Conn's Inc (CONN) 2017 Q2 法說會逐字稿

Good morning and thank you for holding. Welcome to the Conn's Inc. conference call to discuss the earnings for fiscal quarter ended July 31, 2016. My name is Kevin and I'll be your operator today.

(Operator Instructions)

As a reminder this conference call is being recorded. The Company's earnings release, dated September 8, 2016, distributed before the market opened this morning and the 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 must remind you that some statements made in this call are forward-looking statements within the meaning of the federal securities laws. The 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 Norm Miller, the Company's CEO; Mike Poppe, the Company's COO; and Lee Wright, the Company's CFO. I would now like to turn the conference over to Mr. Miller. Please go ahead, sir.

Good morning and welcome to Conn's second-quarter FY17 earnings conference call. I will begin the call with an overview and then Mike Poppe will discuss our retail and credit performance for the quarter. Lee Wright will complete our prepared remarks with additional comments on the financial results.

The underlying operating and financial performance we achieved during the quarter met our expectations. And I am encouraged by the 20 basis point year-over-year improvement in our adjusted provision rate, the 130 basis point sequential increase in our retail gross margin and the progress we are making reducing losses, increasing yield and lowering our borrowing costs. Our retail operation continues to perform at a high level despite a challenging retail environment and we are making progress improving credit's operating performance.

As we have stated over the past two conference calls, FY17 is a year of transition that is focused on returning to profitability by integrating our new leadership team, implementing initiatives to improve the performance of our credit operation and continuing to enhance our retail business.

On slide 3 in the earnings call presentation, we have outlined several significant actions we have undertaken since the start of the year as part of our plan to drive improved operating results. You have heard me discuss many of these activities before, so I would like to use this opportunity to update you on our progress.

Let's start with an update on the leadership team on slide 4. Conn's has a differentiated and complex business model which requires a unique and experienced leadership team. I am extremely pleased with the talent we have assembled over the past 12 months. During the FY17 first half we have added several new members to our leadership team, including Lee Wright as CFO, Mark Prior as General Counsel and Corporate Secretary, John Davis as our Chief Credit Officer and Michael Liu as VP, Collections and Customer Service.

The team we have in place today represents proven and motivated business leaders who are experienced managing both national retail organizations as well as consumer finance companies. For example, our credit operations leadership team has an average 18 years experience working in the consumer finance industry.

While many are new to Conn's, this team's significant industry experience has quickly contributed to improving our business processes, data analytics and customer service. We are assembling a strong organization of experienced leaders and I am confident in our ability to execute our turnaround plan while creating the foundation to support Conn's long-term market opportunity.

Conn's has a strong, unique and well positioned retail strategy. In the second quarter of FY17 the retail segment expanded sales and successfully opened four new stores while adjustments in underwriting, that I will speak to later, significantly impacted same-store sales growth. Higher-margin furniture and mattress products represented 35.2% of product sales in the second quarter compared to 33.7% in FY16 second quarter and 30.8% in FY15 second quarter. We continue to believe that 45% of our product sales can ultimately come from furniture and mattresses and we are making progress towards this goal.

Appliance sales and margins experienced a nice rebound in the quarter and total appliance sales were up 4.2% from the same period last year. During the quarter we reverted back to our prior in-store pricing policy after testing the strategy to drive appliance volume in the first quarter which helped increase our product margin sequentially in this category. I am pleased with the 130 basis point sequential improvement in our retail gross margin as a result of our higher furniture, mattress and appliance sales.

In our effort to turn around our credit business we are refining our underwriting model, adjusting our new store grand opening strategy and reducing the number of new stores we plan to open over the next 18 months which is slowing total sales growth. As a result, SG&A costs continue to deleverage in the second quarter due to higher new store occupancy and advertising expenses, as well as the investments we are making within our organization to build the necessary infrastructure for future expansion.

We expect SG&A expenses will continue to increase as a result of new store growth and higher advertising expenditures. However, during the quarter we went through a thorough evaluation of our overhead expenses and developed a cost mitigation plan which we expect will offset planned increases in our SG&A budget by approximately $10 million over the remainder of the year.

Finally, as you saw in our press release this morning, we have made further revisions to our near-term new store growth plans. We expect to open a total of 10 stores this fiscal year compared to 15 new stores last year. And for FY18, we have a current commitment to open only three locations. Slower unit growth, combined with the recently announced changes to our credit business and programs to enhance portfolio yield, are aligned with our core focus on profitability while creating a sustainable business model that appropriately manages credit risk and retail growth.

Turning to slide 5. We continue to dedicate a significant amount of resources and investments to transform our credit operation and improve its financial performance. Changes in customer behavior and under-investment in credit risk management in the past has significantly impacted the performance of our credit operation.

