Conn's Inc (CONN) 2005 Q2 法說會逐字稿

Good day, ladies and gentlemen. And welcome to your Q2, 2005 Conn's Services conference call. My name is Jean. I'll be your conference coordinator.

At this time all lines are in a listen-only mode until the end of the conference call when we will be accepting questions.

[OPERATOR INSTRUCTIONS]

At this time I'll turn the call over to your host, Bill Frank. Over to you, sir.

Thank you, Jean and good morning everyone. And thank you for joining us again.

By now you should have received a copy of our earnings release that was distributed before the market opened this morning. It outlines our operational and financial results in the second quarter of fiscal 2005.

If for some reason you did not receive a copy of the release, you can download it from our website at www.conns.com and click on the investor relations' tab. In addition certain financial and statistical information that will be discussed during this conference call will also be provided on the same website.

Now for the legal stuff, I need to remind you that some of the statements made in this call are forward-looking statements within 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. These risk factors include, but are not limited to, the following - the company's growth strategy and plans regarding opening new stores and entering new markets.

The company's intention to update or expand existing stores.

The company's estimated capital expenditures and costs related to the opening of new stores or the update or expansion of existing stores.

The company's cash flow from operations, borrowings from its revolving line of credit and proceeds from securitizations to fund operations, debt repayment, and expansion, growth trends and projected sales in the home appliances and consumer electronics industry, and the company's ability to capitalize on such growth, relationship with the company's key suppliers, the results of the company's litigation, interest rates, weather conditions in the company's markets, changes in the company's stock price, and the actual number of shares of common stock outstanding.

Further information on these risk factors is included in the company's filings with the Securities and Exchange Commission including our 10-K, which was filed on April 16, 2004.

I would now like to hand the call over to our host for today's call, Mr. Tommy Frank, Chairman and CEO of Conn's.

Tommy?

Good morning and thank you again for joining us.

As we review the numbers with you this morning you will see significant growth in our top line and same store sales and in profitability. In fact, all five of our significant product categories performed well with increases in all five categories.

Additionally, our Austin market, which is a market that we had concentrated on improving, performed well and we got significant increases out of it.

The Dallas market continues to perform at about what our expectations are for this point in its development with five stores.

Relative to new stores being opened, we will open on Wednesday of this week a new store in Mack Island, Texas, which is on the Texas, Mexico border. We're very excited about that addition, which will be three stores opened so far year to date.

There was some confusion the last time, I think, as to how many stores we would actually get opened this year. It is anticipated at this point we will have three additional stores opened in the Dallas, Fort Worth area prior to this fiscal year end. That will give us a total of six stores that we would have opened this fiscal year.

As we look at some other things we accomplished this quarter, an immense amount of work and focus has been given to the section four for the Sarbanes-Oxley law and will tell you that the cost of that is extremely high and is probably costing us a penny a share. The quarter that just ended is going to probably cost a penny a share, the quarter we're in and probably another penny a share in the latter quarter.

Hopefully some of these costs are one time costs and in the future we should be able to reduce that ongoing cost somewhat. But it's a very expensive process.

I would also point to the fact that we brought on a new external director in Scott Thompson, a very qualified, independent member who is now serving on our audit committee. The Stephen's representative on that committee resigned from the audit committee and so we have all members that now meet the independent requirement test, three independent members qualified.

An additional relative to the resignation or pending resignation or retirement of our current CFO, I would like to tell you that we have a CFO designate. His name is David Rogers. His credentials are very good. He has served with us nine years as our controller. David is 57 years old. Previously worked 20 years in a public company in the utilities industry and is very familiar with not only our accounting processes but is very familiar with the public companies and how they operate.

To back him up we have two additional staff members, one was already on board for about eight months and that is has both a law degree and an accounting background. His name is Sidney Boone (ph), 56 years old. And Sidney has public accounting experience in audit as well as a law degree. And he will be helping David Rogers in the preparation of his material.

We also have engaged a new controller to fill David Rogers position. His name is Mike Polk (ph). He's a seven year veteran of Group 1 Automotive, a Fortune 500 Company. And has extensive qualifications in public accounting and public owned companies.

And at this time I think that concludes my general remarks. I'm available for questions and we'll let Bill give you the numbers. Thank you.

Thanks, Tommy.

