Conn's Inc (CONN) 2016 Q1 法說會逐字稿

Good morning, and thank you for holding. Welcome to Conn's Inc conference call to discuss earnings for the quarter ended April 30, 2015. My name is Marcus, and I will be your operator today.

(Operator Instructions)

As a reminder, this conference call is being recorded. The Company's earning release dated June 2, 2015, distributed before the market opened this morning, and slides that will be referenced during today's conference call, can be accessed via the Company's investor relations website at IR.Conns.com.

I will remind you that some of the statements made in this call are forward-looking statements within the meanings 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 CEO; Mike Poppe, the Company's COO; David Trahan, the Company's President of Retail; and Mark Haley, the Company's Interim CFO. I would now like to turn the conference over to Mr. Wright. Please go ahead, sir.

Good morning, and welcome to Conn's first quarter of FY16 earnings conference call. I'll begin the call with an overview, and then Mike Poppe will discuss the Credit segment. Mark Haley will complete prepared remarks with additional comments on results and our balance sheet.

Starting with current retail trends, May same-store sales were up approximately 4%. We'll provide final May sales reporting on June 4. Inventory levels and availability were better in May. Availability was near normal or normal in all categories by the later part of the month.

Retail execution in May improved as well. Traffic was stronger over the holiday weekend than in the prior year. Our marketing team executed a better plan to drive traffic than in the prior-year Memorial Day weekend. Sales and distribution teams were able to convert the traffic to sales at a higher rate. As we said on our last conference call, comparisons will be less challenging in Q2 and for the remainder of the year.

Television sales trends have been consistently good during promotional periods, and have improved over the last several months. April and May television sales were both positive, with May same-store sales of TVs up about 5%. For May, 70% of our television sales were UHD or 4K televisions. When customers have a need or desire for a new television, the value of the product is compelling. The hoped for replacement cycle may have arrived, but concerns remain about the category, given the volatility and performance and the critical importance of vendor promotions, which we don't control.

We decided last quarter, as a result of ongoing evaluation of credit standards, to stop selling gaming hardware, cameras and certain tablets. Exiting of these categories will be fully complete this quarter, and meaningfully impacted revenues in May for electronics and home office.

Overall electronics same-store sales for May were down about 3%, and home office sales were down 12%. Overall same-store sales, excluding the exited categories, would have been about 6.5% for May. Appliance same-store sales increased approximately 11% in May. Appliance inventory availability improved, and promotions from key vendors were strong for the Memorial Day holiday period.

Since our primary appliance suppliers are LG and Samsung, port issues had more of an impact on Conn's than some competitors who had more share with the domestic suppliers. Conn's is not as likely as some of our competitors to benefit from a strong home building or home remodeling cycle. Our core customers are less likely than more affluent groups to purchase new homes or complete major remodels. And we have minimal sales to homebuilders.

It's hard to determine if lower oil prices are impacting sales and collections performance significantly. Houston sales are outperforming other mature markets. Stores in oil and gas producing areas like Laredo, Odessa and Lubbock are showing more signs of slowing sales, but evaluation is still complicated by the effect of grand opening periods.

However, the expectation that stores in oil-producing markets will be reduced by sustained lower oil prices is being realized to at least some extent. Lower gas prices are benefiting the cost of living in all markets year over year, but the more recent trend is up. Like many other observers, we haven't seen as much benefit to consumer demand from lower gas prices as we originally expected.

Turning to retail operations in the first quarter of FY16, on slide 2 we show product gross margins by product category for the first quarter. Total retail gross margin percentage for the quarter was 41.3%, slightly above our guidance of 40% to 41%, and similar to the performance a year ago.

Leverage of warehousing costs was down year over year, but we are improving sequentially. No warehouses are opening this year. All store openings will improve leverage of warehouse costs over the course of the year. With improving inventory availability, continuation of positive same-store sales -- which is consistent with our guidance -- would also improve leverage.

Over the last several years, we have worked with vendors to make vendor programs more consistent and reduce quarterly volatility and gross margins. That process is finished, and gross margins in the first quarter of 2016 were not as affected by vendor programs as in the first quarter of the prior year and earlier years.

Positive trends in sales of repair service agreements continued. And with stable portfolio performance and increasing RSA sales, we began to receive retrospective commissions again in the quarter. Our gross margin goal is 42%, and confidence is increasing that this goal is achievable with decreasing share of revenues from electronics and home office, increasing sales of furniture and mattresses, improving warehouse utilization. And better material handling, with a reduction in related scrap or discounted sales of products.

On slide 3 you can see a four-year trend in furniture and mattress sales. With inventory returning to normal, furniture same-store sales in May were up about 9%. For new stores, sales of furniture and mattresses are about 40% of the total in the quarter. Completion of our relocation and remodeling program, along with store closures and new store openings, should increase the share of sales from these categories. We are currently in-process for 10 relocations or expansions that will increase square footage. In addition, expansion or relocation opportunities are being pursued for another 11 locations.

