Bluestem Group Inc. Second Quarter 2017 Earnings Results Call. September 13, 2017

Transcription

1 Bluestem Group Inc. Second Quarter 2017 Earnings Results Call September 13, 2017

2 C O R P O R A T E P A R T I C I P A N T S Gene Davis, Executive Chairman of the Board Steve Nave, President, Chief Executive Officer Pete Michielutti, Executive Vice President, Chief Financial Officer Andy Spicher, Vice President, Corporate Development and Investor Relation C O N F E R E N C E C A L L P A R T I C I P A N T S Andrew Gadlin, Odeon Capital Group Andrew Shannahan, Knighthead P R E S E N T A T I O N Operator: Greetings, and welcome to the Bluestem Group Inc., Second Quarter 2017 Earnings Results Call. At this time, all participants are in a listen-only mode. As a reminder, this conference call is being recorded. It is now my pleasure to introduce your host, Mr. Andy Spicher, Vice President of Corporate Development and Investor Relations at Bluestem. Please go ahead, sir. Andy Spicher: Good morning, everyone, and thank you for joining us on our second quarter earnings call. Before we get started, I would like to point out that today s presentation may be found on our Investor Relations page at bluestem.com. If you haven t already, you can find it there while I run through the forward-looking statement. I need to remind you that during the course of today s presentation, various remarks we make about expectations for our Company and other statements that make use of forward-looking words such as may, expect, believe, or similar expressions constitute forward-looking statements. Actual results may vary materially from those contained in the forward-looking statements based on a number of factors. Also in today s presentation, we supplement historical financial data derived from Bluestem s financial statements, which are prepared in accordance with GAAP, by use of non-gaap performance measures including contribution margin, adjusted G&A expenses, Adjusted EBITDA, and lender Adjusted EBITDA. Please refer to the press release document available on our website at for further information. With that, I will now turn the call over to Gene Davis, our Company s Executive Chairman. 1

3 Gene Davis: Thanks, Andy, and thanks, everyone, for joining us on the call this morning to discuss our Company s second quarter financial results. Leading today s discussion is Steve Nave, our President and CEO, and Pete Michielutti, our Executive Vice President and CFO. As we ve discussed, starting with our fourth quarter earnings call, our Company faced significant headwinds in the back half of 2016 which led to the decision to begin an aggressive turnaround plan in the fourth quarter designed to stabilize financial results and drive improved financial results. The Board is very pleased with our progress to date and the second quarter results reinforce our belief that we re taking the appropriate actions to ensure the sustainable long-term profitability of the Company. Steve and Pete will walk you through our second quarter results and progress regarding our turnaround plan as part of today s discussion. As always, we ll set aside time at the end of the call to take your questions. With that, I ll turn the call over to Steve. Thanks, Gene, and thanks, everybody, for joining us today. Before I get started, I want to take a moment to formally introduce our new Chief Financial Officer, Pete Michielutti. Pete joins us most recently from Christopher & Banks, where he served as their Chief Financial Officer and Chief Operating Officer. Pete s been on board now for about seven weeks, and we consider ourselves very lucky to have him on the team. Okay, so let s get started on Page 3 of the presentation. Overall, I m pleased with our second quarter results and the positive momentum we re seeing so far in the third quarter, as well as the progress we re making on the turnaround efforts, which are running ahead of plan. We re successfully driving costs out of the business, stabilizing the credit portfolio and improving inventory productivity while preserving top line sales in a very tough retail environment. Northstar sales were strong in the quarter despite the tightening of our credit risk underwriting and a substantial reduction in inventory levels. Orchard sales were not as strong in the quarter, but we re very excited about promising new assortment strategies we re piloting for the fall within the Orchard portfolio. As part of our decision to exit non-core businesses, we ve begun to wind down the LinenSource brand and we expect to complete the liquidation of the LinenSource inventory here in the third quarter. Next, I ll cover a few more specifics about the turnaround plan, starting with initiatives to drive cost out of the business. We continue to actively pursue new savings opportunities and have increased our estimated 2017 in-year savings to above the $50 million mark we shared last quarter. As a reminder, roughly $30 million of the total 2017 savings came from the workforce reductions completed in March, and the remainder is a mix of improvements in our cost of goods sold, marketing investment efficiencies, and reductions to other indirect G&A expenses. The majority of the non-headcount related savings will be realized in the third and fourth quarters of this year, and again, we feel very good about how these opportunities are ramping up. As I mentioned earlier, we re starting to see some promising signs of stabilization in the credit portfolio. Although the 30-plus delinquency and loss rates are still higher year-over-year, we re beginning to see some positive trends that Pete will discuss in more detail. Importantly, new 2017 vintages continue to demonstrate improved delinquency levels compared to prior year vintages. As I ve mentioned in the past, the process of improving the portfolio performance is a multi-year commitment, but underwriting adjustments we ve made are starting to yield the expected results. Another area of focus within our turnaround strategy is our migration to a true e-commerce site merchandising execution model. This migration will enable us to improve our site experience and 2

