savings initiative has more than offset our comp declines to date and helped us generate positive EBITDA year-to-date. Through nine months, we have generated a $3.4 million EBITDA profit, which is approximately $4 million better than the first three quarters of last year. We remain confident we will achieve positive EBITDA for the current fiscal year ending this March.
As it relates to the tax provision and tax benefits, during the third quarter we recorded a $1.3 million tax expense due to a settlement of an IRS examination for a prior year. There was no income tax expense or benefit recorded related to the current quarter’s operations due to our full valuation allowance that was recorded last year. We continue to believe we will not recognize a tax benefit or expense in the foreseeable future.
Our third quarter results included a $20.9 million pre-tax, non-cash charge related to the impairment of fixed assets of 40 store locations. This charge is a requirement under current accounting regulations; however, we are very comfortable with our current portfolio of store locations.
Our net loss for the quarter was $26.9 million or $0.97 per diluted share, compared to a net loss of $86.9 million or $3.10 per diluted share last year. Net loss as adjusted for the current quarter was $4.8 million or $0.17 per diluted share. On a comparable basis, net loss as adjusted last year for the third quarter was $5.1 million or $0.18 per diluted share.
Although our sales performance did not meet our expectations, our cost savings initiatives and management of working capital have continued to give us a strong liquidity position. During the first nine months of fiscal 2016, we have improved our liquidity position by $40.9 million. As of December 31, we had net availability of $205.9 million with no outstanding borrowings under our $400 million revolving credit facility. We also had a cash balance of $7 million. We believe our strong balance sheet continues to position us well for executing on our strategic initiatives and stabilizing this business.
With that, Dennis and I would be happy to take any questions that you have.
Our first question comes from Greg Melich from Evercore ISI. Your line is now open.
Thanks guys. I just wanted to follow up on appliances. You talked about how the promotional environment had changed but that it was specifically about delivery. What changed for you to decide to switch to free--to doing that type of promotion now, as opposed to what you were doing in the past?
Yes Greg, I think there’s a couple elements. First of all, we’ve taken all the learnings that we can out of our fiscal third quarter around appliances. I think consumer preference clearly has changed. As consumers research online and they purchase more online, to them free shipping and free delivery is one and the same, so I think their expectations around free delivery has been a change in the marketplace. I also think that you now have clear alignment from the national competitors around offering free basic delivery on appliances, so as we look at both consumer preference and the competitive landscape, we see that just being more aligned and more clear.
The other thing that we’ve been able to do coming out of holiday is make a litany of system changes in which we’re going to be able to offer free basic delivery, but be able to sell our a-la-carte premium services. In the past, whenever we have dabbled in free delivery, we were giving away our free deluxe delivery. Moving forward, and actually this will start next week, we will offer free basic delivery to our customers, just like our national competitors, and then we will charge for any of the premium or a-la-carte services that we would perform on top of it. So we have moved quickly to change our website, to change our POS systems, to change with our delivery partners to be able to launch this the first week of February.
We think that we’ll be able to mitigate most, if not all of the cost of offering this service. What it does for us is it improves our traffic, so as the consumer clearly changed their preference and the national suppliers have aligned and moved around--sorry, national retailers have moved around offering free delivery, as that consumer is researching their purchase, it’s a complex story to tell them, so we need to make that much more clear. We’ll be rolling that new plan out the first week of February, and we think it’s going to help our traffic.
It sounds like you think the gross margin dollar profit per unit now is really unchanged. Is this sort of by taking some cost out and shifting where the promotion would go, it would be the same, or do you expect it to be less?
We expect it to be the same. I think the most important element here, Greg, is that we’re going to be able to clearly market to the consumer on our website and through our advertisements that delivery is free at hhgregg, just like our national competitors.
Thanks for that. Just if I could follow up with one more, switching to TVs in particular, what do you think the market did in the quarter ending December, because between NPD and other sources, it seemed like it was up a little a bit or maybe it was down a little bit. What do you think the market did for both overall TVs and in the bigger screens?
Well the overall TV market, for example, December was minus 5.7, so that was revenue dollars for the TV category from NPD, so think about a number just shy of 6%. And then November, Greg, was more like low single digits, like a minus 3 or 4% in total dollars. These numbers get adjusted usually 30 days in arrears, so our expectation is when you blend holiday together and the numbers are finalized, you’ll see a number in that minus 4% range for what we call the holiday period.
And given the importance of that category, how does it look so far this quarter in terms of people getting ready for the Super Bowl? Is Denver-Carolina good enough?
Well you know, we have a lot of stores around the Carolinas, so that’s a good thing. Peyton Manning certainly generates a lot of interest. What will be interesting about current trends in this quarter is there is a lot of shifts--you know, Super Bowl is a week later this year, so that certainly will influence just how it plays out from a current timing perspective. But within the quarter, we see our comps returning to what we’ve guided to in the past, of more of that mid-single digit negative. Now again, a lot of the quarter is in front of us, you’ve had some weather, Super Bowl, President’s Day will be very important to us. So as we look forward, we see our comps more in that mid-single digit negative range.
Great, thanks. I’ll give someone else a chance.
Our next question comes from Michael Lasser from UBS. Your line is now open.
Good morning. It’s Michael Goldsmith on for Michael Lasser today. Thanks a lot for taking my question. You’ve implemented a number of initiatives recently, but so far they haven’t really shown up on the top line, so where do you expect to see the initial positive results? Is there a specific product or category where we should look out for it to see these initial successes?