The Company's longer-term goal is 45% of sales from the furniture and mattress categories. Despite issues at the ports that depressed furniture availability, furniture and mattress sales were 33% of total product sales. 18 stores in five regions were at or near the goal of 45%. The port issues brought to light inventory availability problems that had been ongoing and are correctable. Our sales process is not designed to order product, so inventory shortages have an immediate impact on sales. Prior to any port issues, availability for next-day delivery has been too low a percentage of the assortment for some categories within furniture.

Stocking levels are expected to improve, although this will require additional inventory investment. Based on the experience with the recent supply chain problems, we believe that improving availability will help generate additional furniture revenues.

To comment now on retail expenses, as shown on slide 5, overall retail SG&A was 22.8% of sales, compared to 23.1%. Lower sales than originally expected reduced SG&A leverage. We were able to counteract some of the impact of lower sales on certain expenses by adjusting forecasts, particularly for advertising. Other corporate and overhead costs were most affected by the loss of leverage.

Advertising expenses increased with store opening pace, offsetting much of the operating leverage from increasing sales the last several years. In the first quarter, we successfully executed on a number of efforts to increase advertising efficiency, such as refining targeted geography for both direct mail and print, and advanced buys for television.

However, only three stores opened in the first quarter. In the second quarter, the pace of store openings will accelerate. With more store openings, we don't expect advertising expense to be sustained at the same level as in Q1. Many of the planned new stores for this year are in markets with existing advertising spending. Advertising spending as a percentage of sales should benefit from these store openings in existing marketing areas.

Advertising expenses for furniture and mattress retailers, in particular, are higher than for electronics. Achievement of our furniture goal will likely require higher spending on advertising as a percentage of sales. However, in the short term, investments are being made only in smaller-scale tests in selected markets, to assess the ability to change furniture sales rates with additional advertising spending. We expect to be able to comment on these tests on the Q2 conference call.

More products are delivered to customers' homes as the percentage of total revenues than in prior years, with the decline in electronics and home office as a percentage of total sales. Furniture deliveries are about 50% more expensive per delivery than appliance or electronics. Delivery cost is included in our SG&A, as you can see on slide 5.

Transportation costs have also increased, as we have added locations in smaller markets with our warehouses. Transportation of inventory to these locations is included in SG&A. Our distribution and delivery teams have done a terrific job reducing the cost per delivery, and efficiently managing transportation. We expect the relative improvement trend in Q1 in these costs to continue the next few quarters.

Overall, retail and corporate SG&A has been well-controlled. Growth plans have been refined to maintain this control. Many of the more recent additions to management have made important contributions to our improvement in Q1 compared to the prior year.

Turning to our growth plans, we plan to open 15 to 18 stores in FY16, and are on track to complete the plan. Tighter underwriting standards over the last year and a half have minimally affected existing customers' approval rate. The impact of underwriting changes has reduced sales rates much more at newer stores than in mature markets.

Advertising for grand openings has been scaled back to better allow for the sales team to develop skills and tenure. Although by no means a soft opening, grand openings are less front-loaded than in the past. With many stores opening in existing markets, cannibalization remains a factor in both new store productivity and same-store sales. The Phoenix market was an exceptional example of this affect, and we expect the impact of cannibalization to be reduced from the last several quarters.

Given current underwriting, store opening locations and grand opening advertising strategy, we don't expect our new stores to return to the high levels of productivity of FY13, 2014 and early 2015. We now expect that stores will average about 70% to 75% of the sales of average stores in their first year. Accordingly, store opening plans for FY17 have been adjusted to target opening 22 to 25 stores. This is a modest increase, designed to deliver a 15% growth rate in revenues from new stores.

The increase in store openings should have no impact on credit risk, because we're targeting a consistent amount of revenue growth from new stores and related new customer originations. SG&A will come under some pressure from a few more stores, but longer-term we expect this to be offset, at least in part, by improved same-store performance.

Last December, the Board introduced a number of initiatives to provide additional oversight. The Board established a Credit Risk and Compliance Committee, responsible for reviewing credit risk, underwriting strategy and credit compliance activities. This committee is actively engaged in supervising an independent evaluation of underwriting standards and collections performance. The evaluation of historical performance is complete, and will not progress to developing additional information for the committee.

The Board also approved additional positions to augment the management team. We've appointed a Chief Credit Officer to assist in analyzing and assessing risk. Additional searches for senior leadership are moving towards completion in the short-term.

The Board of Directors also authorized management to actively pursue the sale of all or a portion of the loan portfolio or other refinancing of our loan portfolio. This process is well underway. The Company, its advisors and prospective purchasers, are engaged in active dialogue and exchange of information. There is considerable interest in acquisition of the portfolio and a potential ongoing arrangement to fund future originations. We expect the loan sale process to be completed this quarter or early next quarter.