As we have outlined previously, our customers have experienced greater access to credit, a higher cost of living and little or no improvement in their income, while our rapidly evolving regulatory environment has made it more difficult for all lenders to collect from consumers. In addition, the transformation and rapid growth of our retail segment combined with the significant influx of new customers, amplified the negative portfolio performance trends. We have seen the change in customer performance across all cycle bands and for both new and existing customers.

During the quarter we continued upgrading our credit operation which includes changes to our leadership team, investments in systems and analytics, refinements to our underwriting model and strategies to improve yield. With improved systems and greater insight into the portfolio's performance, we were able to shorten our response time to changes in behavior and make appropriate adjustments to manage risk, reduce losses and improve collections. From an underwriting perspective, the second quarter reflects the first full quarter of our refined underwriting model.

As we outlined on our last conference call in late March 2016, we made additional enhancements to reduce the credit risk related to new customers. These changes, combined with previous underwriting refinements in 2016 fourth quarter, reduced total retail sales in the second quarter by over 700 basis points. We have made conscious and proactive decisions to refine our underwriting model, slow sales growth and improve our infrastructure to produce consistent and predictable earnings.

While it will take several quarters for the new underwriting model and recent adjustments to our underwriting scorecard to impact overall credit performance, we are confident these actions will enhance our ability to acquire new customers, develop better credit quality customers and reduce losses. We continue to believe our credit model has the ability to produce long-term static loss rates of 10% to 12%.

While we are not there yet, our recent experience demonstrates improving trends. For FY14 and FY15, we expect losses to be in the low 14% range. We expect FY16 losses to be better than 2015, and FY17 losses we expect will show even further improvements.

Early this fiscal year we implemented changes to our no-interest program to improve portfolio yield and our returns on capital. All long-term no-interest programs are now offered through Synchrony as of early February. And sales underwritten by Synchrony represent 17.2% of Conn's FY17 second-quarter retail sales, compared to 7% in last year's second quarter and 12.5% in the FY17 first quarter. We do not expect this change will have a significant impact on long-term profitability, but it will improve returns on capital as we recapture the capital invested in similar accounts on our books today.

Additionally, we removed no-interest eligibility for certain higher risk customers under Conn's in-house no-interest programs. We are not anticipating a meaningful impact on sales as a result of these changes, but expect these adjustments combined will improve yield by approximately 100 basis points over the next few quarters from our second-quarter levels.

In this morning's press release we announced that the Company has received the regulatory license in the State of Texas required to issue higher APRs on customer accounts financed through Conn's in-house credit offerings. We are working to fully implement our new direct loan program across all 55 Texas locations by the end of this fiscal year.

I want to stress that it will take time to roll out this program because we want to ensure our systems, our sales and marketing programs, regulatory and compliance framework, employee training and customer service centers are fully prepared to handle this important change to our credit business. The long-term potential of our direct loan program is significant and will fundamentally enhance the economic model of our credit business given the lower rates we have historically charged customers.

The State of Texas currently represents approximately 70% of originations and under state statutory rates for retail lenders, the most we can currently charge customers in the state is 21%. Under the framework of the new direct lending program, we have the ability to charge higher rates and can charge customers a stated APR of up to 30%.

Over time this will significantly improve the profit profile of our credit operation, while continuing to offer customers affordable payment options. For example, a hypothetical $2,500, 32 months loan at a 21% APR under our existing terms in the State of Texas today would have a monthly payment of around $103. Under our direct loan program a $2,500 loan at 30% now under a 36 month term would have a monthly payment of approximately $106. As you can see, our customers will not experience a material increase in their monthly payments, and even at the higher 30% rate payments will still be significantly below what other lenders, retailers and rent-to-own providers offer.

We have provided in-house credit options for over 50 years to our customers and understand the value our offerings have to our customer base. We remain committed to offering our customers attractive payment options at affordable rates to purchase quality products while providing exceptional customer service. These values are what have made Conn's successful and will remain the foundation of our future accomplishments.

During August in Arizona, New Mexico, Nevada and South Carolina we have increased our stated APR to 29.99%, consistent with guidelines in those states. These four states represent 11% of our originations, and while the change in rates were only recently implemented, we have not seen a change in consumer behavior.

Finally while our near-term efforts are focused implementing our direct loan program in Texas, there are four additional states, Louisiana, Oklahoma, Tennessee and North Carolina, that represent another 14% of our originations and offer regulatory frameworks that we believe will allow us to increase rates.

We expected the benefits from our new direct loan program in changes to our no-interest program will increase our overall yield by 600 to 900 basis points on new originations by the end of FY18. Higher portfolio yield, combined with improving loss trends and lower borrowing costs, will significantly increase the profit contribution of our credit business.

We still have a lot of hard work in front of us, but as I hope you can see in my remarks today, we are making progress improving our credit operations while maintaining our strong retail performance. I am encouraged by the experience and motivated leadership team we have assembled.

Across all levels of our organization we are intensely focused on returning to profitability and I appreciate our shareholders patience as our initiatives to drive improved results take hold. I remain confident we are headed in the right direction and the decisions we are making today will create significant shareholder value in the future. Now, I will turn the call over to Mike.

