Conn’s Swings to Losses on Higher Costs and Bad Debts

Retailer revises methods for calculating estimates related to allowance for doubtful accounts

c1Durable goods retailer Conn’s Inc. (NASDAQ: CONN) reported its Q2 FY17 financial results on September 8th, 2016.

The Woodlands, Texas-based Company operates over 110 retail locations in Arizona, Colorado, Georgia, Louisiana, Mississippi, Nevada, New Mexico, North Carolina, Oklahoma, South Carolina, Tennessee, and Texas.

It operates through two segments: Retail and Credit. The company’s stores provide home appliances, furniture and related accessories, home office products, and consumer electronics. Conn’s also provides repair service agreements, installment credit plans, and various credit insurance products. Unlike its competitors such as Best Buy Co. Inc. (NYSE: BBY) and Bed Bath & Beyond Inc. (NASDAQ: BBBY), Conn’s provides flexible in-house credit options for its customers in addition to third-party financing programs and third-party rent-to-own payment plans. Read more about Conn’s financial results below.

Q2 FY17 financial highlights

During Q2 FY17, Conn’s total revenues inched up to $398.15 million from $396.05 million in the year-ago period. On the other hand, total costs and expenses ballooned to $391.80 million from $359.95 million in the year-ago period. On account of provisions for bad debts and credits, operating income nosedived to $6.3 million in the reporting quarter from $36.09 million in the year-ago period. Interest expenses also increased to $24.1 million from $10.05 million in the year-ago period.

As a result, Conn’s swung to a net loss of $11.9 million, or $0.39 loss per diluted share, in Q2 FY17, compared to net earnings of $16.5 million, or $0.45 earnings per diluted share, for the prior-year quarter. On a non-GAAP basis, adjusted net loss for the quarter was $1.2 million, or $0.04 adjusted loss per diluted share, which excludes charges and credits and the impact of changes in estimates. This compares to adjusted net earnings for the prior-year quarter of $17.2 million, or $0.47 adjusted earnings per diluted share, which excludes charges and credits.

c2During Q2 FY17, the Company revised its methods for calculating its estimates related to the allowance for doubtful accounts, allowances for no-interest option credit programs, and deferred interest. To turn around its credit business, the Company refined its underwriting model and improved infrastructure to produce consistent and predictable earnings. The Company also plans to reduce the number of new stores over the next two years. Furthermore, Conn’s developed a cost mitigation plan, which is expected to offset planned increases in its selling, general, and administrative (SG&A) budget by about $10 million over the remainder of FY17.

Segmental highlights

Retail: During Q2 FY17, Conn’s retail revenues grew 2.1% to $332.4 million due to new store openings, partially offset by a decline in same store sales. Excluding the impact of its decision to exit video game products, digital cameras and certain tablets, same store sales for the quarter fell 4.6%. Sales growth was also impacted by underwriting changes made in Q4 FY16 and Q1 FY17. During the reporting quarter, retail gross margin expanded 130 basis points from Q1 FY17.

During Q2 FY17, Conn’s retail operating income was $35.7 million, and adjusted operating income was $38.6 million, after excluding net charges of $2.9 million primarily associated with impairments from disposals, legal and professional fees related to its securities-related litigation, charges for severance and transition costs due to changes in the executive management team.

Credit: During Q2 FY17, Conn’s credit revenues fell 6.7% to $65.7 million. The decline was mainly 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 option credit programs and deferred interest. These declines were partially offset by an 8.7% growth in the average balance of the customer receivable portfolio. Excluding the impact of changes in estimates, yield was up 10 basis points as compared to the prior year period. The total customer portfolio balance was $1.5 billion at July 31st, 2016, rising 6.4%, or $92.4 million, from the comparable period last year. Provision for bad debts for H2 FY17 was $60.1 million, an increase of $8.7 million from the same prior-year period.

Other highlights

Direct loan program: During Q2 FY17, Conn’s received regulatory licenses in the state of Texas that is required to offer direct loans at higher annual percentage rate (APR) to customers financed through its in-house credit offering. The direct loan program is expected to be implemented across all 55 Texas locations by the end of FY17. The state of Texas represents Conn’s strongest markets, accounting for approximately 70% of its recent originations, which had a maximum equivalent APR of about 21%, compared to 30% under its new direct loan program. Additionally, the Company is working for a regulatory framework to raise APR in other states that represent 14% of its originations.

Store updates: During Q2 FY17, the Company opened four new Conn’s HomePlus stores each in North Carolina, Mississippi, Tennessee, and Alabama, bringing the total store count to 112. Conn’s plans to open 1 additional store during FY17 for a total of 10 new stores this year. For FY18, the Company has only committed to opening only three new locations.

Liquidity and capital resources: As of July 31st, 2016, the Company had $97.7 million of borrowing capacity under its $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. The Company also had $15.5 million of unrestricted cash available for use.

Guidance for full year FY17

For Q3 FY17, the Company expects same store sales to decline by high single-digits and retail gross margin to come in between 36.50% and 37.25% of total net sales. SG&A expenses are predicted between 29.25% and 29.90% of total revenues, provision for bad debts between 14.25% and 15.25% of the average total customer portfolio balance (annualized), and credit segment finance charges and other revenues between 18.25% and 18.75% of the average total customer portfolio balance (annualized). Conn’s forecasts interest expenses between $24.5 million and $26.5 million during Q3 FY17.

Stock Performance

c3Conn’s stock ended the day at $11.88, jumping 16.93%, at the close on Wednesday, September 21st, 2016, having vacillated between an intraday high of $12.41 and a low of $11.26 during the session. The stock’s trading volume was at 5,527,819 for the day. The Company’s market cap was at $347.97 million as of Wednesday’s close.

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