If Conn's sells the portfolio, we believe we can increase the aggregate capital available to support our business strategies. Separation of the credit portfolio from the retail business will allow the use of higher leverage on the portfolio. This higher leverage should reduce the after-tax cost of capital, as well as increase availability.

Removal of the loan portfolio from Conn's financial statements would make financial analysis simpler. Current accounting for loan losses results in a mismatch of revenues and expenses. Loss recognition is front-loaded, and interest earnings occur over time. The result of this mismatch is that a growing portfolio depresses earnings. The faster the growth, the more negative the impact on earnings.

A loan sale and related flow arrangement could allow us to use a bank issuer. A bank issuer could allow charging a higher rate than some states allow today, and enable the use of risk-based pricing. We could also charge one rate for all customers of similar credit quality in all states. A loan sale transaction, assuming our on-balance sheet liabilities are restructured or retired, could enable returns of capital to shareholders or M&A.

For these reasons and others, the Company believes the loan sale and related ongoing arrangement to fund future originations has significant strategic value to the Company and its shareholders. Despite the high level of interest, there is no assurance we will be able to complete a sale of the portfolio on terms acceptable to the Company. Completion of the sale is also not required to execute our business plans.

FY16 is off to a good start. We've faced and overcome a number of challenges over the last two years. The port situation has proven a temporary disruption, but exposed a number of correctable weaknesses in management of our supply chain. Likewise, credit-collection system implementation issues were quickly overcome, and the system is now delivering many of the expected benefits, including improved compliance. Conn's distribution and marketing teams have done a great job addressing expense challenges from growth, while maintaining revenue and customer service performance.

Goals for gross margins in furniture sales have been raised, and we're progressing towards these increased goals. Sales, merchandising and marketing execution have successfully offset the significant impact of tighter underwriting on revenue. The Company has hired and integrated a number of key executives, and expanded the talent at all levels of the organization to support growth. Compliance functions have become more formalized and robust, although we have work yet to do.

With steadily tightening credit standards over the last year and a half, improvements in collections execution seasonally adjusted delinquency performance provides evidence of stabilization. Entry into delinquency has been stable and should improve with the tighter underwriting product mix changes and increased prime origination seasoning into the portfolio.

The remaining major challenges to improve curing of delinquency in late stages accounts more than 60 days past due. This challenge is shared by many in the consumer credit market. But our performance appears to be somewhat worse than the market, although precise comparisons are not possible.

Actions such as changing re-aging requirements have already been taken. A number of other actions are planned or are being implemented to help improve late-stage cure rates over the next several quarters, to the extent possible. We continue to evaluate our underwriting standards and product categories and may make further adjustments if progress is not made in improving late-stage cure rates.

Conn's business model provides a sensible alternative for sub-prime finance for consumers, and a compelling overall value to customers. Our growth plans are intact and the loan sale, if completed, will allow optimization of a proven business model. Now I'll turn the call over to Mike. Mike?

Thank you, Theo. Starting with underwriting on slide 6, is the average FICO score in the portfolio for the last five years. The portfolio has been in a narrow range of credit scores, and remained there last quarter. We started making underwriting changes in late FY14 and throughout FY15 to reduce risk. These changes are summarized on slide 7. Slide 8 shows the impact of these underwriting changes, which are estimated to have reduced the sales rate by 3% to 5%, compared to the first quarter a year ago. The impact of these changes should diminish in the second quarter and the remainder of the year, as we lap the changes.

Turning to slide 9, beginning in late October of FY15, we began originating 18- and 24-month no-interest loans to customers with prime credit scores, as we had several years ago. As of May 31, 2015, 18- and 24-month no-interest consumer loans represented 5.7% of the total portfolio, and we expect this percentage to increase over the next few quarters. The average FICO score of these loans at origination was 697 during the quarter. The FICO score of all originations in the first quarter of FY16 was 617, compared to 605 in Q1 of FY15, and 611 in Q4 of FY15.

See slide 10 for our delinquency data by product category. Consistent with historical performance, appliances delivered the best delinquency performance, while home office products delivered the worst. As our product mix shifts towards more furniture and mattresses, and appliance balances, it is expected to benefit our delinquency rates over time.

On the next slide, slide 11, you can see the trend in the proportion of new and existing customers. Which, after several quarters of increases in new customers, has reversed recently, with the percentage of originations to existing customers beginning to increase, compared to the same period in the prior year. I would note that we typically see a higher percentage of repeat customers during the fourth quarter, related to holiday purchases.

At this time, internal and external evaluations of underwriting have not identified other underwriting changes necessary to achieve our objectives. We have engaged FICO to update our risk scoring model and provide a more advanced tool for early payment default detection. This engagement may yield changes to underwriting later in the year.