Thank you, Norm. Starting with our retail performance, as shown on slide 6 of the earnings deck, total retail sales for the second quarter were up 2.2% compared to the same period last fiscal year. Growth was driven by furniture and mattresses up 7%, and home appliances up 4%. These are our two highest-margin and best credit-quality product categories. Sales of consumer electronics declined 6% on softer TV sales.

Same-store sales for the second quarter of FY17 were down 5.1%. Excluding exited products, same-store sales for the second quarter of FY17 were down 4.6%. The second quarter is the last quarter influenced by our strategic decision to exit video game products, digital cameras and certain tablets. Recently implemented underwriting refinements impacted total retail sales during the quarter by approximately 700 basis points.

Slide 7 in the presentation recaps product gross margins which were 30.9% of product revenue and were impacted by the loss of leverage on our warehouse and delivery costs as a result of slower sales and the opening of our 10th distribution center. Higher costs were partially offset by the favorable shift in product mix towards our furniture and mattress and appliance categories.

The retail margin was impacted by the same factors. However, underlying product margin remains strong and in the second quarter increased approximately 90 basis points compared to the prior year when excluding warehouse and delivery costs. Sequentially, retail gross margins improved 130 basis points from the first quarter of FY17.

Inventory levels declined 5% since the end of FY16 and we are comfortable with our sales and purchasing plans. Inventory increased year over year, driven primarily by the 17-store increase since July 31 of last year.

During the second quarter, we opened a total of four new stores, including locations in North Carolina, Mississippi, Tennessee and Alabama. We will open a total of 10 new stores this year, with one location planned to open in the second half. We continue to be pleased with the performance of our retail operations, highlighted by sequential improvements in operating income and margin.

Slide 8 presents the average FICO score of the portfolio for the last four years. The portfolio has been in a narrow range of credit scores and remained there last quarter, reflecting the consistency of underwriting over time. The FICO score of all originations in Q2 of FY17 was 611 compared with 617 in Q2 of the prior-year and 609 in the first quarter of FY17. Year-over-year change was driven largely by our decision to use our program with Synchrony to offer all long-term no-interest financing promotions.

As Norm noted, during the first half of the year we made additional changes to our underwriting model to reduce credit risk specifically related to new customers. Additionally, in late June we implemented our new origination score card and strategy, as well as moving to a new decision platform.

These changes, combined with the refinements we made since the fourth quarter, include modifying our credit limits, down payments and cash option eligibility to reduce risk for some customers while declining other unprofitable customers. Enhancements to our origination score card, improvements to our credit analytics and increased customer segmentation will offset some of these headwinds to sales and has helped us identify profitable segments of customers to begin approving.

Underwriting refinements and the shift of long-term no-interest promotions to Synchrony have had a significant impact on originations. As a result, current year originations as a percentage of total sales were approximately 72% in the second quarter versus 83% for the prior-year period.

As shown on slide 9, the underwriting refinements we have implemented are increasing the mix of this existing customers in our originations. This is important because existing customers historically have had a meaningfully lower loss rate the new customers. Customer originations with more than five months since their first credit transaction at Conn's was over 50% in the most recent quarter.

On slide 10 you can see the increase in existing customers as a percentage of originations for the Company overall; Houston, a legacy market; and Phoenix; a newer market. The Phoenix trend shows the impact our underwriting changes have had on new markets with a sequential increase of over 500 basis points for repeat customers.

Year-to-date, the portfolio has contracted $43.5 million or 2.7%. And compared to July 31, 2015, the portfolio has increased 6.4%, the slowest pace of year-over-year growth in four years, since the April 30, 2012 quarter. While slower growth is benefiting the underlying performance of the portfolio, it has a negative effect on portfolio metrics, including delinquency, provision and charge-off rates.

The underlying performance of the portfolio has stabilized as the Company has experienced improving static pool delinquency and loss trends for the late FY15 and FY16 quarterly originations. In addition, the speed of portfolio runoff has continued to accelerate with both FY15 and FY16 origination balances declining faster than the prior-year period. Accelerating runoff, combined with improving static pool delinquency trends, should lead to improving provision expense trends in the future.

However, slower growth continues to impact the rate of change seen in the total delinquency rate and has extended the timeframe needed to realize improvement in the rate. Adjusting the 9.6%, 60-day delinquency rate we reported in the most recent quarter, to reflect the same rate of portfolio growth in the prior-year second quarter, the 60-day delinquency rate would have been 9.2% compared to 9.2% for the same period last year.

The allowance for bad debt as a percentage of the total customer portfolio balance was 13% at July 31, 2016 compared to 11.3% at the same time last year and 12.7% at April 30, 2016. Our allowance for bad debt since July 31, 2016 implies static loss rates for FY14 and FY15 in the low 14% range, with expected loss rates for FY16 to be better than 2015 and FY17 to be better than FY16. While seasonality and slower growth may put near-term pressure on the provision rate, we believe we are adequately reserved for future loss expectations as a result of underlying improvements in the portfolio, refined underwriting standards and the current collection environment.