Yes, I think that what you will see the company really emphasize and focus on in the upcoming year is around revenue. For us, our number one objective last year was to return this company to positive EBITDA, and as we said in our remarks earlier, we’re going to perform and deliver on that this year. So again, returning the company to a positive EBITDA, generating a more efficient organization was very, very important to us. So we are pleased to return the company to positive EBITDA, very pleased to be able to exceed our $50 million SG&A savings, but as we look forward, our emphasis certainly has to be and will be around generating improved revenue trends.
I think furniture would be an area where we would point to where we’ve seen some traction. We had a plus-15 comp last quarter in furniture, and we see those trends continuing. We’ve also seen very positive trends around the stores that we’re reset in furniture, so we’re getting even greater than the 15% comp there. So as we reset more and more of these stores, we think that number just continues to be more meaningful to the company.
The other area that I would point to and believe that we are going to show improved performance is around appliances. Q3 for us was a setback in the appliance category - we missed a couple things not only around free delivery, but also around some of the staffing transformations that we did, so we are currently adjusting some of the staffing in the appliance category. I think you’re going to see those have a positive impact in our appliance business. So I would look toward the furniture business and I would look toward the appliance business.
Also, the addition of Fine Lines continues to perform very well for us. We continue to comp positive in our Fine Lines departments, not only for the quarter but consistent quarter after quarter comp growth, so as we add more Fine Lines locations to our mix, that also is going to help our appliance business.
That’s helpful. As my follow-up, you’ve essentially met your cost savings plan for the year as of the end of third quarter. Does this suggest that the cost savings in the fourth quarter should decelerate materially, or is there more low-hanging fruit that you should expect to reap in the upcoming period?
Michael, this is Bob. So I think in the past, we’ve mentioned that we expected to realize on the $50 million this year, but on an annualized run rate, that would top out more at the 75 level. So I still think there’s opportunity in Q4, but we still think based on the initiatives that have been enacted on so far, that number annualizes out at $75 million.
Thank you. Good luck in the fourth quarter.
Our next question comes from Dan Binder from Jefferies. Your line is now open.
Hi, this is Dolph Warburton on for Dan. Just following up on the Fine Lines, were openings in Fine Lines pushed back due to what you were seeing in the appliance promotion? Have your thoughts changed about how many stores that Fine Lines can fit into? For next year, are you able to give any color on the cadence of the roll-out for the remaining Fine Lines departments for next year? Thank you.
So we announced in October that we would be doubling the number of Fine Lines locations we have in the upcoming fiscal year, so in October when we spoke, our expectation was that we would--we had 11, and that we would add at least an additional 11 in fiscal 2017, which starts in April. So our expectations for those Fine Lines stores is that they would open on a pretty even cadence through the course of the fiscal year, other than obviously not around our holiday season due to the amount of construction. So I would anticipate an additional 11 locations to be added, and kind of broken evenly amongst the quarters.
Your second question around has our thinking changed relative to the number of locations, we actually think that there is even more of an opportunity and more locations that Fine Lines can be added to. As we learn more about this and see continued success and consistent performance out of our Fine Lines stores, we believe that there could be up to 50 to 60 Fine Lines locations added to the current chain.
You had also asked about the cadence and have we slowed it down. No, we didn’t do anything in the recent Q3 really because of the holiday activities. Keep in mind, when we had a Fine Lines department, it is just a department within existing box, so it’s not a new location. So we did not want to be in construction and have that activity going on during the holiday, but it is going on now.
Okay, thank you. If I can just ask one last housekeeping question. I might have missed this earlier in the call. Did you disclose the growth in internet sales or ecommerce sales for Q3?
What we spoke to was 10.4% comp growth fiscal year-to-date, and we had slight growth in the quarter. I would say it did slow, and we have made some adjustments out of that, that you’ll see us get back on track with our more prototypical growth moving forward.
One of the learnings that we had out of the holiday season was from a mix perspective. If we could go back and do it over again, we would have spent more dollars in mobile, so we came up--though we did grow dot-com in the quarter, it was not the number we were looking for.
The other thing to keep in mind is our mix of sales online is consistent with our mix in-store, so with us having a tough quarter Q3 in appliances, it did have an impact on the online business also.
Basically we had mid-single digit type growth online in the quarter, and that certainly was below our growth that we had and below our expectations moving forward. Part of that is just continuing to reshape how we spend our advertising dollars. You’ll see the company allocate more dollars toward mobile advertising, which will be beneficial to both our online sales and our in-store sales.
Okay, thank you and have a great day.
Our final question comes from Anthony Chukumba from BB&T Capital Markets.
Good morning. Thanks for taking my question. Just had a clarification question. You mentioned your liquidity position has improved year-to-date, and I’m just trying to reconcile that because as I look at your balance sheet on March 31, you had $23 million more of cash, and at least in terms of debt on your balance sheet, you didn’t have any debt at the beginning of the year, as you have no debt now. So I’m just trying to reconcile--first, confirm that number in terms of how much your liquidity has improved, and I’m just trying to reconcile that.
Yes, I think it’s primarily driven by the inventory level and the borrowing base, so based on the advanced rates under our revolver is the driver.
Got it, okay. So it’s an asset-based revolver with inventory as the borrowing base?
Okay. Okay, that’s helpful. Thank you.
Thanks everyone for your interest in hhgregg, and we look forward to providing you an update on our next call in May.
Ladies and gentlemen, thank you for participating in today’s conference. You may all disconnect. Everyone have a great day.
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