As Theo commented, the consultants engaged by the Board to review the portfolio and underwriting have completed their assessment of the historical performance. Their findings have largely confirmed our previous comments about the drivers causing deterioration in portfolio performance over the past few years. Including the increase in new customers in the portfolio, the changes in policies -- specifically, more restrictive re-aging requirements and a more conservative charge-off policy -- and the system implementation issues experienced during FY14.

Additionally, their analysis confirmed that the performance deterioration in late-stage delinquency resulted primarily from cure-rate declines across all risk levels for new and existing customers, and not underwriting changes. And as we have seen in other reports, their data also confirmed that this trend occurred in bank credit cards as well.

Turning to static loss trends, it appears that static loss rates will end higher than our most recent projections. However, it should be noted that due to our decision to stop selling charged-off accounts, current static loss rate trends are being negatively impacted by the reduced recoveries. We expect to collect these amounts over time through our own recovery collection efforts, which should benefit the static loss rates in future periods.

Additionally, as can be seen on slide 12, the speed of portfolio runoff has accelerated in recent quarters, and is especially evident for FY14 and FY15. With only 2.6% of the original balance remaining, FY14 is a quarter or more ahead of the previous vintages. FY15, which had 480 basis points more of its origination balance remaining at the end of the year of origination compared to FY14, is now only 120 basis points higher, and has gained ground each quarter since the year of origination.

This acceleration in the amortization of the vintages is being driven by a return to our historical account combination practices and is expected to reduce future losses. It is important to understand that when applying for a new purchase, the customer must satisfy all underwriting requirements, including being current on all existing accounts.

Lastly, as we return to some of our historical re-aging practices, the benefit of additional cash collections is expected to help reduce the frequency and severity of future losses. Our current re-aging practices are still more restrictive than those in place prior to FY12, capping the number of times an account can be re-aged, and requiring a meaningful payment to be re-aged. Re-aged accounts as a percentage of the portfolio decreased 50 basis points from the end of Q4, compared to an increase of 30 basis points for the same period a year ago.

While we believe that the static loss rates will improved sequentially from FY14 to FY15, and again to FY16, the current allowance for bad debts implies static loss rates of approximately 9.5% for FY13, and roughly 12.5% for FY14, FY15 and FY16. The originations for the last half of FY15 have exhibited better delinquency trends than FY14 and early FY15 vintages. While the proportion of new versus existing customers in the portfolio increased in FY15 compared to FY14, the pace of increase has slowed in FY16. This will offset some of the benefit of improved collections performance and tighter underwriting.

Slide 13 shows recent trends and near-term expectations for several origination and portfolio metrics. The weighted average credit score and mix of high- versus low-scored customers at origination has trended towards higher quality, and we expect to maintain the recent levels. Average income at origination has trended higher with the addition of the high FICO customers, and we expect to maintain the recent levels there too. As noted earlier, the proportion of originations to new customers has been decreasing year over year recently, and we expect that trend to continue.

We expect the proportion of originations supporting sales from home office and consumer electronics products to decline. First-payment default balances over 30 days past due, as a percentage of the portfolio, have been declining. Which we expect to continue, given the higher average credit score underwritten, higher average income and decreasing proportion of new customers underwritten. And average account age has increased slightly year over year, and we expect that trend to continue, given the slower growth rate of the portfolio.

It will take time for these changes to be fully reflected in portfolio performance, especially in late-stage delinquency. In fact, as of April 30, nearly 40% of the balances 90 or more days past due were originated prior to FY15, more than 15 months ago. Our long-term goal is to deliver a static loss rate of 8%. The changes we have made in underwriting, increased originations to prime-scored customers, improvements in collection operations and policies, and changes in customer and product mix, should help move us towards that goal. Additionally, we will continue to review underwriting and make changes as appropriate.

In the first quarter, total originations grew 17% over the prior-year quarter, compared to a growth rate of 34% a year ago. The portfolio grew 1.2% from January 31 to April 30, compared to 3.4% growth in the prior-year period.

Slower portfolio growth is benefiting the underlying performance of the portfolio but has a negative affect on the reported delinquency rates. A year ago, our collection operations were under extreme stress from portfolio growth. Rapid growth in the workforce led to high turnover rates and a workforce with minimal tenure. At the end of April a year ago, 46% of collections agents had more than six months tenure at Conn's and a large percentage of the managers and supervisors were new as well.

At the end of April of FY16, 72% of collections agents have tenure of more than six months. All of our managers have more than two years tenure today. And senior leadership for the collections operation hired or promoted in FY15 have had time to season.