Finally, looking quickly at programs to increase yield. The changes we implemented to our third-party and in-house no-interest programs are expected to improve the yield on our portfolio by approximately 100 basis points over the next few quarters from second-quarter levels. In addition, the direct loan program Norm outlined in his prepared remarks, combined with changes to our no-interest programs, are expected to increase our yield by 600 to 900 basis points on new originations by the end of FY18 from 16% today.

From a compliance perspective, our new direct lending program will require additional oversight on a state level, primarily through regular state examinations. We have already adapted our compliance systems, procedures and standards to comply with this new level of state oversight and feel comfortable with our compliance infrastructure.

The benefits to our net yield from changes in our promotional credit strategy and new direct loan program will be significant, but will be partially offset by increased bankruptcy losses and other structural changes. Despite these minor impacts, the changes we're making to increase yield, reduce losses and lower our borrowing costs will meaningfully increase the long-term contribution potential of our credit business.

We remain focused on delivering outstanding value and a great experience to our customers by continuing to improve execution in our retail and credit operations. I am encouraged by the direction Conn's is headed and the foundation we are creating to drive sustainable long-term profitability and growth. We're happy to have Lee Wright join our team and I look forward to working with him as we move forward. Now, I'll turn the call over to Lee.

Thanks, Mike. I'm excited to be on board at Conn's and look forward to working with the investment community. While we still have a lot of hard work to accomplish over the near term, I am very encouraged by the leadership team we have assembled, the strategies that we have created to improve profitability and the direction we are headed.

With that being said, let's get into the numbers. We reported a loss for the quarter of $0.39 per share compared to diluted earnings for the prior-year quarter of $0.45 per share. On a non-GAAP basis, adjusted diluted loss for the quarter, which excludes charges and credits and the impact of the changes in estimates, was $0.04 per share compared to adjusted diluted earnings for the prior-year quarter, which excludes charges and credits of $0.47 per share.

On slide 11 and within this morning's press release, we outlined the impact that charges and credits as well as several changes in estimates had on our results for the quarter. The charges and credits for this quarter totaled $2.9 million and were primarily due to severance and transition costs due to changes in leadership team and impairments from disposals of two real estate assets.

The accounting adjustments we made during the quarter include: revisions to our methodology for calculating our estimates related to sales tax recoveries in the allowance for doubtful accounts which increased this forced provision expense by approximately $5 million; estimates related to allowances for no-interest credit programs which decreased this quarter's interest income and fees by approximately $4.7 million; and, estimates related to deferred interest which decreased this quarter's interest income and fee by approximately $3.5 million. Additional information regarding these changes in estimates and charges and credits will be made available in our 10-Q which will be filed later today.

For the retail segment of the business, total revenues for the second quarter of FY17 were $332.4 million, which was an increase of $6.8 million or 2.1% versus the same quarter a year ago. This growth reflects the impact of a net addition of 17 stores over a year ago, offset by negative same-store sales of 5.1%. Excluding the impact of the exited product categories, same-store sales decreased by 4.6%.

Retail gross margins declined by approximately 60 basis points versus the prior-year period to 37.1%, but were up approximately 130 basis points sequentially. The sequential improvement in retail gross margins was primarily due to the enhanced product margins and the non-recurrence of the shrink issues that occurred in Q1.

We continue to believe that we can grow our retail gross margin as a result of: increasing the mix of sales of furniture mattresses which have a higher margin, decreasing share of revenues from lower-margin small electronics and home office products, and improving warehouse and distribution utilization and optimizing our transportation delivery expenses.

Slide 12 of the earnings presentation shows retail costs and expenses. Starting with the top row, we show the cost of goods, including warehousing and occupancy costs, deleveraged by 60 basis points as a percent of total retail net sales increasing to 62.9%.

Retail SG&A, as a percent of retail revenues, was approximately 25.5% for the quarter compared to 23.6% for the same period year ago and 25.1% for the FY17 first quarter. The 190 basis point increase in year-over-year SG&A was driven primarily by the impact of new store openings, which drove the 120 basis point increase in occupancy and contributed to the 50 basis point increase in advertising.

Taking a look at the credit segment, finance charges and other revenues were $65.7 million for the second quarter of FY17, down 6.7% versus the same period last year. The decrease in credit revenue was due to a yield rate of 14%, 210 basis points lower than a year ago, which included an $8.2 million negative impact as a result of changes in estimates for allowances for no-interest credit programs and deferred interest, partially offset by growth in the average balance of the customer receivable portfolio of 8.7%. Excluding the impact of the changes in estimates, yield was up 10 basis points as compared to the prior-year period.

