Conn's Inc (CONN) 2011 Q2 法說會逐字稿

Good morning, and thank you for holding. Welcome to the Conn's Inc. conference call to discuss earnings for the second quarter ended July 31, 2011.

My name is Mimi and I will be your Operator today. During the presentation, all participants will be in a listen-only mode. After the speakers' remarks, you will be invited to participate in a question-and-answer session. As a reminder, this conference call is being recorded.

The Company's earnings release dated September 7, 2011, distributed before the market opened this morning, and the slides that will be referenced during today's conference can be accessed via the Company's Investor Relations website at ir.conns.com.

I must remind you that some of the statements made on 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.

Your speakers today are Theo Wright, the Company's Chairman, Mike Poppe, the Company's Chief Financial Officer, Rey de la Fuente, President of the Company's Credit Division, David Trahan, President of the Company's Retail Division.

I would now like to turn the conference over to Mr. Wright. Please go ahead, sir.

Welcome to Conn's second quarter of 2012 quarterly earnings call.

I'll begin the call with comments on our retail strategy and retail sales outlook. Mike Poppe will discuss our quarterly results and changes in our credit portfolio management. David Trahan and Rey de la Fuente will then add information on our Retail and Credit segments.

We're pleased to report progress towards returning the Company to high standards of operating performance. Our gross margins have increased as we improve product mix both between and within product categories. Sustained improvement in product gross margins over two quarters has not impaired our ability to be price competitive; product compared to like product, model compared to like model. We match competitors' prices and deliver to our customers both an unmatched credit offering and low prices. David will have further comments on this topic.

Our strategy of providing a valuable credit offering to all customers, regardless of their credit quality, continues to advance. For the quarter, 14% of sales were financed by customers using promotional credit provided by GE Money. This compares to 6.3% in the prior quarter and a goal of 10% to 15%. We were pleased to recently announce the extension and enhancement of our relationship with GE Money and believe our target for sales using this credit offering for consumers remains appropriate. Using promotional credit provided by GE Money, we can offer a lower ownership cost alternative to higher credit quality customers.

Sales to RAC Acceptance accounted for 4.4% of sales in Q2, compared to 3.5% in the prior quarter and a target of 5% to 10%. For the stores with RAC Acceptance in place, sales to RAC Acceptance were 5% of sales. As our sales associates and the RAC Acceptance employees gain experience and confidence, we should achieve higher sales through this channel.

Credit penetration through Conn's Credit offering was 53.1% of sales, compared to 50.6% last quarter. Our target was to provide customers financing on 50% to 55% of sales. We are raising our target to 55% to 60% of sales, in part to incorporate our Internet strategy, which we will discuss later.

For the quarter, 77% of all sales, including down payments, were completed by customers using one of the monthly payment purchase options we offer. Unquestionably, we are providing a service that is valued by the consumer. Our credit penetration goals and performance is on slide 2.

We previously announced plans to close five locations and allow two leases to expire. Both of these leases have now expired. Three of the locations to be closed are now closed. One location with a short remaining lease term has been converted to a clearance center. One location will remain open until mid-fiscal 2013 to complete a favorable lease termination arrangement and will then close.

Results to date indicate that we can capture a meaningful percentage of the lost sales from closed locations in adjacent stores. For example, the closing of two under performing stores in the Austin market has dramatically increased both the total profit contribution and the profit margins from this market. As we've increased staffing and customers become familiar with the alternative locations, we've seen the stores adjacent to the closed locations capture an increasing percentage of the sales lost.

We are currently evaluating a small number of additional stores for closing, and our experience with the stores closed today will be a factor in the case-by-case evaluation of these locations. We expect that our review of these potential store closings will be completed this fiscal year.

The experience from the closed stores, as well as analysis of our total store base, is being used to support our selection process for new store locations. With a large enough market area and population of our core customers, we believe we can open new stores with sales and earnings potential higher than our average store today.

Slide number 4 illustrates the potential unit economics for larger stores. We expect to open between five and seven stores in fiscal 2013. The process to evaluate different state regulatory environments, market sales potential and available sites to achieve this goal is underway. Slide number 3 illustrates some of the areas we are considering for expansion.

On our last conference call, we discussed our plans to expand the floor space devoted to furniture. We have completed two of the larger remodeling projects and all 15 of the smaller expansions of approximately 2,500 square feet. The two remodeled locations each have over 15,000 square feet of floor space for furniture and mattresses. We expect to complete additional remodeling projects this fiscal year. Sales of furniture and mattresses at the two stores remodeled have more than doubled. We also learned a number of lessons from these two stores, including better advertising alternatives and the opportunity to dramatically expand the quality and extent of our offering in all of our stores.

