Bluestem Group Inc. Third Quarter 2017 Earnings Results Call December 21, 2017
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 P R E S E N T A T I O N Operator: Greetings and welcome to the Bluestem Group Inc. Third Quarter 2017 Earnings Results Call. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Andy Spicher, Vice President of Corporate Development and Investor Relations of Bluestem. Please go ahead, sir. Andy Spicher: Good morning everyone and thank you for joining us on our third quarter earnings call. Before we get started, I would like to point out that today s presentation can 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 www.bluestem.com for further information. With that, I will now turn the call over to Gene Davis, our company s Executive Chairman. Gene Davis: Thanks, Andy, and thanks everyone for joining us on the call this morning to discuss our third quarter financial results. Leading today s discussion is Steve Nave, our President and CEO, and Pete Michielutti, our CFO. 1
We are very pleased with the progress we have made over the last several quarters on our turnaround plan to stabilize our performance and drive improved financial results. Our performance in the third quarter illustrates that we re taking the right actions to ensure that we can create sustainable, long term profitability for the Company. Steve and team will walk you through our third quarter results, and update you on the progress we ve made in our turnaround plan as part of today s discussion. As always, we ve set aside some time at the end of the call to take your questions. With that, I ll turn the call over to Steve. Steve Nave: Thanks, Gene, and thanks everybody for joining us this morning. Beginning on Page 3 of the presentation, I m pleased with the continued momentum we re seeing in the business as we continue to execute our turnaround plan. We re making decisions to ensure that we are maximizing our earnings and we drove meaningful improvement across several areas of our business during the quarter. We achieved significant gross margin expansion, 280 basis points in the quarter thanks to our pricing optimization actions and continued efforts to drive costs out of the business. We improved advertising efficiency by 240 basis points in the quarter by continuing to optimize our catalog circulation and pausing national advertising for Fingerhut in mid-september. Although these actions negatively impacted total demand, we believe we are taking the right steps to drive stabilization in our business and achieve sustainable profitable growth over the long term. Regarding other turnaround initiatives, we completed the exit of the LinenSource business, including the successful liquidation of all the remaining inventory during the quarter. Although net credit expense increased in the quarter, we continue to see stabilization in our credit portfolio. Delinquency rates were sequentially flat in the third quarter despite pressure from the season s hurricanes. Pete will provide more details on trends shortly. Also, importantly, new 2017 vintages continue to show improved delinquency levels compared to prior year vintages. We were pleased at the underwriting adjustments we ve made and are starting to yield improved results; however, keep in mind that this is a multi-year commitment and we still have work to do. As I mentioned last quarter, we ve set ourselves up to successfully migrate the business to a true ecommerce site merchandising execution model which will begin in the first quarter of next year. Looking at Slide 4, as expected, sales excluding exited businesses declined 5% to $398.2 million. As a reminder, exited businesses include the PayCheck Direct business, the Draper s & Damon s retail stores and the Solutions and LinenSource brands. As I mentioned earlier, we ve made conscious decisions to reduce advertising expense and are very pleased with the tradeoff between demand and profitability in the quarter. To that point, Adjusted EBITDA increased by $11.9 million to $11 million, as compared to the same period last year. Bluestem Group cash and equivalents were $119.1 million compared to $129.1 million at the end of the second quarter. Net liquidity ended the quarter at $70.5 million, well above our liquidity covenant requirement of $40 million. Overall, we remain pleased with the progress to date on the turnaround plan, remain comfortable with our covenant cushion and we believe that we can again deliver similar cushions in the fourth quarter. As a reminder, the second and third quarters represented 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. 2
Before I turn it over to Pete to cover the financial results in more detail, let me touch on how holiday sales have progressed. Although the warm fall weather impacted our apparel businesses early in the season, I m happy to report that we have seen a strengthening trend following the Thanksgiving holiday and currently expect fourth quarter demand compared to last year to be similar to what we experienced in the third quarter. With that, I ll pass it over to detail to go through the financials in more detail. Pete Michielutti: Thank you, Steve, and good morning everyone. Thank you all for joining us. Starting on Slide 5 of the presentation materials, I ll walk you through the third quarter GAAP P&L for Bluestem Brands, Inc. Net sales decreased 10.2% year-over-year compared to the third quarter of 2016. At the portfolio level, Northstar s third quarter net sales decreased 3.8% to $210.1 million, while Orchard portfolio sales decreased 7.8% to $201.7 million. As Steve mentioned earlier, Bluestem s comparable sales, which excludes (inaudible) businesses decreased by 5% in the quarter. As we evaluate our business, we continue to make strategic decisions regarding our sales and ensure that we maximize profitability. As demonstrated by our contribution margins, we continue to successfully drive improvements in the third quarter. To that end, the gross profit rate increased by 280 basis points to 47.7%, resulting from a 470 basis point increase in the Northstar portfolio gross margin as we benefit from a combination of higher markup and lower promotional discounts. In addition, we experienced lower product returns and obsolescence related to improved product quality and lower inventory levels. Gross margin in the Orchard portfolio stabilized to last year. We are pleased that we saw significant improvement in our gross margin rate year-over-year in the third quarter, as well as continue to see meaningful improvements in gross margin trends throughout this fiscal year. Sales and marketing expenses decreased by 240 basis points or 17.6% due to improved catalog efficiency in both portfolios and reduced television spend at Fingerhut. Net selling margin improved by 520 basis points as compared to the third quarter of 2016 as a result of the improved sales and marketing expense and gross margin increase. Bluestem s net credit expense increased 200 basis points year-over-year due to the 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 $5.6 million as compared to the same period last year, primarily due to lower professional fees and reduced compensation and benefit expenses resulting from the March reduction in force, partially offset by higher incentive compensation. I wanted to note that the third quarter 2016 included an accrual reversal of $3.2 million for incentive compensation, while the third quarter of 2017 includes an accrual of $2.2 million, consistent with our revised bonus structure. On Slide 6 of the deck, net sales of the Northstar portfolio decreased $8.2 million or 3.8% compared to the third quarter of 2016. This decline in sales was largely expected due to our efforts to improve our advertising expense as a percent of sales, which included the reduction of our least productive catalog circulation, discontinued our national television campaigns in September, and the implementation of tighter underwriting standards that resulted in fewer new customers. 3