SG&A expense in the credit segment for the quarter grew 24.4% versus the same period last year, driven by the addition of collections personnel to service the 8.7% year-over-year increase in the average customer portfolio balance, as well as the investments we are making to improve the performance of our credit business. Credit SG&A, as a percentage of average total customer portfolio balance, delevered by 120 basis points versus last year.

Provision for bad debts in the credit segment for the three months ended July 31, 2016 was $60.1 million, an increase of $8.7 million from the same prior-year period. The increase in the provision for bad debts included the following: a $5 million increase in the provision for bad debts as a result of a change in estimate related to sales tax recoveries; an 8.7% increase in the average receivable portfolio balance resulting from new store openings over the past 12 months; and customer receivables accounted for as troubled debt restructurings increased to $128.6 million, or 8.3% of the total portfolio balance, driving $1.9 million of additional provision for bad debts.

As a result of these factors and the shrinking portfolio balance, the provision for bad debts as a percent of the average portfolio balance was 15.6% compared to 14.5% in the second quarter of last year. Excluding the change in estimated related sales tax recovery, the provision would have been down approximately 20 basis points from the second quarter of last year.

Slide 13 in the presentation shows our liquidity compared to the same period last year. As of July 31, 2016 we had $15.5 million in cash and $97.7 million of immediately available borrowing capacity under our $810 million revolving credit facility, with an additional $407.5 million that could become available upon increases in eligible inventory and customer receivable balances under the borrowing base.

For the FY17 second quarter, interest expense increased by $14.1 million year over year, driven largely by our reentry into the ABS market, which increased the average debt balance outstanding and contributed to an increase in the effective interest rate. For the quarter, annualized interest expense as a percentage of the average portfolio balance was 6.3%, with average debt as a percent of the average portfolio balance of approximately 78.6%.

Accounts payable as a percent of inventory was approximately 61% at July 31, 2016 compared to 43% at January 31, 2016 and 61% at July 31, 2015. During the quarter, we made significant progress improving our payable to inventory rate.

Looking at our ABS transactions, our 2015 and 2016 ABS notes are performing in line with our expectations. At July 31, 2016, approximately 32% is remaining of our total 2015 A notes that were issued, and approximately 63% is remaining of our total 2016 A notes that were issued.

As of July 31 we have $621.3 million of receivables that are eligible for securitization and we are looking at completing another ABS transaction in the coming months. For point of reference, in our March 2016 transaction we issued BBB rated class A notes and BB rated class B notes with an aggregate advance rate of 70% and all-in cost of funds of approximately 7.8%. We expect our next transaction will have a similar structure but a lower all-in cost of funds.

While our initial cost of funds through the ABS market was high, we expect continued reductions in our ABS funding costs will occur as prior deals perform in line with expectations and investors experience with our receivables increases. Slower growth and our decision to move long-term no-interest programs over to Synchrony provides us with more flexibility in the ABS market.

As a result, we expect to complete ABS transactions two to three times a year, which is important as we continue to build a track record, not only with investors but also with the rating agencies. However, as the time between ABS transactions has increased, we are able to warehouse more receivables through our lower-cost ABL facility. This will enable us to lower our blended cost of funds. Furthermore, as we improve the spread of our portfolio by increasing the yield on our origination and lowering our losses, we believe that we will continue to lower our cost of funds from our ABS transactions.

We understand we presented a lot of information on today's call as there are many drivers impacting this year's results. Our turnaround strategies are well underway and we are making progress towards our near-term focus of returning to profitability. I'm excited to be part of the leadership team at Conn's and the opportunity we have in front of us to drive shareholder value.

This concludes our prepared remarks. Operator, please open the call for questions.

(Operator Instructions)

Brad Thomas, KeyBanc Capital Markets.

Appreciate all the details this morning. Wanted to follow up on the topic of the rates that you will charge customers in Texas. And get a little bit more of your thinking around how you think those loans will end up performing if the customer is paying a higher rate or as a term that ends up being longer than what you are offering today. And then on a net basis, how productive this tailwind could be for you all as you put it into place.

Sure, Brad. I'll start off, give a couple of comments, then I'll hand it over to Mike with some other details. A couple of comments on it. First, we actually have already begun piloting it in one store here in Texas. We have written several hundred loans since the beginning of August and we're seeing very little to no impact from a sales standpoint.

As I highlighted in my comments, we're very focused and our customer is very focused on what their average monthly payment is. So we think that is the primary driver of the sales decision for our customer, as opposed to what the APR is. We're obviously conscious about what that monthly payment is because that can impact credit losses down the road, if that monthly payment to income is not managed appropriately from our end, let alone from the customer's end.

Very encouraged by what we're seeing with the pilot store that we have been running now for a little over a month. The other comment I would make before I hand it to Mike would be, just from a clarification standpoint, and I guess an awareness standpoint, we have been charging higher APRs in the mid to upper 20%s in several states for several years, including Nevada, Arizona, New Mexico. And we have not seen differences from a customer behavior in those states as a result of the higher APRs as well. Our expectations are that we will not see a material impact from a sales standpoint with this Texas direct loan change. Mike?