With more square footage for furniture and mattresses and a better selection, our sales growth in these categories has accelerated. Same-store sales in furniture and mattresses increased 16% in July and 51% in August. Merchandising of furniture and mattresses has improved, but our product line will not be complete for many months yet. As we improve customer awareness, store square footage, sales expertise, our in-store presentation and our product offering, we believe we can continue to grow furniture and mattress sales. The furniture and mattress market in the US is larger than the market for appliances, television or computers, and the furniture and mattress market is similar in size to appliances and television combined.

Over the last few quarters, we've been developing ways to apply our credit base competitive advantage on the Internet in our local market areas. We can't be an effective competitor to Amazon or others on direct sales of smaller items, but we can use the Internet to expand our sales and improve our customer experience.

We've improved our Internet application process and the message to the customer about their Internet application. We've included information about the Internet application process in our traditional media advertising, to drive more traffic to the Internet application process. Over the last year, we averaged about 5% of sales to customers that first contacted the Company via our Internet credit application process. In July of 2011, 8% of our sales were to these customers, and we received 8,400 applications for credit over the Internet.

Slide 5 graphs our percentage of sales to Internet applicants. Two-thirds of our sales from initial contact over the Internet are to new customers. Of our total credit sales, approximately 73% overall are to existing customers. The Internet application process is clearly attracting a different customer base to Conn's. Some consumers may find applying for credit in the store uncomfortable. Our Internet application has the potential to allow us to reach consumers that we might not otherwise reach. A customer who has already applied for credit and has been approved speeds up the sales process. A quicker sales process will improve customer satisfaction with the sales experience at Conn's, and make our sales associates more efficient.

We also added to our website an alternative for customers to complete their purchase using Conn's credit over the Internet. The customer will still execute documents in person, but can select a product and a payment method on the Internet. This alternative was just launched and we expect to learn more in the current quarter. Our Internet strategies are not yet fully operational and will develop over time; but the number of credit applications we are receiving over the Internet indicate substantial consumer demand and sales potential.

A commissioned professional sales team is another competitive advantage for Conn's. On our last conference call, I discussed the need to improve our sales associates' ability to consistently deliver a quality experience to customers. Thanks to the efforts of our associates and managers we made progress in this area. We added product specialists in all our major product categories and improved sales associate product knowledge. But we are still not meeting acceptable performance standards and need to improve more. A properly staffed, trained and motivated team of sales associates could allow us to recapture some of the market share lost over the last two years.

We've improved our marketing to better align with what we have learned from our customers, and traffic in our stores is improving. We just need to convert more of this traffic to sales. From our peak product sales year in fiscal 2009 to fiscal 2011, our product sales declined 18%. These lost sales are an indication of the size of the opportunity, if we can improve our sales execution.

Our same-store performance to date this quarter is positive, with August same-store sales up approximately 6%. Appliance same-store sales for the month were positive, and electronics were down mid-single digits. September is off to a solid start as well, with a strong Labor Day weekend. We did not perform well on the holiday weekends in the second quarter, and poor sales performance over these weekends was a large part of our shortfall in sales compared to expectations. Product gross margin remains on trend.

Looking at our core customer, they remain pressured, but the recent declines in fuel prices have provided some relief. Otherwise, we don't see any significant changes in our core consumers' behavior, despite the negative headlines.

With those comments, I will now turn the call over to Mike Poppe. Mike?

Thank you, Theo.

Our adjusted net income for the quarter was $5.5 million, or $0.17 adjusted diluted earnings per share, as compared to $1.6 million, or $0.06 per share, in the prior year. The key drivers of this improvement were higher adjusted retail segment profitability, driven by higher retail gross margins, and expanded credit profitability, due to lower servicing costs and reduced provision for bad debts. Adjusted diluted earnings per share were nearly triple to prior year results, despite a 27.5% increase in diluted shares outstanding.

The reported GAAP net loss for the quarter included charges for three store closures completed during the quarter and the loss from the early payoff of the term loan. We have significantly reduced our cost of capital as a result of the term loan payoff and the financing transactions completed during the quarter, and estimate annual EPS going forward will benefit by approximately $0.27 per share.

Before I begin my review of our segment performance for the quarter and discuss recent changes in our credit operations, I'd like to point out that we have revised our prior-year average shares outstanding for EPS calculations, and thus our reported EPS, to retroactively adjust for the impact of our November, 2010 common stock rights offering. This change had no impact on reported net income.