And as Tommy said, obviously again we enjoyed a nice quarter from an operating standpoint. We substantially increased our pre-tax income in the quarter by approximately 23% over the prior year. Net income available for the common shareholder increased almost 38% while diluted earnings per share actually decreased one cent due to the additional stock issued in the IPO.

If you assume that the shares of stock we issued in the IPO were outstanding for the entire 2004 fiscal year and that we used the proceeds of the IPO to pay off debt, retrospective to the beginning of that year, pro forma diluted earnings per share would have increased approximately 16%.

And I'm going to, during this section, I'm going to cover the quarter results first and then I'm going to talk about the year to date results of operations. And then spend just a minute on our balance sheet.

Going back to the quarter, total revenues increased $19.5 million or 16.6% from $117.1 million in the quarter ended July 31 '03 to $136.6 million for the quarter ended July 31 '04.

The increase resulted basically from two components. The first, net sales, increased $16.1 million or 15.7% and that included a same store sales increase of 7.2%.

Finance charges and other increased $3.4 million or 23.5%.

Also, during the quarter we continued to experience a reversing trend in price point deterioration as increases in sales volume at the retail level resulted, really, from about 50% was volume increases and about 50% was price point increases. And I would tell you that I think that's the third quarter in a row that we've seen that reversing trend.

The combination of the credit portfolio of the QSPE and the accounts that are retained on our balance sheet increased 22.6% from $311 million at July 31 of '03 to $382 million at July 31 of '04. And during this quarter our earnings associated with the operations of the QSPE increased approximately $2.8 million.

Again, for the quarter, our gross margins decreased slightly from 37.1% to 36.5%. We attribute this primarily to promotional credit that we used to drive same store sales.

For the quarter, selling, general, and administrative expenses increased by $5.1 million or 15.8% increasing from $32.4 million in the second quarter of 2004 fiscal year to $37.5 million in the second quarter of fiscal 2005.

As a percentage of revenue, SG&A expense actually decreased from 27.7% to 27.5%. Much of the slowdown in the SG&A line growth resulted from lower payroll and payroll related costs that was offset by higher advertising expense.

As you look at our provision for bad debts for the quarter, you'll see it increased roughly $400,000 from a year ago. This bad debt expense includes write-offs and provision for those accounts that are held on our balance sheet and are not transferred to the QSPE.

And as a matter of practice, we review reserve balances, bad debt reserve balances, relative to outstanding receivables and adjust that reserve through the provision on a monthly basis. And we use our prior write-off experience as a basis for that calculation.

In the quarter ended July 31 '03, we actually recorded about a $300,000 reversal of bad debt expense based on our prior experience last year.

Consequently, much of the increase in the current quarter was driven by the prior year reversal. In fact, as you look at the year to date numbers, we'll get into that in just a second, you should see that the increase in bad debt expense is very much in line with the growth in our credit portfolio.

For the quarter our operating margin decreased from 8.7% in the second quarter fiscal 2004 to 8.1% in the second quarter 2005. This decrease reflects the decrease in gross margin we previously talked about resulting from the impact of discounting receivables recorded from promotional programs that extend beyond one year. The effect on the quarter was approximately $573,000 net pre-tax.

We expect that operating margin - we expect that the operating margin will continue in the 7.8 to 8.3% range as we continue these promotional credit programs and our SG&A expenses return to a more normal level during the final two quarters of this fiscal year.

Interest expense for the quarter decreased by $1.1 million or 66%, dropping from $1.7 million in the second quarter of fiscal '04 to $567,000 in the second quarter of 2005.

Most of this decrease resulted from the payoff of balance sheet debt, the reclassification of amounts previously recorded and other comprehensive income, the application of FAS 133, and the expiration of $80 million in interest rate swap agreements.

Let's take a look now at the year to date results. So for the six months ended July 31 '04 we increased our pre-tax income line by approximately 36% over the prior year. Net income available for the common stockholder increased approximately 55% and diluted earnings per share increased roughly five cents to 61 cents per share.

Again, if you assume the shares of stock that we issued in our IPO were outstanding for the entire 2004 fiscal year and that we used proceeds of the IPO to pay off debt retrospective to the beginning of the year, our pro forma diluted earnings per share would have increased 25% from 49 cents to 61 cents.