Great, thanks, Norm. On top of Norm's comments on sales, as he pointed out, our customers are payment buyers and they're not focused necessarily on the interest rate, as we've seen across the various markets that we're in today at different rate levels. When you think about credit portfolio performance, since the customer is more focused on their monthly payment, we do not expect a big impact on credit losses. And we'll take that into account in our underwriting, to the extent we think adjustments need to be made. But we're focused on making sure we have an affordable monthly payment for that customer based on their income level.

When you think about the ultimate flow-through impact of this and the changes we made in the four states in August plus the opportunity we have in four additional states we identified, we think when this is fully seasoned in, this can improve the operating income in the low to mid single-digits range. And then when you consider the work we're doing on improving static pool losses and targeting that 10% to 12% range. And then the add-on benefits that would come from cost of borrowing, we think we ultimately can move the credit business into a profit contribution as opposed to a loss level where it is today. Ultimately this helps us drive profitability out of the credit operation.

One other thing to highlight, Brad, in essence, out of the Texas originations, the four states we've already impacted plus the four states ultimately that have similar-type programs that the Texas direct loan project offers, we're going to be able to impact north of 92%, 93% of all of our originations as they sit here today.

That's very helpful color, thank you, guys. If I could ask a follow-up question around same-store sales. Could you quantify for us what the headwind was in the second quarter from tighter underwriting standards versus last year? And what you're assuming for a headwind in the balance of the year for same-store sales?

Absolutely Brad. I think it might be helpful to break out the second-quarter same-store sales to give you some additional detail on how we got to the 5.1% in negative same-store sales for the overall business. The total impact from -- first, I will say -- the total impact from the underwriting changes that we did at the beginning of April, as well as the changes in the fourth quarter, were a little over 700 basis points.

Now, if you break out our store base for same-store sales into three groups. The three groups being our core stores, which represent about 60%, it's our Texas stores, our core stores. And then the second group being our new stores in single markets. So stores that we went into that are new markets where there is only a single store in that market, that represents about 20% of the same-store sales base. And the last one being new stores in new markets with multiple stores. These are cannibalized markets, if you will, where we already had one new store and we added a second or added a third store into those markets. And that represents about 20% of the same-store sales base.

If you look at the same-store sales in each of those three groups, in our core stores for the second quarter the same-store sales for that 60% of the stores were down 1.8%. That's what they represent out of that 5.1%. Now, understand, they had underwriting changes that were impacted there, but out of that 700 basis points of underwriting changes that we undertook, a significant portion, or a greater portion of that 700 basis points, was in new markets and with new customers. So with the core stores, even though it wasn't at 700 basis points, it was more like 300 or 400 basis points, they would have comped positive in the second quarter.

If you look at the new stores -- single stores in new markets -- their same-store sales were down 10% for the second quarter. And again, they have higher underwriting impact out of that 700 basis points, more to the tune of 800 to 1,000 impact of the basis points from a change from an underwriting standpoint. And the last group being the cannibalized markets with multiple stores in new markets, those same-store sales were down 19.7% in the second quarter.

A couple of comments that I would put as a result of that. Number one, our core business is still very, very strong, with positive comp after the underwriting changes. And secondly, the changes that we've taken to impact credit losses into the future with new customers and new markets, you're seeing that impact on that same-store sales. It's reflecting the actions that we believed we were taking from an underwriting standpoint. We're seeing that flow through from a sales standpoint.

What I will say is that even with those new markets in the same-store sales being down at those percentages, we're seeing the revenue growth obviously ramp up slower. But those doors are still from an EBITDA payback standpoint, historically we have run in the 4- to 6-month payback range. These newer stores are running in the 7- to 9-month EBITDA payback standpoint.

Still very, very profitable as we ramp up sales at a slower pace initially out of the gate. And ultimately we believe the longer-term potential revenue of those stores is not impacted fundamentally. We still believe even in those newer markets, we can ultimately get that revenue to the $12 million to $15 million per store that we see in our existing core market. It just may take a little longer to get there.

That's very helpful, Norm. To think but the second half of the year here, if you had 700 basis point drag in 2Q in aggregate, it sounds like you made further refinements in July and August in the presentation. So what are you expecting through the balance of the year in terms of impact on same-store sales?

As you saw from our guidance, Brad, we slightly lowered guidance down to high single-digit same-store sales. As you know, we have provided an increased guidance these past two quarters as we turn the business around. We're trying to provide and give insight on a quarterly basis around margins, costs, loss provision and including quarterly same-store sales.

When we did this, we got away from doing the monthly because it tends to be a little lumpy and a little more reactive at the end of the day. We did lower slightly what our same-store sales are here. For the third quarter at least, we'll re-look at what we're going to project in the fourth quarter as we announce the third-quarter results.