Portfolio growth and staffing needs have become more predictable, and we believe the team is well-positioned to execute our plan. Our objective is to improve execution over the course of the year. Sustained improvement will be needed before the provision rate and related reserves will decline. We do not expect a decline in the reserves in the second quarter. Second quarter of FY16 delinquency is expected to increase seasonally. In May, greater-than 60-day delinquency is up seasonally to 8.5%.

A quick update about the regulatory environment. The CFPB recently announced that they are considering including large installment lenders under their oversight. At this time, as a retail installment seller, it is not clear if we would be included. However, we are continuing to proceed under the assumption that we will ultimately be subject to CFPB regulations, and the potential portfolio sale or forward flow arrangement could accelerate that timeline. We are not aware of any other significant regulatory developments that would impact us at this time.

We have remained focused on achieving and maintaining appropriate staffing levels, and improving underlying credit quality at origination. And we'll continue to identify opportunities to improve execution and credit quality. Now I will turn the call over to Mark Haley. Mark?

Thank you, Mike. Starting with the Retail segment financial performance, total retail sales were $298.5 million for the first quarter of FY16, an increase of $20.9 million or 7.5%. This growth reflects the impact of the net addition of 12 stores over a year ago, partially offset by a decrease in same-store sales of 4.3%. As we highlighted in our April sales release, same-store sales for the quarter were negatively impacted by tightened underwriting and supply chain disruption as a result of the prolonged port labor dispute, which is most evident in the furniture category.

Retail gross margin was 41.3% for the quarter, a decrease of 10 basis points from the prior-year period, primarily as a result of unleveraged warehousing costs. However, you should note that delivery, transportation and handling costs -- also as a percent of product sales and repair service agreements -- improved by 20 basis points, favorably impacted by the new warehouses, as well as other efficiencies gained in our delivery operations.

Retail SG&A, excluding the delivery costs, was 22.8% for the quarter, compared to 23.1% for the same period a year ago. The 30-basis point decrease was primarily due to improved leveraging of advertising expense compared to a year ago. This benefit was partially offset by unfavorable medical expenses, as we have experienced significantly higher costs of claims.

During the quarter, we recognized $619,000 in charges related to facility closures and professional fees associated with our review of strategic alternatives in the class action lawsuits, compared to a $1.8 million charge a year ago due to facility closure costs. On an adjusted basis, retail operating margin increased to 14.5% during the quarter, from 14.2% last year.

Now turning to the Credit segment, finance charges and other revenues was $66.4 million for the first quarter of FY16, an increase of $9.1 million or 15.9%. This increase was primarily driven by a 26.4% increase in the average balance of the portfolio, partially offset by a decline in yield as a result of higher provision for uncollectible interest. And the increased balance of 18-and 24-month equal-payment no-interest finance programs we started late in the third quarter of last year.

Credit SG&A expense for the quarter increased 15% year over year, also due to the growth in the portfolio. But were down as a percent of the average portfolio balance outstanding to 8%, from 8.8% last year. The Credit segment was also negatively impacted by the unfavorable medical expenses we experienced during the quarter.

The provision for bad debt increased $25.3 million from the prior year, to $47.5 million for the quarter. The increase resulted from several factors, including a 26.4% growth in the average portfolio balance, a 17.5% increase in origination volume compared to the same quarter last year, a year-over-year increase of 40 basis points in the 60-plus days delinquency, the accelerated pace of realization of credit losses, and a $9 million increase related to a 6.9% increase in balances treated as troubled debt restructuring.

As a result of these factors, the reserve for bad debts as a percent of the portfolio balance was 11.1%, compared to 6.6% last year, and 10.8% at the end of last quarter. Interest expense rose $4.7 million on increased borrowings and higher effective interest rate due to the senior notes issued in July of last year.

Turning now to our balance sheet and liquidity, as of April 30, 70% of our $129 million in inventory was financed with outstanding accounts payable. Our inventory turn rate was approximately 5.5 for the quarter. Keep in mind, the inventory levels declined from January to April due to the port disruption.

Turning to slide 14, total debt was $720 million at April 30, or 52% as a total customer portfolio balance, after paying down $54 million during the first quarter. At the end of the quarter, we had $474.9 million of borrowing outstanding under our revolving credit facility, including standby letters of credit issued, with a total of $405.1 million of total borrowing capacity available. As of April 30, we were well within compliance of our debt covenants.

Our cash recovery rate was 5.51%, compared to 5.79% a year ago -- well above the required minimum level of 4.49%. The decrease in the cash recovery rate was primarily due to our discontinuation of the three-month and six-month no-interest finance program in August of 2014. Based on current facts and circumstances, we expect to remain in compliance with our debt covenants, and we believe we have sufficient liquidity for the foreseeable future.

