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1 February 20, 2015 hhgregg Inc (HGG-NYSE) NEUTRAL Current Recommendation Prior Recommendation Underperform Date of Last Change 02/20/2015 Current Price (02/19/15) $6.71 Target Price $7.00 SUMMARY We are reverting to a Neutral recommendation on hhgregg from Underperform after the company delivered improved performance in the third quarter of fiscal Though it missed the Zacks Consensus Estimate for sales and reported wider-than-expected losses in the third quarter, gross margin increased after declining for many quarters. Comparable store (comp) sales declined 6.3% in the quarter. But the decline was narrower than a decline of 11.2% in the year-ago quarter, which signals that hhgregg is making efforts to improve sales, particularly in the consumer electronics and appliance businesses. E- commerce comps also witnessed a solid increase of 60% in the third quarter. Though the continued efforts have moderated the rate of comp sales decline, category sales are expected to remain in the red. Moreover, the company expects continued volatility within the consumer electronics industry in the upcoming quarters. SUMMARY DATA 52-Week High $ Week Low $4.83 One-Year Return (%) Beta 1.43 Average Daily Volume (sh) 232,059 Shares Outstanding (mil) 28 Market Capitalization ($mil) $188 Short Interest Ratio (days) Institutional Ownership (%) 96 Insider Ownership (%) 60 Risk Level * High, Type of Stock Small-Value Industry Retail-Cons Elc Zacks Industry Rank * 172 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Jun) (Sep) (Dec) (Mar) (Mar) Annual Cash Dividend $0.00 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 6.5 Earnings Per Share (%) Dividend (%) using TTM EPS using 2015 Estimate using 2016 Estimate A 588 A 800 A 598 A 2,475 A A 568 A 707 A 538 A 2,339 A A 506 A 666 A 500 E 2,144 E E 505 E 665 E 485 E 2,122 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Jun) (Sep) (Dec) (Mar) (Mar) $0.19 A $0.11 A $0.52 A $0.31 A $0.75 A $0.04 A $0.12 A $0.17 A -$0.17 A $0.09 A $0.36 A -$0.37 A -$0.14 A -$0.23 E -$1.10 E $0.28 E -$0.31 E -$0.01 E -$0.18 E -$0.78 E Zacks Rank *: Short Term 1 3 months outlook 3 - Hold Projected EPS Growth - Next 5 Years % 9 * Definition / Disclosure on last page *Note: Actual quarters may not add up to annual year Zacks Investment Research, All Rights reserved North Canal Street, Chicago IL 60606

2 OVERVIEW hhgregg Inc (HGG) is a specialty retailer of home appliances, televisions, computers, consumer electronics, home entertainment furniture, mattresses, fitness equipment and related services. As of Dec 2014, the company had 228 stores located in Alabama, Delaware, Florida, Georgia, Illinois, Indiana, Kentucky, Louisiana, Maryland, Mississippi, Missouri, New Jersey, North Carolina, Ohio, Pennsylvania, South Carolina, Tennessee, Virginia, West Virginia, and Wisconsin. The company operates through four product categories. Appliances: The category comprises major appliances, including the latest generation refrigerators, cooking ranges, dishwashers, freezers, washers and dryers. Consumer Electronics: The category includes accessories, audio, personal electronics and televisions. Computing and Wireless: The category involves computers, mobile phones and tablets. Home Products: It primarily consists of fitness equipment, furniture and mattresses. REASONS TO BUY Improvement in Third Quarter Fiscal 2015: hhgregg delivered improved performance in the third quarter of fiscal Though it missed the Zacks Consensus Estimate for sales and reported widerthan-expected losses in the third quarter, gross margin increased after declining for many quarters. Comparable store (comp) sales declined 6.3% in the quarter. But the decline was narrower than a decline of 11.2% in the year-ago quarter, which signals that hhgregg is making efforts to improve sales, particularly in the consumer electronics and appliance businesses. E-commerce comps also witnessed a solid increase of 60% in the third quarter. Initiatives to Revive Business: hhgregg is leaving no stone unturned to revive its struggling business. Product innovation, discounts and promotional offers, improvement in home-delivery facilities, focus on developing brands, exit from underperforming businesses and store openings are some of the measures taken by the company to boost sales. During the first half of fiscal year 2015, the company remained focused on executing key initiatives to strengthen its infrastructure, improving in large screen televisions, improving the cost structure to enhance operational efficiencies, improving e-commerce capabilities and enhancing merchandising assortment toward appliances and other home products. In addition to the above investments, the company has exited the mobile and fitness businesses and has utilized this space for the addition of new furniture vendors in the first half of fiscal 2015 to enhance the home category. hhgregg continues to expect the home products categories, specifically furniture, to be a growth opportunity for the business in the upcoming quarters. In fiscal 2015, the company also worked on management changes in order to improve operational efficiencies and cost reduction and to improve overall performance of the company. This transition is on and is expected to deliver improved results over the near term. Innovation in the Consumer Electronic Business: The consumer electronic business has been facing sluggish comparable store sales since the last few quarters. However, owing to the improving mix with larger screen sizes and 4K ultra high definition TVs during the holidays, hhgregg witnessed improvements in the consumer electronics category. In fact, the comps decline was less than half of what it had been over the prior 11 quarters. During the third quarter of fiscal 2015, 4K ultra high definition televisions accounted for over 26% of the total television sales, which was higher than Equity Research HGG Page 2