In reviewing our segment performance for the quarter, the Retail segment delivered a 2% adjusted operating margin, as a 320 basis point retail gross margin improvement offset the 270 basis point deleveraging of SG&A expenses as a percent of sales, due in part to the lower sales volume. The Credit segment operating income increased sequentially and as compared to the year ago period, and the improvement was driven by lower servicing costs and provision for bad debts, which were partially offset by lower interest earnings, though the interest and fee yield on the portfolio did increase to 19% for the quarter. These trends were driven by the improving credit quality and delinquency performance of the portfolio.

Over the past six months, we have taken several steps to reduce overall risk in the credit portfolio, improve profitability of the Credit segment, and more effectively manage the capital invested in our credit business. The following is a summary of the actions we have undertaken.

During the second quarter, we implemented a more strict charge-off policy requiring the charge-off of any account over 209 days past due at month end. This change did not have a significant impact on our profitability this quarter, as the accounts charged off had already been provided for in our reserve for bad debts. While this change may result in an increase in net charge-offs over time, we expect a greater reduction in servicing expenses incurred to collect on these accounts. This policy change brings us more in line with industry practice, where it is more common to see charge-off at 180 days past due.

During the quarter, we implemented a more restrictive limitation on re-aging of credit accounts. Our analysis indicates that the benefit we were receiving from continued re-aging of accounts was less than the servicing costs we were incurring to continue collection activity on the accounts. We have not seen a meaningful impact on our portfolio performance due to the change, and will further tighten this policy in the future.

We have begun applying shorter contract terms when financing smaller balance transactions and certain product categories, primarily home office. Home office and other short-lived items have significantly higher delinquency and charge-off rates than our other core categories. We expect this change to benefit charge-off rates in the future, as balances are paid down more quickly, and to increase the payment rate on the portfolio.

During the first quarter, we increased our use of third-party payment options relative to our historical trend. This strategy allows us to focus the use of our capital on financing sales to our core customer that does not have access to credit, while driving sales to non-core customers using these other payment options. We have expanded credit limits for proven Conn's credit customers with higher credit scores by 25% to 30%. The charge-off expectation for these customers is much lower than for newer customers, especially at lower credit scores.

Given the expansion of our product offering over time, specifically furniture and mattresses, we found there was a need to give these customers greater access to credit, to allow them to make these purchases from us as opposed to pushing them to other retailers of the same products. While we will not know the full impact of these changes for several quarters, we expect the benefits of these changes to include increased transparency into the performance and condition of the portfolio, by virtually eliminating the possibility that an uncollectible account will remain in the portfolio due to re-aging or making infrequent payments to avoid charge-off; improved earnings from the credit portfolio, driven by improved portfolio performance and lower servicing costs; and a shorter average life for the credit portfolio requiring less capital to fund Conn's financed sales, thus supporting a faster growth rate for the Company.

Turning to our capital and liquidity position, strong cash flow from operations, including cash received from reductions in the credit portfolio balance, allowed us to reduce our total debt balance outstanding by $21.5 million during the quarter. As of July 31, we had total unused borrowing capacity of approximately $137 million; and of that, $73 million was immediately available to be borrowed.

As of today, as a result of the growth in the credit portfolio and inventory during the month of August, our immediate borrowing availability increased by an estimated $6 million to approximately $79 million, while total debt outstanding is roughly equal to the July ending balance. As of July 31, we were comfortably in compliance with the required credit facility covenants.

Turning to slide 9 in the presentation, we are re-initiating earnings guidance, given the stabilizing trends we have seen in our business. Our expectations for full-year earnings for the current fiscal year are for adjusted diluted earnings per share between $0.65 and $0.75, excluding the loss on the extinguishment of the term loan and the cost of the store closures.

Our estimate is based on roughly flat same-store sales for the rest of the year, being positive in the third quarter and slightly negative in the fourth quarter; retail gross margin between 27% and 29% for the last two quarters, with the fourth quarter expected to be lower than the third quarter due to seasonal product mix changes; provision for bad debts between 3.3% and 3.7% of the average portfolio balance on an annualized basis during each of the last two quarters, with the portfolio shrinking slightly in the third quarter before growing slightly in the fourth quarter; consolidated SG&A expense similar to prior-year levels as a percent of revenues; and lastly, interest cost should be down significantly on lower interest rates as a result of the term loan payoff.

Much of this analysis and more will be available in our Form 10-Q, to be filed later with the Securities and Exchange Commission. Additionally, we have posted an update to our full investor presentation on our IR page today.

Now, David and Rey will provide additional color on our Retail and Credit segment operating performance. David?

Thank you, Mike.