For the second quarter of FY16, we expect the percent of net charge-offs to average outstanding balance to be between 11.5% and 12%. And interest income and fee yield to be between 16.5% and 17%. The yield is impacted by the growth in our 18- and 24-month no-interest program, as well as the elimination of certain fees previously charged to customers. For the full fiscal year, we are reaffirming our expectation of change in same-store sales to be flat to up low-single-digits, and retail gross margin to be between 40% and 41%.

Before opening the Q&A portion of the call, I would like to note that the Company will not be participating in any investor conferences during June, while we concentrate our efforts on the portfolio sell. I will now turn the call over to the operator to begin the question-and-answer portion of our call.

(Operator Instructions)

Peter Keith, Piper Jaffray.

Good morning, everyone. Thanks for all of the detail on the call here.

Good morning.

I wanted to ask you, Theo, about the commentary about, under a full-flow arrangement, that the interest rate in certain states might be adjusted. I was wondering if you could provide a little more detail on that? Perhaps what percent of the portfolio is currently under some type of state cap? And your level of comfort, as a retailer, with potentially seeing that interest rate move up?

Okay. I don't have the exact numbers in front of me, but roughly 90% to 95% of the portfolio is subject to some form of a cap. We have unlimited interest rates in Arizona, New Mexico and Nevada. But other than that, we operate in states that have some form of a cap. I'm sorry, South Carolina is another uncapped state. And those represent a fairly small percentage of our outstanding consumer loans and originations.

We are charging, in states that are uncapped, about 28%. In those states, we haven't seen a significant impact on revenue rates, as we've made adjustments to rates. Upward, I don't anticipate in the event that we were able to charge uncapped rates in all markets, that our interest rates would be as high as 28%. But we're confident that we could charge more than the average of about 21.5% that we charge today, without having a negative impact on sales, because of the modest impact on the monthly payment amount for the customer.

Okay, that is helpful detail. As a follow-on to that, I was curious about -- I think you suggested you could look at interest rates across the entire portfolio maybe by quality of credit customer? Did I interpret that comment correctly, that you might be using some type of a tiered approach for new or repeat, under some type of forward-full arrangement -- in other words, that could be a possibility?

Yes, we could have a tiered approach. I don't think we would have a complex set of tiers and pricing. But I believe we could have a tier that would allow us to underwrite customers that we don't underwrite today, and charge a higher interest rate than we charge today for that group of customers. The benefit that we give to higher credit-quality customers is our zero interest rate program. So I don't believe we would look to lower rates for better credit-quality customers. It's really just giving them the opportunity to pay no interest -- to the extent that they make their payments on time and pay off the loan within the prescribed period.

Okay. That's helpful feedback, thank you. I did want to ask another question, maybe directed more towards Mike. With the change in -- or lack thereof -- of selling charged-off accounts now, I was curious what the impact that is having on your static loss table? The FY15 vintage is running at 2.6% losses, one quarter out in the year, versus the 2014 at 2.1%. And I'm wondering if you can quantify what the impact is on the year-over-year change from no longer selling the account?

You bet. I'd start off by saying, on the charge-off for the period, it's about a 40- to 50-basis point impact on the charge-off rate for the quarter. And then on static losses, depending on which fiscal period you're looking at between 2013, 2014 and 2015, cumulatively, it can be somewhere in the 30- to 40-basis point range.

That's great, thanks for all of the feedback. I'll get back in the queue.

Thank you.

Brad Thomas, Key Capital.

Thank you. Two questions, if I could. First on the underwriting side, you did talk about on the static losses, that long-term target of 8%. My question is, with all of the initiatives in place today to improve the quality of the credit portfolio, do you think there's enough going on to get to that level? Or are there other changes that you may need to make to get to that level?

Brad, we're continuing to monitor the performance of the portfolio and the impact of the changes that we've made thus far. There could be additional changes that we need to make, and those changes could be reflected either by changing our underwriting standards or changing the product mix. As I said, we're continuing to monitor performance, and we'll make changes as we see they're necessary over time.

Great. And if I could follow up on some of the cost buckets from slide 5 that you highlighted, specifically the delivery costs and the advertising costs. Those have obviously come up over the last couple of years. And they would seem to be areas that you could get significant leverage as you in-sell some of the new markets that you've recently entered. But by the same token, you did highlight that the costs can be higher, with some of the sales of furniture and appliances. How much margin opportunity do you think there is from the fill-in opportunity that you have ahead of you?

The fill-in opportunity has impact in two areas. One, in gross margins, because we're more efficiently using the warehouse capacity that we have. And the impact of that improved leverage could be in the range of 50 basis points or more as we open stores that are served by those warehouses. And then, we don't expect significant declines over time in delivery, transportation and handling costs, so much as we believe that the relative trends of significant year-over-year deterioration has been reversed.

And then advertising, we should receive some benefit. But we don't expect to see that advertising expenses in total -- including new stores -- will return to the levels that we saw several years ago when we weren't growing. But if you look at our advertising expense in mature markets, it's actually lower than historical norms, as we've become more efficient in our use of media, and more targeted towards our core customer.