On a year to date basis, total revenues increased $33.6 million or 14.1%. That's up from $237.9 million in the six months ended July 31 '03 to $271.5 million for the six months ended July 31 '04. And again, breaking those increases down, $28.0 million or 13.4 % came from our net sales and that included a same store sales increase of 5.3%. Finance charges and other also increased $5.6 million or about 19.7%.

During the six months ended July 31 of '04 we continued to experience the reversing trend that we talked about in the price point deterioration. Product sales volume resulted, wound up with about $12.4 million of that increase from volume. And the other $14 million resulted from increases in unit price points.

The combination of the credit portfolio of the QSPE and the accounts retained on our balance sheet as we discussed before increase 22.6%.

On a year to date basis, our earnings associated with the operations of the QSPE increased approximately $3.7 million.

For the six months ended July 31 '04, gross margins increased from 36.1% to 36.4% and that's again due primarily to the good quarter that we had last year where we did not have to discount our prices as much as we had in the previous year to achieve our same store sales growth.

On a year to date basis, SG&A expense increased by $8.2 million or 12.8%. This increase was from $64.2 million in fiscal 2004 to $72.4 million in 2005. As a percentage of revenue, SG&A expense actually decreased again from 27.0% to 26.7%.

As in the quarter, much of the slowdown in the SG&A growth resulted from lower payroll and payroll related costs.

And again, as we've talked about earlier, our bad debt provision increased for the six months ended July 31 '04 $461,000 or about 21% over the prior year. And as I've mentioned earlier, this increase is consistent with the increase in the total credit portfolio, which we mentioned earlier was 22.6%.

A couple of comments about the balance sheet, first of all, as we look at the changes that have taken place since January of '04 we increased - had significant increases in receivables, interest and securitized assets, inventories and fixed assets. We also had an increase in accounts payable, which is primarily related to growth and somewhat to timing.

On January 31, 2004 we adopted FASB interpretation number 46, relative to consolidation of variable interest entities. The resulting impact to our balance sheet at July 31 included the recording of approximately $939,000 in cash of the non-owned subsidiary SRDS, $16.0 million in fixed assets, $15.0 million in current and long-term debt, and $1.9 million in minority interest.

The increase in accounts receivable of $11.9 million is a direct result of the increase in our credit promotion programs that do not qualify for funding under the asset backed securitization program. This obviously had a negative impact on our cash generated from operations, which declined approximately $10.2 million from the prior year.

However, we believe that the benefit that we receive from selling the base product at higher margins, and the resulting ancillary services, such as service maintenance agreements, more than offset the cost to carry these receivables.

Our credit portfolio continues to perform at a very consistent manner. If you took a look at the information that we posted in the supplemental information on the website this morning, we had an increase from January of '04 of about 9.3% in the outstanding balance. We've already indicated that balance increased about 22.6% from July a year ago.

Our delinquency rates very consistent. We're actually down from a year ago from 5.4 to 5.1 and down from January to from 5.2 to 5.1 and our gross bad debt write-offs and our reserve as a percentage to outstanding balance very consistent at the 3.4 mark.

With that, we would, I guess, Jean, like to turn it over to anyone who has questions.

[OPERATOR INSTRUCTIONS]

Please hold for your first question. And that will come from the line of Rick Nelson (ph) of Stephen's. Please go ahead.

Thank you. Good morning.

Good morning.

When you referred to the expansion of credit programs in excess of one year, is that the no interest, no payment?

It's both, both no interest and no payment and interest payable. We have used two programs in the past quarter. One of them was an 18 and a 24-month program, which was a cash option type vehicle similar to the ones we've been using on 12-month cash option.

There's a 36-month program that we have used on a limited basis where it's truly a no interest program.

And tell me what, something a feel for maybe a percent of sales that you're generating on these programs compared to a year ago? And how much more aggressively can you push these programs?

I think the total volume, and I'm going to qualify, but I think it was about $6 million of total volume or roughly. So ...

I think it was a little more than that. I think it was ...

Well on the ones over one year.

Yes.

It was $6 million over one year.

And that's the program I'm referring to. And I'm not sure how further, how far we can push it, Rick. We're comfortable if we look at the bottom end on our high-risk credit we're at about 17% of our portfolio.

We think that we're not uncomfortable with somewhere between 15 and 20% of this kind of additional credit on the top end.