I'm going to speak to you today about our sales and margin performance for the quarter. We achieved a 28.9% retail gross margin during the second quarter, as compared to a 25.7% during the second quarter of last year, and 28.4% during the first quarter of this year. We have been able to drive this improvement by focusing on improving our product mix we offer to our customers. From a profitability standpoint, the increase in our retail gross margin largely offset the impact of same-store sales decline of 12.8%.

To recap our same-store sales for our primary categories, furniture and mattresses were up 11%, consumer electronics were down 20%, home appliances were down 10%, and our home office was down 18%.

In addition to our gross margin profits we obtained from focusing on improved product mix, we saw higher average selling prices in all of our major categories -- excuse me, major -- our primary categories, as compared to the same time last year. This is in slide 6 of our presentation. We had a strong quarter in furniture and mattresses, as we continue to expand floor space and product assortment for this category and increase in our promotional activity and advertising exposure. The decrease in consumer electronics was driven by a 27% decrease in total unit sales, as our average selling price increased 7.2%. This was the result of improving product mix into better-featured, larger screen televisions. Appliances were down on lower unit sales, though we experienced a 5% increase in average selling prices, as we continue to mix into high-efficiency laundry and French door refrigeration. Home office sales were down on a 28% drop in notebook, desktop, netbook computer unit sales, as average selling prices increased 7%.

While our home office sales were down, we drove an increase in our total gross profit contrition, as gross margin increased to 14.8% this year as compared to 1.3% last year. Our retail gross margin benefited from an increase in our furniture and mattress sales and an increase in consumer electronics, furniture, mattress, appliance and home office product gross margins. For the quarter, our leading gross margin category was furniture and mattresses, which had a 33.9% gross margin, followed by appliances with a 22.8% gross margin, and consumer electronics with a 19.4% gross margin.

We remain focused on improving our product mix that we offer to our customers by displaying more of the latest technology, better-featured products. We are also leveraging our competitive advantage in providing those customers with affordable payment solutions. We feel very comfortable with our inventory position going into the third quarter and do not see any issues at this time with availability for our holiday selling season.

That concludes my prepared remarks. I would like to turn it over to Rey. Rey?

Thank you, David.

We continue to see improving credit trends during the second quarter, including improved segment operating profitability. Referencing slide 7, the portfolio balance 60-plus days delinquent was reduced by $9.5 million since January 31, to 6.1% of the portfolio, down from 7.5% at the same time last year, adjusted for the change in our charge-off policy. As is typical this time of year, we have seen portfolio delinquencies increase since the end of the first quarter, and would anticipate an increase during the third quarter. However, we continue to be solidly down versus the prior-year period.

Net charge-offs for the second quarter totaled $11.6 million, including $4.4 million related to the change in the charge-off policy. After adjusting for the current year charge-off policy change, this is a $2.1 million improvement as compared to the $9.8 million of charge-offs incurred during the same period in the prior-year fiscal quarter. We expect to see charge-offs decline further in the third quarter.

With portfolio balance and delinquency reductions, as well as policy changes to limit re-aging activity, we have also been able to reduce the balance of re-aged receivables. At July 31, we had $103.2 million of re-aged receivables in the portfolio, or 17.2% of the portfolio, down from $133.6 million at January 31, and $135.7 million, or 19.2%, at the same time last year. Additionally, through August we completed our 19th month in a row of achieving a year-over-year increase in the payment rate, with the second-quarter payment rate increasing to 5.45%, as compared to 5.2% last year. This can be seen in slide 8.

The credit operating margin for the quarter improved to 40.7%, up from 21.7% at the same time last year. With the improving credit quality in the portfolio, the interest and fee yield increased to 19%. SG&A expense was reduced by $2 million, and the provision for bad debts declined by $5.3 million. We expect these year-over-year trends to continue for the next couple of quarters, given improved credit portfolio quality and continued focus on cost control.

During the quarter, the weighted average credit score of accounts originated was 625, as compared to 623 for the second quarter of the prior year; and the weighted average score of the portfolio at July 31 was 594, as compared to 586 at the same time last year.

Theo, this concludes our prepared remarks. We will open up the lines for questions now.

Thank you. (Operator Instructions) David Binder, Jefferies.

Hello. It's Dan Binder. A couple questions for you. First, I was curious, in terms of the sales progression, understanding it is a much easier comparison in Q3, what would you identify as being the key difference in the sales trends that you were experiencing last quarter versus the positive sales trends for this quarter? Do you think it is more credit extension? Is it more promotion? Is it just the expanded categories in furniture and mattress? Maybe you could just touch on that first.