But part of the reason for doing that is not as much being more aggressive from an underwriting standpoint. We are seeing a greater impact on those new markets and the cannibalized markets that are impacting the overall number a little bit greater. And frankly my desire to be a bit more conservative as we go about business from a normal course of action. Our mindset is to be conservative and make sure that we have in place the foundation and we are providing guidance and direction that people, as they look at our stock and our performance, can count on that guidance going forward.

Got you. Thank you so much, guys.

Brian Nagel, Oppenheimer.

Start with a couple quick questions to follow up on Brad's, on the direct loan program. As this ramps in Texas, just for clarity, what share of your loans do you think will fall into this program versus the financing programs you have now? The question I'm asking, is the direct loan, is that something you're going to be offering your less credit-worthy customers? Or is it more an across-the-board type shift in the financing for your customers?

It's across-the-board, Brian.

Okay. Then the second question is a follow-up. As you look as the performance of those loans -- I guess I understand from the perspective that the monthly payment would be largely the same, as you articulated in your prepared comments. But, the duration or the term of these loans will be longer. In some cases, I would think, depending on the product, the loan may outlive the useful life of the product. Does that impact the performance of the loan longer in its term?

A couple of comments on that, because that's a good question, Brian. First, as we slightly extended the length of the loan from 32 to 36 months, four months, if you go back historically, it was only three years ago or four years ago, we typically wrote loans that were 36 months in length at that time. So it's not something that's new to us.

And secondly, we're very conscious about, from a product standpoint and a quality standpoint, to ensure that -- the quickest way to get a customer who's being financed, not to pay their monthly payment is to have issues from a quality standpoint. So it's an extremely high level of focus for us and we're extremely confident that it will have no impact on -- our quality of products will far exceed that 36-month timeframe that the new direct loan product will have.

And a couple of quick additional comments on that, Brian. Certainly a longer tail on the loan could modestly increase risk, but we can adjust for that in our underwriting and who we approve. But the other thing we do is for certain products, when you think about products that the loan may outlive, for small electronics, those type of products, we only offer a 24-month term as it sits today. Because of that very reason, we need that loan paid off before --

That won't change with this program.

Exactly. So we think the terms are matched very well with the lifespan of the products that we're financing.

Got it. That's very helpful. Then shifting gears a bit, a bigger picture question. We've heard some indications recently from other companies that have exposure to Texas, that the consumer performance in these oil-related markets has turned down. You're obviously very exposed to the Texas market, any comments on that front?

Sure. We'll give you a little bit of color on both ends, both the sales and the credit end. First from a sales standpoint, in the second quarter we continued -- and oil markets for us represent about -- we don't consider all of Texas as oil markets.

We consider Houston and where there's actually oil produced, for example in Dallas, we don't consider that an oil-impacted market. But we also consider Oklahoma and several other states where we do do business, and it's about a third of out total originations.

What we're seeing is in the second quarter from a sales standpoint, a consistent performance, albeit it continues to perform -- the oil markets -- softer from a sales standpoint to the tune of about 70 basis points. But that's been consistent over the past couple of quarters. It hasn't degraded any as we sit here today.

We'll say from a credit standpoint we have seen some softness, specifically in the Houston market. Now, Houston still performs credit-wise better than our average market does, but we have seen some softening, especially with higher FICO customers, in the past quarter.

Got it. Okay, thank you very much.

Rick Nelson, Stephens.

To follow up on the securitization, you mentioned that your objective was to do two to three a year. I think you've got one under your belt. What are you thinking in terms of timing for the next one?

In terms of the next one, we're thinking over the next month or two of going out in the market and doing another ABS transaction.

Got you, great. And you think that will come at a lower cost?

We do believe that it will. And what I would point to is if you look at the trading of our existing notes, they have traded inside where we initially priced those. So we do feel good about getting lower cost of funds in our next transaction.

Great, thanks for that. Also, I would like to follow up on these markets, Louisiana, Oklahoma, Tennessee, North Carolina. Those originations make up 14%. Are there caps on those markets? Or can you go to 30% there, as you are in Texas?

It varies by market, Rick. Some of them, certainly, can go to 30%, a couple of them maybe not quite as high. We'll definitely have increases over where they are today.

High 20%s or so in all of them at a minimum.

You mentioned 609 basis points opportunity with the yield by year-end 2018. Where do see that opportunity by year-end 2017? And how will that scale?

As Norm pointed out, we're just testing and piloting in one store right now. Our goal is to ramp up in Texas over the remainder of the year, so it depends on how quickly we're able to get all the systems and infrastructure and training in place, as what impact it could have this year.

And if by doing it -- when we highlighted it in the remarks, this program basically touches every part of the business, from marketing to the sales force to collections to our loan documents from a compliance standpoint. It is a fairly complex, complicated change and very focused on doing it, obviously, correctly and executing it well. Because we will have to do individually in the other four states, similar-type programs. They're all a little bit different but similar-type framework. And it will require different items in each of those elements from a business standpoint in those states as well. But Texas should give us the foundation and the game plan when we execute that well to be able to roll those other four states out in FY18.