It's a customer that we have not seen in our stores previously. About 50% of the time we run that promotion. We're able to track whether they've made previous purchases or not. And about half the time on this credit over twelve months we've not seen that customer in our store previously.

So we think we're, that it's generating a customer we'd like to see in there. And the credit quality is pretty high on that group.

And do those credits not qualify for the securitization?

That's correct.

OK, any comments on Dallas market entry?

Well, I think the comment that I made was I made two comments. Number one, it's still performing about where we thought, we had a range and I'd say it's just below the mid range of where we hoped it would be at this point. So it's well within the range.

We have three additional stores scheduled there to open in that Houston market before the year-end, one in October and one in December and one in January.

So, we like the market. It's still consuming an exceptionally large amount of advertising as a percentage to the sales we're realizing out of it. Until we can leverage those costs with some additional stores, that advertising cost as a percent to sales is going to remain higher than the norm.

And Tommy, when you say it's within the range of your plan, is that sales or profits or both?

Well, both. It's both. And obviously and primarily I was speaking to the sales number. The profits are going to occur as soon as we can begin to leverage some infrastructure cross in that market. And we think that a store count of eight, we're going to begin to see some leverage.

We have two components we're trying to leverage. One is distribution and the other one is advertising, advertising being the greatest. And also there's some fairly large costs associated with training and staffing those stores as a start up basis. So we're incurring some relatively large costs in training as we continue to staff those stores.

And any comments on comps in the third quarter to date?

Well, I think it's early to comment. I mean last year we had the Labor Day weekend was actually in August. This year it's in September. I would say this that I'm not disappointed in what I'm seeing in volume both overall and in comps.

But I also would qualify that by saying it's very difficult when you have an event as big as the Labor Day weekend that's distorting last year's August numbers or you're getting a distortion between the comparison between the two periods.

It's going to be a lot easier to see exactly where we are after we've got about sixty days behind us this time.

Normally we could comment on it. But I would just say at this point I'm not disappointed in what I'm seeing.

And what is the target for comp for the quarter?

I think it's still mid single digits.

Thank you very much.

Thank you, Rick.

We'll take our next question from Frank Brown (ph) of SunTrust (ph).

Hi, good morning.

I wanted to follow up a little bit further on the gross margin ratio in the second quarter and just make sure that I understand. You all talked about that volume and price points contributed about equally in terms of the growth in gross margin dollars. And we had a good mix in the first quarter and I guess you're saying that that mix continued in the second quarter?

And I'm trying to get a better feel for the 130 basis points decline in the ratio. Is that the promotional financing entirely? Or could you break that down again for me, please?

About $517,000 net financing that took place in that second quarter. And I would say that most of that decrease on a percentage basis would be attributable to that.

I don't have a calculator in front of me, but it should be pretty close to it. Hang on just a second. Let me just ...

So the price that the product went out the door was essentially the same as it had been prior year but there's a hit to cost of goods sold for the financing?

I think that we indicated that the price of the product that we actually experienced price point increases and of the 15 or $16 million of increases that we enjoyed in our net sales roughly half of that was from volume and half of it was from price point increases.

And then I think as you look at the margin decrease it's a function of a number of things but primarily that credit promotion program that we put in where we had to discount those receivables because they were longer than one year old.

Now of course as you're probably aware, we discount that on the front end and then we accrete that back into our earnings over the life of those contracts. So we'll begin to see that come back in in the future.

And so that's really a change that occurred between the first quarter and the second quarter instead of going longer than one year?

Well, we actually introduced the program, Rick, in the first quarter. There's a significant difference in the volume that took place in the second quarter versus the first quarter. I think we only did about a couple hundred thousand dollars as my memory serves me in the first quarter. And that number jumped substantially in the second quarter.

So at 517?

That's correct, 517 net of the amortization of those amounts that had previously been recorded.

And just touch base on the portfolio yield, if you would. Did that impact the portfolio yield?

Not substantially. As Tommy indicated, there's really not enough of it out there at this point to where it's going to significantly decrease it. Our portfolio is about $380 million at this point. And these types of promotional programs and I think particularly the ones over a year old only represent about 12 or $13 million.

So it's not a substantial decrease, although obviously on a no interest arrangement, as Tommy described for the 36-month receivables, as long as the customer is paying according to the scheduled program.