Okay. I would say obviously the strong performance in furniture and mattresses has had an impact -- the accelerating growth there. But we have seen improvement sequentially in all of our categories. A big part of that is improved promotion and resulting improved traffic, as well as the increase in average selling prices and a better product mix.

And I'd add lastly, our sales staffing is improving, and our sales floor execution is improving. So I don't think that there's any one thing that is driving the improved sequential performance. I believe it is a combination of things and not just any one thing.

Is there anything about the remaining part of the quarter, in terms of comparisons, that would keep you from maintaining that plus-6% type of level that you are seeing right now?

No. September and October were actually worse performances in the prior year, so if you look at the comparisons to a year ago, they should become easier in September and October, not harder.

What are you seeing in terms of appliance price increases? What have you seen thus far this year? What are you expecting over the balance of the year?

Well we really see that stabilized out there, and I think, again, the balance of the year, I feel it's going to be just like it is right now. The manufacturers are wanting to drive some business out there.

The gross margin range that you provided in your guidance is fairly wide. Based on what we saw last quarter, and taking into consideration that you mentioned just a minute ago about promotions maybe being more effective or higher -- I'm not sure whether they are more effective and higher, or if that's what's at play here, but would you expect to be toward the lower end of that 27% to 29% range, or the upper end? Do you think there's -- for the Q3 period, based on what you are seeing right now.

I think that our range indicates our thoughts on where the range will be. And I believe that the wideness of that range reflects our uncertainty about product mix, particularly in the fourth quarter, as we become more promotional, both in effectiveness and spending on promotion, and how that may influence mix.

Our current gross margins based on our current mix are at the high end of that range, but we do have some uncertainty about how our mix will change in the fourth quarter.

Okay. One final question, if I could.

On the service maintenance agreements, that took a nice tick up in the quarter as a percentage of sales. Just kind of curious what you are thinking is there, or a policy now. I know historically if those have gone too high, it tends to result in unhappy customers, because they are getting pushed too hard. If it goes too low, it is not good for profitability. Do you feel like you are now at a good balance? Should we expect that as a percentage of sales to look similar, going forward, to what we just saw in Q2?

I would expect it to look similar to the second quarter. I think we are at an appropriate balance, and the improvement that we saw this quarter is another reflection of our improved execution on the sales floor.

Great. Thank you.

Thank you.

Thank you. David Magee, SunTrust Robinson.

Hello. Good morning. Congratulations for all the better numbers of late.

I guess a couple of questions. One is -- when you talk about opening the stores next year, can you talk about what you see as the characteristics of a successful store opening versus maybe some of the stores that you've had to close recently?

The characteristics are principally demographic, and they're demographic in 2 ways. One is simply the size of the market that we are expecting to be able to serve. If you look at the stores that we've closed, they tended to be closely adjacent to a number of other stores; so the potential size of the market was too small.

Then the second piece of demographics is the income characteristics, predominantly the income characteristics, but some other things as well, of the market area that the stores will serve. Where the average income in the market area is well above the national medians, we simply are just not as effective competitors in those types of markets. The average income in the stores we've closed would be approaching $100,000 annual household income. Really, our core customer base is going to be $50,000 or less. So what we are looking for is a larger area to serve, and then a larger component of our core customer.

Thank you. And then secondly, Mike, I guess, with regard to the comp assumptions in the second half, what is the assumption regarding TV, specifically? Are you expecting a similar pattern of still down units through the year-end and up ASPs? How do you expect those lines to change?

We do expect ASPs to be -- continue to be positive year-over-year for us. And units probably down slightly to flattish.

And is that because, on the unit side, the comparisons are getting easier, or do you think that the price points are compelling enough that you see the units stabilize?

Comparisons are certainly easier.

Okay. And then, has there been any sort of competitive response to your success in the furniture and mattress side of the business?

That's hard for us to assess, because there are so many competitors in the furniture market. But we have seen some more aggressive financing promotions from some of our competitors. But whether or not that's a response to our relative success, it's hard to tell. Even given our relative success, we are such a small share of the market at this point, I'm not sure that we are significant enough to attract a competitive response.

Thank you. And just one final question. Everybody is worried about the macro right now, and it would be interesting if you could contrast how your positioned now versus when we went through the Great Recession several years ago.

Well, we are positioned better in a number of ways. One, the quality of the portfolio has clearly improved. As we went into the Recession, we had, just prior to that, been considerably more aggressive in our underwriting standards, and the timing of that was not fortuitous. So, the quality of our portfolio, if the macro environment deteriorates, is much better than it was before.

Our stores will be better positioned. We will have a broader product offering effectively, with furniture and mattresses being a more significant component of our product offering. And our overall cost structure has really been adjusted to a lower sales rate already, which it had not been at that time. So, not something that we would look forward to, but we are better positioned.