Do you anticipate having Texas rolled out for the holiday season?

As we said in the remarks, we expect to have Texas completed by the fiscal year end, which for us would be the end of January. Having said that, we will be expanding the test. And as we sit here today, they were already running and it is not lost upon us, the revenue that is generated during the holiday period and the potential impact. The quicker we can get it rolled out properly, we understand what the benefit is of that. Our intention is and our communication is, it will be completed by the end of fiscal year, is our expectation as we sit here today.

Great. Thanks a lot and good luck.

Peter Keith, Piper Jaffray.

This is actually John on for Peter this morning. First off, you mentioned that the FY16 static loss rate should be better than both FY14 and FY15. However, based on the static loss table, it looks like it's running about 50 basis points higher year on year at this point. Given that not much of the refined underwriting model is included in that FY16 vintage, what gives you the confidence that will come in lower than FY15? And when should we really expect that to happen?

The two things that give us confidence is, number one, the balance remaining in the FY15 at the same point in its life, is less than where FY14 stands, and FY13, at the same point in life. There is less of the portfolio remaining at the same point in time.

The other point is when we look at static pool delinquencies by quarter for the FY16 vintage versus 2015, for the majority of the quarters -- and we're still waiting for Q4 two season a bit further -- but they are performing better than the FY15 static pool delinquencies. So delinquencies on a static pool basis, lower and less balance is ultimately losses will turn -- we expect to decline relative to the rate of FY15.

One other comment or add-on to it is even though the underwriting changes that we've talked about are really a FY17 -- the 700 basis points -- remember, it was in FY16 that we eliminated the low-end electronics products which represented about $15 million worth of revenue. And those were discontinued specifically to have an impact from a static loss rate. So we expect that, especially as you look at the fourth quarter there, as that seasons through, to have a positive impact versus FY15 as well.

As our follow-up, given that you guided the Q3 comp to minus high single-digit, would it be fair to say, looking at the Labor Day selling period, that came in a little bit lighter than you expected? Are there any callouts from that selling period that you could mention? And also, did you see any areas of strength or weakness in your geographies over that time period?

I really want to steer away from giving monthly guidance. I know we have done that historically. I want to stick to the quarterly. What I will say is, we are very confident at the guidance we that we've given, that where the performance is at now. Part of the reason I -- where the performance is at for August and September and the holiday period, where that's coming out at.

What I will highlight, again, is that when you look at the same-store sales break-out between the core stores, the new store single markets and the cannibalized markets, we are seeing -- that's where that impact is having. Those new markets continue to have a significant impact. That's what's driving the bigger piece of it.

Okay, thanks a lot, guys. Good luck in the second half.

David Magee, SunTrust.

Good to see the stabilization for this quarter. Couple of things. One is on the direct loan business, are there any added risks or potential downsides from that, that we didn't discuss today?

We brought up in the call very briefly, there is our ability to pursue a collection of customers that file bankruptcies a little bit different. And some other minor structural differences that will result in some offsets to that, which is where we got to the profit impact that we talked about earlier in Q&A.

And at 600 to 900 range, has that baked in there.

I see, okay. With regard to some of those newer stores, do you see any stores that need to be closed?

We really don't, David. It's one of the beautiful things about our retail model, is even the stores that are slower out of the gate, even if you look at FY17 that are getting the full impact of the underwriting changes, we're still seeing revenue build-ups at a pace that for the early ones out of FY17 that are now six months, beginning the seventh month in, starting to turn to four-wall EBITDA profitability.

It is a slower build than the four to six months we've had in the past. But I would say, and we've been very focused, I've been very focused on looking at our real estate. If we had something that wasn't profitable and we didn't think we could get it profitable, it would be something I would absolutely look at. But have a high confidence level, the stores that we're opening will be very, very profitable for us in the future.

Thank you, Norm. Lastly, the commentary, what with all the initiatives you have in place to improve the profit profile of the credit business, do you care to put any rough timeline on how long it takes to return to profitability? Is it a five-year process if all goes according to plan? Is it three years or potentially less than that?

David, this is Mike. I'd tell you that as we make changes, it takes about 18 months for those changes to really season in and bake into the portfolio performance. So as we get these loan program changes rolled out in Texas and in the four states we talked about and we continue to improve our underwriting, you can mark out six quarters after those and start baking into the portfolio.

It is not a five-year process, I'm certain.

Absolutely.

Before profitability, on the credit side of the house, which ultimately is where our expectation and our target is and what we believe is achievable. But we should see as FY18 evolves, continued traction in improvement from a profitability standpoint with the credit business.

Okay, great, thanks a lot.

I'm not showing any further questions at this time. I'd like to turn the call back over to Mr. Miller for closing remarks.

We appreciate everybody's attention and participation today. We look forward to speaking to you in the third quarter. Thank you.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.