And I think that is a significant issue that you need to be aware of is the customer is making payments on all of these programs, even though they may not be accruing the interest, they are required to make a monthly payment.

OK. Also, I was just curious, let's see. In terms of the guidance in the second half, I think that you talked about a 7.7 to an 8.3% kind of EBIT margin. And was that consistent with the thinking before?

I think it was.

Yes. OK. And on the Dallas, Fort Worth stores, I guess the long-term objective had been kind of 18 to 20 stores? Is there any feedback there in terms of is that thinking that same? Is the market changed or presented any opportunities or lesser opportunities than it had six months ago?

I think at this time we're still on track for that number, Frank. And when we say that market that might include some peripheral areas around there, too. So it's not all just within the confines of the corporate limits of those two lower cities. But I think we're still on track for that type of store number.

OK. And just sort of a last follow up on the gross margin and the product mix. I mean bedding and lawn and garden and track all continue to sell well. And can you give any comments in terms of consumer acceptance in those areas? And how we can think about modeling that going forward?

Not sure I can tell you how to model it. Maybe Bill can. But we remain very pleased with the lawn and garden business and the track concept. They're both performing well.

There is one significant thing we did in the past 30 days that should have a positive impact on our bedding. Short-term it's going to reduce the margin but it's increased volume. And that is, we became an exclusive Serta dealer. We had about three brands in our stores previously. And bedding is a very new product category for us and we weren't probably as sophisticated in that area as we needed to be.

We felt that the Serta franchise brought to us a level of help and expertise that we wanted to take advantage of. In signing them on as an exclusive dealer we had a lot of discounting to do to flush out three brands of other products out there. So the volume's going to up. The margin's will be a little down in that.

But we think and the early indications are that that program should really help us propel that category even further.

Beyond that, Frank, I don't know - I don't have much to say about the modeling.

Well I guess I was thinking about the lawn and garden and track both really were introduced or increased at the end of last year. So as we start to get to past those expansions with those categories last year are there sales drivers that we're going to see over the next six months that are going to continue that momentum?

My expectations are that we better do it. That was the program. I mean I guess at any given time that something could falter. But that's sort of my expectations. We've invested a lot of money and fitting our stores to merchandise this product. And at this point I don't see anything that should say that we shouldn't continue to expect increases.

OK. And just one last question, is there any way to quantify some of the negative expense letters in the Dallas, Fort Worth market that you mentioned in terms of advertising and labor and sequentially how that might have changed from first quarter to second quarter?

I don't think it changed significantly as a percent from second quarter to first quarter. I think what my remarks addressed was as we could enjoy putting on additional stores, that we then could begin to leverage some of those costs and bring them down.

But we didn't have any significant decreases or changes in expense structure from one quarter to other as a percent to the volume we're generating in that market. The advertising is an umbrella you hold over the market somewhat. And then the distribution is certainly an umbrella.

One thing that will happen as we add these new stores and we're sort of guesstimating at what point we have to go into a larger distribution facility. Our hope and plan is that where we previously thought we'd have to add more square footage of distribution this fiscal year, we now think that we can make that facility work through these eight stores, which would allow us to leverage that cost through this fiscal year. And certainly we should begin to enjoy some economies of scale on an advertisement as we bring those three new stores on.

Is there anything in the early works in terms of identifying a facility early next year in terms of supporting growth beyond the eight stores?

Well, as far as a distribution facility?

Yes.

A fair amount of due diligence, we have not actually selected a spot yet. We have refined our estimate on the amount of square footage we needed. I think it's - we were a little aggressive in the amount of square footage we would need. And at this point I think about 100,000 square feet is probably going to be adequate there.

That's very helpful. Thank you very much.

[OPERATOR INSTRUCTIONS]

At this time I'm showing no questions. I'll give a last reminder. It's star, one on your touch-tone phone.

This does conclude the question and answer portion. I'll turn it back over to you, Mr. Frank, for closing remarks.

I think at this point we're hopefully have covered all of the issues and the questions and certainly we're available if anything comes up within the confines of what we can address under fair disclosure.

So thank everyone for their participation and we look forward to visiting with you next quarter.

Ladies and gentlemen, thank you for joining us on the conference call. You may now disconnect.