And the last point I would make -- it has not been reflected in our sales numbers yet, but the number of consumers that meet our standards for credit quality, that is customers with scores say 650 to 550 -- the number of customers in those credit score bands have actually increased. So, a downturn does, perversely for us, create a larger pool of potential credit customers.

Thanks a lot, and good luck.

Thank you.

Thank you. Rick Nelson, Stephens.

Thank you, Mike. Congratulations, as well.

Thank you.

I have a question for Theo or Rey on the credit portfolio. The balance is down 15% year-over-year at the 6-month period, and the guidance is implying some stabilization. I'm curious what is driving that, and do you plan to get more aggressive on credit, given the improvement in delinquencies and charge-offs?

What's driving the stabilization of the credit portfolio is quite simply sales rate. It's the fact that our forecast sales are closer to prior levels. As Mike discussed in his comments, we are really not getting more aggressive based on the improved performance. We are doing -- made a number of adjustments, most of which are to be more conservative, and one of which, increasing limits to existing proven customers, is more aggressive.

But overall, we expect the balance of risk in the portfolio to decline. And we expect credit penetration rates, as we said, to be in -- our goal is in that 55% to 60% range; and we are definitely not becoming more aggressive at extending credit to lower credit score customers. In fact, it is the opposite.

So yes, we'd like to do more credit business, but we want to do that because we are attracting more customers into our stores that have higher credit scores, rather than extending credit more aggressively to low credit score customers.

Excellent. Thanks for that clarification.

I noticed the portfolio re-aged; you made some adjustments. I'm curious what was re-categorized, and did it have a positive or negative impact on the re-aged number?

It was certain refinanced accounts, Rick, and it increased the numbers historically. It didn't change the trend line and what has happened in re-aged over the last two years, though.

Okay. And on the refinancing front, you are seeing some significant benefits from the recent refi. I'm wondering if you're contemplating any other refis over the remainder of this year, or as we look into the following year -- the potential there?

We continue to explore the capital markets, Rick. We continue to follow the ABS market as an opportunity to give us additional capital to grow the portfolio. Whether something happens this year or next year, we don't have any specific timing right now.

And the store locations you called out, these potential new markets, are we talking new markets within the existing states, or a higher probability of going into some of those new states that you mentioned?

It would likely be both, Rick. New markets in the existing states, as well as adding some states to our total footprint.

Thanks a lot. And good luck.

Thank you.

Thank you. Ian Ellis, MicroCapital.

Good morning, gentlemen, and congratulations on another great quarter. I've got a lot of questions here, so just stop me if you feel like I've used up too much time. First of all, on the sales side, I'm interested as to why your Labor Day weekend was a better weekend than the 2 holiday weekends in the second quarter.

The answer to that is we -- I, rather, didn't allocate sufficient funds to promote on the July 4 and Memorial Day weekends, and we weren't sufficiently aggressive on price, and so we missed some opportunities. We adjusted our strategy, and it was successful on Labor Day weekend.

Good. Okay. Second question is -- the reintroduction of departmental sales people, Theo. Is that for less experienced or more experienced, more knowledgeable salespeople? Is it a generalist at the lower end and a specialist at the higher end, or do they have to start proving themselves in the specialist department before they get the rest of the floor?

Right now, the restrictions on access to the full floor are for less experienced sales people, but we have added specialists in each of our major product categories that are more experienced, proven salespeople.

Okay. So it is like a barbell thing --?

That's exactly right. You have an inexperienced salesperson with a 1 product focus, and then more experienced salespeople that can sell the whole floor, and then supported by specialists that are experience proven within a category. So it is like a barbell. And we continue to evaluate our approach there, and ultimately we think that the direction is to have more of a closed sales floor, except for very experienced salespeople that have an existing customer base of their own.

Okay. Just on the sales force, obviously a year ago under previous management, there was a change in the compensation plan, which clearly had an impact on retention of experienced salespeople, and also in the Q3 sales level a year ago. Where would you say you are in bringing some of those -- either those same salespeople or comparable sales people back into the Company?

We've brought back -- I'd just be guessing at an exact number, probably 50 or more of the experienced salespeople we've brought back. But we still are not where we need to be, or I wouldn't say even close to where we need to be, in terms of the overall tenure, maturity, and training of our sales force. We're making good progress, but we are not there yet.

Getting back a number of salespeople that we lost has helped, but that's still a relatively small percentage of our total sales force. That would be less than 5%. So they have an impact, yes, but it is not the solution to our ability to execute better on the sales floor.