That's very helpful. Thank you so much.

Thank you.

Rick Nelson, Stephens.

Good morning. In the house, financing increased to 85% of sales. I think you were at 75% last year. And third-party dropped to less than 3%, compared to 11% last year. If you could tell us about that change, provide some color there? And what the economics are for bringing that third-party credit down to your own books?

Rick, this is Mike. Referring back to slide 5 in the slide deck, that's directly related to our originating the 18- and 24-month no-interest programs. Synchrony was previously providing all of that financing for our customers, and that's where we're getting this near-700 FICO customer into the portfolio. It's driving a meaningful increase in the percentage of our originations from a higher FICO score customer. From an economic standpoint, it's running through the margin. And it shows up in the retail gross margin as a discount on those loans, and it's similar to the economics we had with Synchrony.

But you do see the impact on yield from origination of lower-yielding accounts. It's not a zero yield. Because there is a discount to the sale amount, it's not zero yield. But it is lower than our average yield.

All right, thank you for that. Also, I noticed that the number of active accounts was down sequentially, and at the average balance. Was there a change in that calculation?

A couple of things, to your two points. One, the number of accounts -- one, that's typical seasonally. It impacts seasonally. We have a lot of people that liquidate their accounts. Additionally, we've talked about increase in combining of accounts, and that is also impacting the number of accounts. And then to the balance, I probably should have called this out in the call -- we changed the reporting to be the average outstanding customer balance, instead of the account balance that we use to show. So that you can see the impact to -- or what the average customer has outstanding.

Thank you for that. Also curious -- there has been discussion about Bluestem as being a potential model that Conn's could employ, with a third-party finance provider. Any comments on that, as a model?

Sure. Yes, the Bluestem transaction could serve as a potential model for a transaction that Conn's would enter into. But there are other examples of transactions, particularly in the mortgage space. I think there are more examples of the kind of transaction that we're contemplating that even we were aware of, when we entered into exploration of the loan sales. I think there are actually quite a few examples of similarly structured transactions. It's more a market-normal than we fully expected when we started the process.

Bluestem is simply the most pertinent of all of the examples that exist in the marketplace. I'm not sure that, that's a perfect model for us, for a number of reasons. But the overall conception, I think, is similar to what we would contemplate.

Do you expect to have any flow-through agreement until there's going to be a net cost to Conn's, to the retailer, to source sales, in the future?

Yes, we would expect that if we entered into a flow arrangement, it would have a net cost to us. On the other hand, we would have significantly less capital employed. And our returns on capital would increase from levels that we experience today. Overall, we do believe the flow arrangement would be modestly dilutive to earnings; but on the other hand, our capital employed would be much lower.

Okay, thanks a lot and good luck.

Thank you.

Scott Tilghman, B. Riley.

Thanks, good morning.

Good morning.

I wanted to see if you could update us on your real estate strategy. You discussed the relocation and expansion plans, some others being explored. There have been some puts and takes on merchandising over the last year, and then still coming up. So what I'm wondering is, as you move forward, do you expect the box-size changes to have a material impact on margins, either to the positive side or the negative side?

We expect, over the next several years, the average square footage per store to expand slightly. Our model -- our perfect store would have a little over 40,000 square feet today. We don't expect to achieve that average in our store portfolio collectively. We think that sales per square foot in those larger formats might be somewhat smaller than our sales per square foot today, but that the overall gross profit margin dollars produced per square foot would actually be higher. And we think the overall impact of slightly larger stores will be an increase in gross margins and net margins overall.

Just to make sure I'm hearing you right, even though the sales per square foot would be lower, the actual productivity of the box would be higher?

That's right, because the gross margins produced by additional furniture sales are so much higher than our average gross margins today.

And then just a related question, if you look at the changes that have occurred in mix over the last couple of years, how do you think about merchandising as the box size increases?

Obviously furniture and mattresses become more important to us, and I think we would emphasize those categories. As we've talked about on many occasions and I would just reiterate, we have the ability to improve our execution in all aspects of furniture sales. So for us, the opportunity with the larger box is to enable us to compete more effectively as a furniture retailer.

And today, we don't advertise the category, except minimally. We're really just utilizing our existing customer base to sell them an additional product. We're not as effective in sales floor execution with the category as well. And as we expand the footprint, and the throughput per location, we think we'll have the opportunity to improve our sales floor execution as well. We think the change over time will be Conn's becoming a better furniture merchant and retailer than we are today.

Great. Thank you.

Thank you.

Peter Keith, Piper Jaffray.

Thanks a lot. A couple of quick follow-ups. The May comp, I think you said, was a 4%. I was wondering if you did see any negative impact in recent weeks from some of the flooding, and if actually port issues were still a drag on May overall?