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 sub-prime credit supply. Northstar net selling margin was up 870 basis points over the third quarter 2016. As mentioned earlier, gross margin was up 470 basis points, primarily due to our pricing and cost optimization efforts. Sales and marketing expense as a percent of net sales was down 400 basis points as a result of a reduction in catalog production costs and reduced television advertising in the quarter. Net contribution margin rose 430 basis points as efforts to manage our marketing investments and gross margin more than 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 the SCUSA portfolio performance continues to be negatively impacted by the increased supply of third party general purpose credit and increased general purpose obligations. Our portfolio performance trends are beginning to stabilize, reflecting the positive impact of credit underwriting adjustments completed over the last 12 months. Our 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. That said, we did see an impact in the third quarter from the hurricanes in Houston, Florida and to a lesser extent Puerto Rico, and expect this to also impact the portfolio performance in the fourth quarter. Our 30-plus delinquency rate of 19.6% excludes a 20 basis point negative impact from the hurricanes. This is 50 basis points higher than last year and sequentially flat with the increase in the second quarter year-over-year results, signaling continued stabilization. As we look to the fourth quarter, we anticipate continued improvements related to our tightening underwriting as well as the benefit from new fraud detection tools implemented late in the second quarter and additional tools implemented prior to holiday. Risk adjusted margins before the merchant fee was down 230 basis points from the third quarter 2016, which net credit revenues down 70 basis points due to higher charge-offs, finance charges and fees, and lower billed late fee yields, a 100 basis point increase in net credit losses, and an increase of 60 basis points of allocated funding costs. As you know, credit losses are a lagging indicator of credit actions and improvements will begin manifesting themselves as we cycle through the tighter underwriting of last year. Turning to the next slide, the Orchard portfolio net sales for the second quarter were down 7.8% to $201.7 million, primarily due to exiting the Solutions, LinenSource and Draper s & Damon s retail businesses, combined with lower sales from less catalog advertising. The Orchard portfolio of comparable sales decreased by 3.6% in the quarter. Overall, we think that we are moving the assortment in the right direction, however, we were negatively impacted by weather during the quarter as our fall season got off to a very late start given the unseasonably warm weather this year. Gross margin rate for the Orchard portfolio was flat to last year at 52.3%, reflecting a meaningful sequential improvement from the second quarter. Contribution margin as a percent of sales was essentially flat to last year. 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 $234.9 million in merchandising inventories, a 20.1% decrease from last year. Inventory turnover of 3.3 times in the third quarter of 2017 increased to 2.9 times in the third quarter of 2016. The drop ship penetration for our Northstar portfolio increased from 36.3% in the third quarter last year to 40.2% in the third quarter of this year. Our expectation is that we will continue to see lower levels throughout the remainder of the year. 4
We ended the quarter with a lender leverage ratio of 3.84 times, well under the covenant requirement of 4.5 times, which reflects third quarter of last year 12-months lender adjusted EBITDA of $131.2 million compared to a lender ratio debt of $504.1 million. We ended the quarter with lender liquidity of $70.5 million compared to the covenant requirement of $40 million, which reflects $5.3 million of cash and %65.2 million of revolving credit line availability. Leverage ratio debt decreased by $58.4 million or 10.4% from the end of the third quarter last year to $504.1 million. Total Bluestem Group cash and cash equivalents at the end of the quarter was $119.1 million compared to $162.3 million at the end of the third quarter a year ago. The decline in cash balance reflects a dividend in the first quarter of $80.2 million. Our financial performance illustrates the impact of our turnaround efforts to date and we are pleased to see the stabilization of our credit portfolio combined with improving trends at Northstar and Orchard Brands. That said, we have a long road in front of us and we will continue to execute on our strategic initiatives to drive stabilization in the business and return to profitable growth over the long term. With that, I will turn it over for Q&A. Operator: Ladies and gentlemen, if you would like to ask a question, you could signal by pressing the star key followed by the digit one on your telephone keypad. Do keep in mind if you are using a speakerphone, make sure the mute function is released to allow your signal to reach our equipment. Once again, star, one if you have a question. We ll pause for just a moment to allow everyone an opportunity to signal. Once again everyone, star, one. At this time, there s no questions in our queue. Gene Davis: Okay, Operator. Thank you very much. I d like to thank everybody for joining us today and for your past and future support of the Company. We look forward to speaking to you again in a couple of months when we have our year-end results to discuss. Operator, you can disconnect the call, and let me wish everyone a happy, healthy and prosperous holiday season. Thank you very much. We re done. Bye bye. Operator: Ladies and gentlemen, this will conclude your conference for today. We do thank you for your participation, and you may now disconnect. Andy Spicher: Thank you everyone. 5