I mean, how many salespeople were lost a year ago, that it would've been good to keep?

I think we'd just be guessing to say that certainly more than 100, 150; but we certainly don't have them all back, by any means.

Right. Okay. Great. Just to move along to the remodeling. You mentioned you've remodeled some stores; I didn't get all the numbers down, but what would you say has been kind of -- if you can compare a remodeled store to a similar non-remodeled store just in the recent quarter, what would you say the top-line lift, and more interestingly to me because of the change in mix, the gross profit lift in percentage terms is subsequent to a remodel than pre-remodel?

The top-line lift has been much better than our average store. The furniture and mattress sales, in both cases, have more than doubled, and as we've seeded more of our product line in those categories, the improvement in sales performance has accelerated.

The margin improvement has been significant. Those stores have margins that are about 300 basis points higher than our average margins. And so we've seen not just an improvement in sales, but an improvement in margins, both gross and net, at the store level.

Okay. Just want to talk about stores. The new locations, 5 to 7, is that kind of 5 to 7 out of 25- to 27-type possibilities, or are you already down at 5 to 7 kind of first choice locations?

It is definitely not 5 to 7 out of 25 possibilities now. We still have work to do on selection, but I think we've pretty clearly identified the markets at this point that are going to be most desirable for us as our next step.

Are they existing markets, which will be served by existing DCs, presumably?

Our current thoughts would require the possibility of one additional distribution facility, but that's not finalized.

Right. Okay. And then on the slide show, there's -- page 4, there's the unit economics. Forgive me for not doing my arithmetic here, but is this $13.7 million average store sales, is that what you would have as a target for a new store, or is that just the average for your current store basis? Obviously, it still includes some sub-optimal stores.

Our average store is right around $10 million. The $13.7 million was developed using our average of stores that have between $13 million and $15 million in total sales. So it represents a subset of our existing stores.

The ones you'd like to roll out, I've got you. Apologies for that question. I should have been able to figure that out.

My last area of questions is on the Internet-generated credit approvals. I'm just thinking at this point about how much success the payday lending business has had on the Internet, in attracting, interestingly, a different type of customer that wouldn't normally feel comfortable walking into a payday lending location. Are you noticing different income and credit score characteristics of those applicants on the Internet, from what you have in-store?

Generally speaking, the credit scores and the credit characteristics are lower than our average, and I think that would have been our expectation. I think what's interesting is it is not as much lower as we might have thought. Yes, it is definitely lower, and our decline rates are higher for Internet applications, but it is a fairly standard distribution. It would look similar to our distribution in a lot of our stores, if you looked at it store-by-store. So I think what's been interesting to us is -- we are not just attracting low credit score interest to the Internet; we are getting some good credit quality opportunities over the Internet.

Right. Okay, and my final questions. Just on the competitive scenario in furniture and mattresses, you mentioned it is very fragmented compared to, presumably CE and appliances. Are there any -- in your region at least, any competitors out there that run their own credit operations like you do? Or are they all essentially reselling other credit at higher credit scores?

What we see out there is them using the national banks, and also there's one of our competitors in our market that do use a RAC Acceptance in them as well. But no one major competitor having their own credit model like we do.

So nobody in the mid-range, like yourselves?

We do see, in the Rio Grande Valley, Lacks is a competitor that has a credit capability, but we don't see anyone that has a credit capability across our whole footprint or really in our predominant markets.

Great. Thanks for answering all of those questions, and good luck with the second half.

Thank you.

(Operator instructions) We have a follow-up question from Dan Binder of Jefferies. Your line is open.

Hello. It's Dan Binder. I had a couple of follow-up questions for you. The online business, in terms of pricing versus your stores, the promotions you are doing online versus your stores, are they, at this point, fairly consistent, or do you have a different program for the online business versus the store business?

We are very consistent with our stores versus online. We do not want them competing with each other. But we do do some things for our customer base on our e-mails and things like that, the people that sign up.

So ultimately, if there's another online player like Amazon that is, let's say, beating you on price in a given item, I'm assuming that you are able to win, because you're providing that credit offering that the customer might not be able to get at an Amazon. Is that fair?

Yes, I would think so, but also looking at -- from the delivery standpoint, from a service standpoint, that instant gratification. And of course, the credit hook, our credit vehicle -- that's big.

Right. Okay. And then, just jumping around a bit here, but on the TV business, it sounds like ASP is up, units flat to down slightly, you expect TVs to be comping maybe slightly positive in the back half. Is that fair? And what is causing the ASPs to rise? Is it simply a better mix? Or are you not experiencing the same kind of price declines that others are because you are able to hold them, again, given the type of customer that you are serving and the credit offering that you are providing?