4 dramatically shorten the cycle times for reacting to a multitude of site performance metrics. This is improving our ability to maximize the return from each customer visit to our website. We are on schedule to begin the migration of the Orchard portfolio to the Bluestem commerce platform in the first quarter of As we noted last quarter, Fingerhut experienced a significant increase in site effectiveness following conversion to that platform. Turning to Slide 4 and the business headlines, our sales for the quarter were $438.9 million, down 6.2% on a year-over-year basis. Comparatively, sales excluding exited businesses declined only 2.5% to $431 million. As a reminder, exited businesses include the PayCheck Direct business, the Draper s & Damon s retail stores, and the Solutions and LinenSource brands. Bluestem Group cash and cash equivalents were $129.1 million compared to $115.8 million at the end of the first quarter. Net liquidity ended the quarter at $66.3 million, well above our liquidity covenant requirement of $40 million. As Gene noted, overall, we are pleased with the progress to date on the turnaround plan. The second quarter results provided a comfortable covenant cushion, and although we are not providing formal guidance at this time, I will say that I m very confident that our performance will produce similar covenant cushions in the third and fourth quarters. As a reminder, the second and third quarters represent our most stressed financial quarters in the year due to the seasonally higher credit losses in these periods associated with sales from the previous year s holiday season. I ll now hand things over to Pete to cover the financial results in more detail. Thank you, Steve, and good morning, everyone. Thank you, all, for joining us. I m excited to be part of the team during this pivotal time for the Company. I look forward to meeting all of our constituents as we share our continued progress on executing our turnaround plan. Starting on Slide 5 of the presentation materials, I ll walk you through the second quarter GAAP P&L for Bluestem Brands Inc. Net sales decreased 6.2% year-over-year compared to the second quarter of At the portfolio level, Northstar s second quarter net sales decreased 0.7% to $121.1 million while Orchard portfolio sales decreased 9.5% to $204.9 million. As Steve mentioned earlier, Bluestem s comparable sales in the quarter decreased by 2.5%. The gross profit rate decreased by 30 basis points to 47.9% due to a 200 basis point decrease in the Orchard portfolio gross profit resulting from higher shipping expense and increased inventory obsolescence, and this was partially offset by a 130 basis point increase in the Northstar portfolio gross margin primarily due to lower product returns, fulfillment expense and obsolescence. We are pleased with the significantly improved gross margin trend from the first quarter, which saw a 220 basis point yearover-year decrease. Sales and marketing expense decreased by 220 basis points or 13.6% due to reduced acquisition catalog volume in both portfolios and reduced television spend at Fingerhut. Net selling margin improved by 190 basis points as compared to the second quarter of 2016 as a result of the improved sales and marketing expense, partially offset by the slight gross margin decline. Bluestem s net credit expense increased 250 basis points year-over-year due to higher revolving portfolio losses. As Steve noted, although we continue to experience increased losses in the portfolio, new 2017 vintages are demonstrating improved delinquency performance. Adjusted G&A expenses decreased $1.6 million primarily due to reduced compensation and benefit expenses resulting from the marked reduction in force, partially offset by increased incentive 3