3 industry average. These larger and more premium televisions also carry a higher margin rate, which also benefits the company, as demand for such televisions are rising. The industry currently expects to fill 4 million units of 4K televisions in calendar 2015 compared to just 1 million units in 2014 while the forecast for calendar 2016 is 10 million units. hhgregg will also continue to focus on innovations, like 4K ultra high definition, curve TVs and OLED TVs to further gain from the television business. Growing E-Commerce Business: hhgregg has been focusing on its e-commerce business. The company has invested in infrastructure upgrades, additional web application capabilities, and expansion of the assortment, along with a new mobile app prior to the holiday season. The company s e-commerce sales increased 62% during the first half of fiscal 2015, as the company rolled out its new point of sale system. The system will enhance the in-store customer experience and provide operational improvements, customer service improvements and a streamlined checkout process to help the e-commerce business grow further. REASONS TO SELL Declining Comparable Store Sales: hhgregg has been posting declining comps since the fourth quarter of fiscal 2012, mainly due to declines in the consumer electronics category. Though the company has witnessed an increase in sales of larger screen and more premium featured televisions, the decline in unit demand is hurting sales of this category. Moreover, category sales are expected to remain in the red and the company expects continued volatility within the consumer electronics industry in the upcoming quarters. Besides consumer electronics, the company is also witnessing sluggishness in comps in the computing and wireless category since the past seven quarters. The weak comps were the result of a decrease in demand for laptops and computers and lower average selling price for computers and tablets. Category comps were also negatively impacted due to the underperforming contract-based mobile phone business, which the company exited during the fourth quarter of fiscal The appliance category, after posting higher comps for many quarters, declined in the first two quarters of fiscal 2015 and remained flat in the third one. Lower units sold and a highly promotional environment led to the decline. The appliance industry is becoming more promotional as more retailers attempt to capture market share. The company has been employing initiatives to drive sales and improve comps but a continued positive trend is yet to be seen, given the industry weakness. Moreover, the company expects fiscal 2015 comparable store sales to be in negative high-single digits to negative mid-single digits as against the previous expectation of negative low single-digits to flat. Continuously Evolving Industry: The consumer electronics industry is very demanding and depends on new products to drive sales and profitability. The company remains highly dependent on its ability to anticipate and respond in a timely manner to consumer trends relating to major household appliances and consumer electronics products. These merchandises are prone to major technological changes and pricing limitations. The company generally introduces its new heavilyfeatured products at relatively high price points and over time, price points are gradually reduced to drive consumption, which hurts profitability of the company. Equity Research HGG Page 3