I would say it is a mix issue out there. What we are doing is really focusing on our product mix, more technology. And also, in our markets, the bigger the screen, the better we do with it. The introduction of bigger flat-panel and also DLP televisions has helped us.

And we are not as aggressively promoting the low-priced products where we don't have the same competitive advantage. So we are trying to align our promotion strategy with our product mix strategy to make sure that we can take advantage of our competitive advantage with credit.

Okay. I may have missed this earlier, I apologize if you've answered this question, but in terms of the furniture and mattress business opportunity, how many stores have you remodeled with this expanded assortment, and what is the opportunity going forward in terms of number of stores that can see that as well?

We've completed two. We have somewhere between 5 and 10 that have additional square footage. We are working through that to finalize our list of stores where we can expand the square footage significantly, without increasing our rent or adjusting our footprint in the total store. So, I would say we are not 100% sure there, but somewhere between 5 and 10.

Then we are also looking at our strategy on lease renewals, and the possibility of expanding availability at our better stores as well, where we might have to lease additional space that we don't have at this time. So we are taking a look at that, but that's early stages. So I'd say 5 to 10 in the short term, and then more as we explore the opportunity to get additional real estate.

So is the recent improvement in that business more a function of just adding more space in existing stores, or a greater product assortment, more promotion --?

The recent improvement is predominately improving product mix and assortment, and increasing selling prices in those categories.

Okay. Then just on the credit side. Obviously, you're seeing the same headlines we're seeing. There's still a lot of uncertainty in the markets, both in the credit markets and just the general equity markets. It is not clear whether or not we will head into another recession. According to some economists, we will; some say no. But it seems you are running the credit portfolio more conservatively. Given the outlook or given the uncertainty, what is your sort of position on taking this reserve down more aggressively versus maybe keeping it more steady at these levels, given that uncertainty?

Without getting into a long conversation on accounting, the reserve is based on our expectations of charge-offs in the portfolio, based on the information that's available to us today, and doesn't represent an economic forecast. Our approach to the reserve is to ensure that we have the reserves necessary to cover the expected losses.

Right. So today's delinquencies are tomorrow's write-offs; delinquencies are getting better. So unless that changes, we should expect that that would continue to improve, then? Is that fair?

That's right. The reserve should reflect our experience, and our expectations about future performance are included in that. But we are not making an economic forecast of the return to recessionary conditions and increasing unemployment rates, et cetera. That's beyond the scope of our process in evaluating the appropriateness of our reserves.

Based on that, that's where our guidance -- we said 3.3% to 3.7% provision -- that kind of bakes in what's going to happen with charge-offs and the reserve over the remainder of the year.

And I would just say one last thing -- I read the headlines too, but our core customer does not have financial assets. And the fact that there's a lot of stock market volatility, that is not critically important to our credit customers. Really what's important to them is their employment. And we have not seen a significant change in the employment rate in our customer base and in our markets, and that's really what's important.

I understand. Okay. Great. Thanks.

Thanks, Dan.

Thank you. Kurt Wolf, Hestia Capital Management.

I had a question about capital allocation going forward. Obviously, you're looking to expand your store base. But given that your balance sheet is significantly delevered now, your loan facility issues -- or borrowing facility issues are now not an issue, and it looks like your profit outlook is dramatically improved going forward. Can you just expand on your thoughts on capital allocation beyond what you've announced in terms of store openings?

We talked in the prepared comments about our desire to be more efficient in the use of our capital, in the area of credit. We want to increase the payment rate, and we want to allocate our capital efficiently there, where we can earn the highest returns. So I think that trend will continue. We would like to be able to support our sales rate with a lower allocation of capital to the credit portfolio, which earns, on average, a lower return on capital than the retail segment does.

And looking forward, we would like to be in a position to allocate more capital to the higher earning component of our business, which is the retail segment. So that's really how we are looking at it longer-term is we want to be more efficient in our use of capital to support credit, and we want to have the capital available to support a higher growth rate in retail, which may be both new store openings, but also remodelings, and then accelerating growth in categories like furniture and mattress that are newer for us.

And so, as far as the concept of a share repurchase, I know that there might be issues as far as a recap that you performed, and maybe with your covenants. But that sounds like that would not be a potential use of capital, absent some dramatic changes?

I think at this time we wouldn't be anticipating a stock repurchase, and we would look to deploy it in growing the business.

Okay. Thank you very much.

Thank you. There's no further questions in the queue at this time. Ladies and gentlemen, thank you for attending today's conference. This does conclude the conference for today. You may all disconnect, and have a wonderful day.