5 compensation. I wanted to note that the second quarter 2016 included an accrual reversal of $1.6 million for incentive compensation while the second quarter of 2017 includes an accrual of $3.7 million for incentive compensation, consistent with our revised bonus structure. On Slide 6 of the deck, net sales for the Northstar portfolio decreased $1.6 million or less than 1% compared to the second quarter of Strong customer catalog response, increased website conversion rates, and lower product returns largely offset the negative sales impact from the reduced acquisition catalog circulation. Overall, we are very pleased with the continued strong response by the Fingerhut customer. As previously discussed, we have lowered new customer acquisition circulation as part of our strategy to tighten credit underwriting in response to the negative impact of the increased subprime credit supply. Northstar contribution margin was down 180 basis points over Q As mentioned earlier, gross margin was up 130 basis points primarily due to lower product returns, fulfillment expense, and obsolescence, while sales and marketing expense as a percentage of net sales was down 300 basis points as a result of lower acquisition catalog circulation and reduced television advertising in the quarter. As a result, net selling margin was up 430 basis points year-over-year. We continue to manage our marketing investments very tightly, utilizing positive net selling margin dollars to offset the impact of higher credit losses in the credit portfolio, which I ll discuss in more detail on the next slide. Turning to Slide 7, we believe that SCUSA portfolio performance continues to be negatively impacted by the increased supply of third party general purpose credit and increased general purpose obligations. However, we were pleased to see the portfolio performance trends begin to reflect the positive impact resulting from credit underwriting adjustments completed over the last 12 months. Our early reads on 2017 vintages continue to demonstrate improved delinquency rates compared to last year due to a higher proportion of new customers coming from our solicited selection process, which historically had better credit performance than unsolicited customers. Stabilization of the portfolio performance has gained momentum in the first half of this year with a 30-plus delinquency rate of 18.2%, 50 basis points higher than last year, while the first quarter s 30-plus delinquency rate was 100 basis points worse year-over-year. As we look to the second half of the year, we anticipate continued improvement related to new fraud detection tools implemented late in the second quarter as well as additional tools to be implemented prior to holiday. Risk-adjusted margin for the merchant fee was down 390 basis points from Q with net credit revenues down 150 basis points due to higher charge-offs of finance charges and fees and lower billed late fee yield. Turning to the next slide, the Orchard portfolio net sales for the second quarter were down 9.5% to $204.9 million compared primarily due to lower sales resulting from reduced new customer acquisition catalog circulation combined with the exiting of the Solutions and the Draper s & Damon s retail businesses. Orchard portfolio comparable sales decreased by 7.2% in the quarter. As Steve mentioned earlier, enhancements to the assortment strategy we re piloting in one of the brand segments are showing positive early results. More to come in this area next quarter as we get further sales results in on the new fall assortment. Gross margin rate for the Orchard portfolio decreased by 200 basis points compared to the second quarter of 2016 due to the increased shipping and fulfillment expenses combined with an increase in inventory obsolescence. Turning to our last slide, Number 9, selected balance sheet and covenant compliance information, we continue to make progress managing our inventory levels, ending the quarter with $183 million in merchandising inventories, a 27.8% decrease from last year. Inventory turnover of 3.2 times in Q

6 increased compared to 3.1 in Q and the dropship penetration for our Northstar portfolio increased from 29.9% in the second quarter last year to 40% in the second quarter this year. Our expectation is that we will continue to see lower inventory levels throughout the year. We ended the quarter with a lender leverage ratio of 3.84, well under the covenant requirement of 4.5, which reflects Q2 last 12-months lender Adjusted EBITDA of $128 million compared to lender ratio debit of $491.5 million. We ended the quarter with lender liquidity of $66.3 million compared to the covenant requirement of $40 million, which reflects $3.9 million of cash and $62.4 million of revolving credit line availability. Leverage ratio debt decreased by $76.6 million or 13.5% from the end of the second quarter last year to $491.5 million. As Steve indicated earlier, we are highly encouraged by the turnaround efforts to date and the associated financial performance in the quarter, and feel good about momentum in the third quarter. That said, we still have a long process ahead of us to improve the credit portfolio performance and return to profitable growth. We believe that we are executing the correct plan to achieve these goals. With that, I will turn it over for Q&A. Gene Davis: Operator, are you with us? Operator: Yes. If you would like to ask a question, please press star, one on your phone at this time. If you re on a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, that s star, one if you would like to ask a question. We ll pause for just a moment to assemble the queue. Our first question will come from Andrew Gadlin with Odeon Capital. Hi, good morning. I was wondering if you guys could review Holdco assets again; cash, real estate, any other assets; and then the second part of that question is if you subtract the Bluestem Brands balance sheet from the Bluestem Group s balance sheet, you re left with negative liabilities, and I was wondering if you could explain what that is and whether those really (inaudible) assets. Thanks. Sure. The primary assets left at the Holdco at the end of the quarter will be some real estate, residual real estate assets as well as (inaudible) primary cash and then the remaining PayCheck Direct receivables, which are in the process of being collected, I would say, at a pace at or above what we originally anticipated from the original sale. As it relates to the negative liabilities between the inventory between the two balance sheets, I m going to have to I ll get back to you with a specific answer on that. I don t have the schedule in front of me that shows that. The cash balance is, what, about $120 million at Holdco? Yes. 5