I don't believe the port issues were a meaningful drag on May overall. It still impacted our upholstery furniture category. But overall, I'd say it was a minimal impact. The flooding issues affected a few stores for a brief period of time, but not in any material way, overall. And in fact, at some point, we might experience a benefit related to those flooding issues, as customers replace damaged products in their homes. But we also don't expect that to be significant, because the flooding was not that widespread. In summary, the flooding is not expected to have a material impact on us one way or another.

Okay, that's helpful. Also, wanted to confirm that you were talking, Theo, about remodels and reloads. If I heard correct, I think, was it 10 this year? And then you still have 11 more? So in aggregate, 21 stores in total? And then, as a follow-up on that, what type of comp lift are you seeing these days off a remodel or reload, as you can expand that furniture area?

To clarify, at this point, they're really not remodels; they're relocations. The store base where we expect to remain in the current location has been fully remodeled. The activity today is to relocate to other locations or expand the existing footprint in the current location.

The comp lift -- I have not looked at that recently, so I hesitate to make a guess. But we do continue to see a significant positive benefit, particularly in the furniture category. And to a certain extent, over the last quarter or two, that comp lift has been masked by the impact of the port situation. I think May is reflecting a more accurate view of how those remodels and relocations should benefit comp performance.

Okay. And in the aggregate, it's still 21 stores you'd like to relo?

Yes, and we're talking about a period of several years, as we're not anticipating significant costs or charges related to those remodels. It's more around the time of the expiration of the leases, or in collaboration with existing landlords.

Okay, thanks. One last unrelated question, in regards to the CFPB, you had mentioned that you are proceeding as if you will be included with their oversight in the future. What changes have you made, if any, to say your procedures are now under your expected guidelines that may come forth at a future date?

We continue to monitor the guidance issued by the CFPB and other bodies, and make sure we're addressing that commentary in our compliance structure. And as Theo noted in his prepared remarks, that we have invested in formalizing our compliance structure, and continue to invest there.

I'd just summarize it by saying -- a lot. There have been significant changes to our collections practices and collections operations, as a result of planning for compliance. Many of those changes are really formalization of existing practices, but in other cases, they're actual changes. I think perhaps most significantly, it's our view that although the FDCPA does not apply to Conn's under the law, that the view of the CFPB would be that it does apply. So we're taking the steps to apply to FDCPA, which does have an effect on collections practices.

Okay, thanks a lot for all of the feedback, guys.

Thank you.

Ben Clifford, Nomura Securities.

Hi, guys, thanks for the call. I just want to get a little feedback on a hypothetical -- what if the credit portfolio sold and you enter into a flow agreement? What are the costs that stay with the credit business, in terms of collections?

The costs that stay with the credit business under the planned structure would be the same costs that we have today. We would also receive a fee, though, for servicing the portfolio, which would offset a substantial part of those costs that would not offset corporate overhead -- and some other costs. But would cover substantially all of the direct costs -- if not all of the direct costs of servicing the portfolio.

So in terms of the direct costs of servicing the portfolio, what do they run at, as a percent of the portfolio, right now?

They're in the vicinity of 5%.

75%?

5%.

5% of the average portfolio balance.

So if you enter into one of these flow agreements, do you think you'll get 5% servicing fee?

We believe that we'll be able to achieve a fee that covers our costs and expenses --

Based on our understanding of market servicing fees for similar transactions that would be market-normal.

Okay, thanks for that commentary. And then you said that you expect the loss rates for the 2014, 2015 and 2016 origination years to fall around 12.5%. I'm just wondering how that 12.5% loss rate that you're underwriting to right now, how does that fall into your 8% loss rate overall?

To clarify, we did not say that's where we expect the static loss rates to fall; we said that is what the allowance for bad debt implies. Our actual commentary was, we expect FY15 to be -- static loss rates to be lower than 14%. And for FY16, to be lower than 15%. And that with the changes in product mix and customer mix, and the underwriting changes over the last year, we expect that trend to continue towards the 8% level over time.

All right, that makes sense. And then, just last question. In terms of the decision to bring the charge-off collections in-house, what drove that decision? Was there a partner you were using before that wasn't working out? Or just what drove that decision?

I think it relates to the commentary we had earlier about changes in our practices that relate to potential future regulation by the CFPB.

Okay. Sorry, just one last question. The insurance commissions revenue that you earned in the Credit segment appear to be down compared to the last few quarters. What drove that decline?

It was mostly the result of us adjusting prices downward for our most significant insurance product, which is property insurance.

All right, thank you.

Thank you.

All right, we have no further questions in the queue at this time. I would now like to turn the call over to Mr. Wright for closing comments.

All right, thank you, everyone, for joining.

Ladies and gentlemen, thank you for attending today's conference. This does conclude today's program. You may now disconnect. Have a wonderful day.