4 RECENT NEWS hhgregg's Third Quarter Loss Wider than Expected as Comps Decline January 30, 2015 hhgregg reported a loss of $0.14 per share in the third quarter fiscal 2015, as against prior year earnings of $0.17 per share, and wider than the Zacks Consensus Estimate of a loss of $0.04. The loss was primarily due to a drop in comparable store (comp) sales, slightly offset by an increase in gross margin. Quarter in Detail As announced in its preliminary results on Jan 7, hhgregg reported net sales of $665.6 million. Sales lagged the Zacks Consensus Estimate of $671 million and decreased 5.9% year over year due to a decline of 6.3% in comps. Comp sales declined in all categories in the quarter, except the appliance category where it remained flat. The company s e-commerce business is an exception as its comparable sales witnessed a solid increase of 60% in the third quarter. We note that the comparable store sales decline of 6.3% in the quarter is narrower than a decline of 11.2% in the year-ago quarter, which signals that hhgregg is making efforts to improve sales, particularly in the consumer electronics and appliance businesses. However, the company needs to increase the rate of progress. Adjusted gross margin improved 20 basis points to 27.0% in the quarter owing to a favorable product sales mix shift to categories carrying higher gross profit margin rates and higher gross profit margins in the video category. Video category margins increased due to an increase in sales of larger screen and more premium featured televisions. However, selling, general and administrative (SG&A) expense ratio increased 120 basis points to 19.9% due to an increase in occupancy costs, consulting expense and increase in home delivery expenses. Net advertising expense ratio also increased 60 basis points to 5.8% due to the deleveraging effect of the net sales decline and an increase in advertising spend. The increase in SG&A expenses and advertising expenses led to an increase in operating losses. Operating loss margin was 0.3%, compared with a profit margin of 1.3% in the last year quarter. Share Repurchase Update During the quarter, hhgregg repurchased 732,805 shares for $4.3 million under the company s share repurchase program of $40 million, which will expire on May 20, At the end of Dec 31, the company had approximately $34.7 million worth of shares available for repurchase under the current share repurchase program. Category Details The company reports its business under the following product categories: Appliances: Comparable store sales in this category were almost flat with no changes in average selling price or unit demand. Last year, comp sales had increased 1.5%. Computers and Tablets Category: Same store sales in this category declined significantly by 35% in the quarter as against growth of 24.5% in the last year quarter. The decline was due to a decrease in unit demand for computers and tablets as well as a decrease in average selling prices for computers and tablets and the exit from contract-based mobile phone business. Excluding mobile phones, the decrease in comparable sales for the three months ended Dec 31, 2014 for the computers and tablets category was 29.6%. Equity Research HGG Page 4

5 Home Products: Same store sales in this category declined 9.2% in the quarter compared with 36.1% growth in the prior year quarter. The decline was largely due to the exit from fitness equipment. A double digit decrease in demand for TV stands, recliner and sofa products also led to the decline, offset slightly by increased average selling prices for nearly all product lines within this category and increased unit demand within mattresses. Excluding fitness equipment, the decrease in comparable store sales in the category was 2.7%. Consumer Electronics: Same store sales of this category declined 3.9% in the quarter. The decline was due to a double digit decrease in units sold within the video category, offset slightly by an increase in average selling price. The hike in average selling price was driven by an increase in sales of larger screen and more premium featured televisions. However, the decline was narrower than a 19.7% decline recorded in the year-ago quarter. Outlook The company stated that it does not expect to close any store location in fiscal Also, considering some non-cash charges and uncertain market conditions, the company has withdrawn its fiscal year 2015 EBITDA outlook. VALUATION At the end of the third quarter of fiscal 2015, the P/B multiple of the stock was approximately 0.8x, which is at 46.7% discount to the industry average of 1.5x. On a P/B basis, the price target of $5.5 is based on a P/B multiple of approximately 0.99x. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low HHGREGG INC (HGG) NA 6.4 Industry Average S&P AARONS INC (AAN) RADIOSHACK CORP (RSHCQ) CONNS INC (CONN) YOSEN GROUP INC (YOSN) TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA HHGREGG INC (HGG) Industry Average NA S&P Equity Research HGG Page 5

6 Earnings Surprise and Estimate Revision History Equity Research HGG Page 6

7 DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of HGG. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1005 companies covered: Outperform %, Neutral %, Underperform 7.6%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Research Analyst Copy Editor Content Ed. QCA Lead Analyst Reason for Update Sneha Nahata Debasmita Banerjee Shikha Kansal Kinjel Shah Sneha Nahata 3Q15 Earnings Equity Research HGG Page 7