7 How much is the real estate on the books? I think we re thinking the net value of the real estate is about $13.5 million $9.4 million. Nine-point-four? Yes. That s expected to be liquidated by the end of this calendar year or next, is that right? The majority of it, yes; but probably some of it is going to go into next year. Then the other asset is the PayCheck Direct receivables. How much is that on the balance sheet? I think, at the end of the quarter, it was approximately 20, and that s going to continue to get liquidated over the next 12 months. It s paying down right now at about a clip of $3.5 million a month of cash that s coming in on that. That will slow down with the tail on the collections. Twenty million dollars is the face amount or that s where you re estimating the fair market value of what you ll actually collect? That is the face amount, so the collections the actual collections we believe will be higher than that in order to get a proper return into the Holdco. Got it, okay. Any other assets? Is there any term loan held at the Holdco? No. 6

8 Okay, thanks. Then a couple other questions, just about the broader environment. How does the recent Equifax breach affect the Company, if it does? Yes, we re still hey, Andrew, it s good to hear from you, this is Steve. We re still trying to diagnose that, so obviously consumers are going to respond not great to that situation and we re going through our customer files right now to try to understand a better view of any fraudulent activity or anything like that, accounts being opened without consent, things like that. We feel like we well, we know we have very tight processes around that, but it s given us an opportunity to take a much closer look at it, just to make sure that things are continuing to be as buttoned up as they had been in the past. That s a pretty fluid issue right now, but believe me when I say it s got all of our attention. Have you found any fraudulent activity yet? Not at this point, no. Okay. Then in terms of the recent hurricanes in Texas and Florida, those are obviously very large markets and there s some competition from store-based retail that has a similar strategy in some ways to Fingerhut, and I was wondering, have you thought about the unfortunate circumstances there and does that affect the Company, one way or the other? Yes, so that s a great question. We are watching that really closely. On the Northstar side, obviously our concern right now is around the portfolio that we have in those states and what s going to happen to collections. We ve basically adopted all the same general standards that other issuing banks have adopted, where we ve ceased collections activities and calls and things like that for the time being, so the downside there is something that we re keeping a close eye on and it s just still too early to know, right, because you re starting to see a dip in repayment rates in those areas, but what we don t know yet is how much of that is distraction from the really unfortunate event versus an ability to pay, so it s something that we re watching really closely. It will obviously also affect our line increase strategies in those areas, just to make sure that we re suspending those and not going further than we should in an area that s got basically a lot of noise and disruption in it. Then, on the other side of what s going on in those states, we are thinking about how we can be more helpful to customers in those areas that have that are basically going to have a need that they weren t expecting, while also being really responsible about credit. Obviously the Orchard portfolio is very well positioned with its core customer demographic as being a little bit older for the State of Florida, for example, so it s something that we re watching really closely. It is still way too early to understand what the impacts are, both on the upside or the downside, but we are trying to figure out how we can be there for those customers or consumers that haven t yet shopped through our brands. Got it, and then just a final leverage question. What are the covenants are there any changes to the covenants (inaudible) lender leverage to the program agreement next year? 7

9 No, they re all fixed at this point. Okay, thank you very much. You re welcome. Operator: Again, that s star, one if you would like to ask a question. We ll go next to Andrew Shannahan with Knighthead. Andrew Shannahan: Hi, two quick questions. When you look at the inventory decrease from the beginning of the year, how much of that inventory decrease was driven by businesses that were closed, or lines of business that were closed, PayCheck and Linens and Draper s, and how much of that was actually a reduction in inventories in the existing, continuing-to-operate businesses? Hey Andrew, that s a good question. I ll let I ll see if Pete has the specific numbers in front of him, but I can tell you the vast majority has nothing to do with the business closures. The businesses that we closed on a relative basis were not really that big, quite frankly, so PayCheck Direct was the biggest. It was about a I think about a $75 million annual top line business. It shared inventory with the Northstar portfolio, so the impact on inventory of eliminating the PayCheck Direct business was pretty insignificant. The Draper s & Damon s retail stores would have probably had the biggest impact on the inventory reduction, and I don t know the number off the top of my head but it can t be significant it can t be significant to the overall reduction. LinenSource and Solutions inventory levels were rounding errors, quite frankly, to the overall. But I don t know, Pete, if you have the actual numbers in front of you, by any chance? I do not have the actual numbers, but I ll I would imagine 75% of the decrease, or maybe even higher, is associated to changes that we ve made to the business as opposed to business that we ve exited. Andrew Shannahan: Since we had some fulfillment issues kind of Q3, Q4 in some of the Orchard portfolios, what changes did we make that will allow for us to hit our target fulfillment but operate with a much lower inventory? Yes, so we have fully centralized inventory management across the entire enterprise at this point, and we re not where we need to be yet from a fully integrated systems perspective. That s a high priority that s being worked on right now, but we have put in standardized processes across the entire enterprise that are yielding quite a bit of benefit. I feel like we re in pretty good shape in terms of managing 8

10 inventory and making sure we ve got the right products at the right time, so I wouldn t expect to see the same level or I wouldn t expect to see disruption like we saw last year as a result of that. Andrew Shannahan: Then, one last question. You were saying that 2017 vintage portfolio was performing better than the historical. Two questions; what s the average kind of life of our portfolio assets, meaning are we giving people 18-month payment terms, 36-month payment terms? Kind of when I look at a vintage, how long does that go out for? Then two, is there any way to put some kind of statistics on, or rough numbers on the 2017 performance, meaning are we 200 basis points lower on 30-day delinquencies and 200 basis points lower on ultimate charge-offs and slightly better on rate, or kind of how are we supposed to think of that improvement relative to the last set of specifics we saw for this quarter? Yes, sure. I ll let Pete give you those specific data points, but I ll tell but just keep in mind, when you talk about the life of the portfolio or the life of the accounts, keep in mind that we re the vast majority, in probably 95% of the portfolio range is a revolving portfolio, so there s not really a life associated with it because customers are constantly making repurchases and paying down the bill and making repurchases. You can t really look at the portfolio that way, that would be you d look at an installmentbased portfolio, and the only installment portfolio we have is the Fresh Start portfolio, which I believe is around a $40 million portfolio, kind of in that ballpark, out of a total of roughly $1.4 billion, so not even a rounding error. I ll let Pete get you the specific details on the metrics you re asking for. Sure. Obviously the (inaudible) hasn t approached charge-offs at this point in time, so some of the things that we look at relative to year-over-year is credit scores and behavior scores on the portfolio, and all of the 17 vintages are performing at higher credit scores than the vintages from the prior year. The 30-plus delinquency is lower than the prior year. I m just it s 200 to 300 to 400 basis points. Expected chargeoffs are going to be down, we think, in the same range, but it s early. It s really early in the life cycle, but all of the metrics that we use relative to comparing it to the prior periods are favorable at this point in time. Andrew Shannahan: Okay, super helpful. Thank you, guys. Operator: That ends our question-and-answer session for today. I d like to turn it back to Mr. Gene Davis for closing remarks. Gene Davis: Okay, thank you. I d like to thank everyone for joining us today and for your past and future support of the Company. We look forward to speaking to you again December, reporting our third quarter performance. Operator, you can disconnect the call. Thanks, again, everybody, bye-bye. Operator: That does conclude today s conference. Thank you all for your participation. You may now disconnect. 9