BGI Inc

OTC:BGRP

Earnings Call Transcript

[Operator]

Greetings, and welcome to the Bluestem Group Inc. Second Quarter 2019 Earnings Call. At this time all participants are in a listen-only mode.[Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host, Chris Tukua, Vice President, Investor Relations for Bluestem Group. Thank you, you may begin.

[Christopher Tukua, Vice President, Investor Relations]

Good morning, everyone, and thank you for joining us on our second quarter earnings call. Before we get started, I'd like to point out that today's presentation can be found on our Investor Relations page at www.bluestem.com. If you haven't already, you can find it there while I run through the forward-looking statement.

As a lead-in to our forward-looking statement, and as a reminder, at the end of the fourth quarter of fiscal 2018, we made the strategic decision to exit 6 brands within the Orchard portfolio. To provide the proper context to our results and unless mentioned otherwise, today's discussion will exclude the impact of inventory liquidation efforts on the exited brands.

As always, I need to remind you that during today’s -- the course of today's presentation, various remarks we make about our expectations for our company and other statements that make use of forward-looking words such as 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 the use of non-GAAP performance measures, including adjusted net sales, net selling margin, contribution margin, adjusted G&A expense, 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.

[Eugene Davis, Executive Chairman]

Thanks, Chris, and thank you, everyone, for joining us for a discussion of our second quarter financial results. Presenting on today's call will be Bruce Cazenave, our President and CEO; and Pete Michielutti, our Chief Financial Officer.

Our second quarter results reflect continued progress across a number of strategic initiatives. At Northstar, we continue to benefit from our efforts to improve the quality of our credit portfolio, and drove higher contribution margin. At Orchard, we also drove higher contribution margin as we continued to execute the initiatives to drive improved profitability.

With the exited brands behind us, we've been able to place greater focus on our 6 go-forward brands. Overall, we are moving the business in the right direction as Bruce and Pete will discuss in greater detail.

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 Bruce.

[Bruce Cazenave, President & Chief Executive Officer]

Thanks, Gene. And thank you all for joining us this morning to discuss our second quarter financial results and an update on the progress we’ve made against our strategic initiatives.

During the second quarter, we continued to benefit from initiatives employed to stabilize the credit portfolio and once again delivered higher year-over-year contribution margin rates at both Northstar and Orchard portfolios.

We did have topline pressure at Northstar as a result of lower credit account activations which are attributable to our efforts to improve the profile of the credit portfolio. At Orchard the circulation reductions continued to impact topline sales but as discussed before, we are focused on driving improved profitability throughout the portfolio.

We remain confident that the strategies we’ve been implementing will ultimately strengthen both Northstar and Orchard and result in more profitable growth over the longer term.

Now let’s turn to some of the highlights from our second quarter beginning with a brief overview of the financial results. For the second quarter, sales of Bluestem brands decreased approximately 10% and contribution margin increased 80 basis points to 18.4% as compared to last years’ second quarter.

Adjusted EBITDA for the quarter was $25.1 million, a decline of $6.5 million compared to the same quarter last year. At Northstar, the credit portfolio remained stable in Q2 as we drove improved efficiency in new customer acquisitions. We expect that the 2019 credit vintage to once again be stronger versus the prior year as a result of implementing the next generation of enhanced underwriting strategies.

That said, there were headwinds during the quarter that impacted sales. As I stated earlier, the tightening in the credit underwriting led to lower new account activations. Given our focus on driving future profitability, we view this as the right strategy for the long term health of our business.

Despite these sales pressures, we delivered 110 basis point increase in Northstar’s contribution margin to 18.2%. We expect certain external and internal challenges to persist beyond the second quarter and are implementing action plans to mitigate these impacts.

At Fingerhut, we've taken steps towards rationalizing the overall product offering to ensure we are aligning our assortment with customer demand. This will enable us to provide a well curated merchandise offering and enhance the overall shopping experience for customers. The goal is to drive penetration of higher margin categories including fashion and home, while still offering an assortment in categories that customers want.

To that end, the fashion component of our business accounted for approximately 20% of sales in Q2, which is up from 17% in the same quarter last year. We believe that striking the right balance with our merchandise assortment will lead to more shopping frequency and improved conversion while also creating deeper customer loyalty.

We also continue to refine our catalogs and marketing tactics in an effort to drive higher productivity. As an example, initial testing of personalization initiatives, which we highlighted in Q1 have exceeded expectations and we've begun to scale accordingly. The next step will be creating personalization in the email conversion stream. As part of this, we will be testing bigger promotional offerings targeting at customers we want to win back, while rationalizing offers for those who shop with us more frequently.

On September 1st, we launched a streaming media test that is running through mid-October as part of an initiative to reach both inactive customers and require, acquire new customers. While it is still early, we are encouraged by the initial test results. We will continue to monitor and will potentially carry the campaign beyond this initial test period into the holiday season.

Overall, it's important to note that all of these product and marketing initiatives are aligned with our strategy to deliver incremental improvements in the credit portfolio. At Orchard, there are encouraging signs that the focus on circulation productivity as well as refinements to merchandising and marketing strategies will yield positive results on the go-forward brands. Specifically, contribution margin during the second quarter increased 90 basis points over the same period last year. During the second quarter, we employed more testing and analytics around catalog circulation to better understand demand elasticity.

Marketing expense for the go-forward brands as a percentage of sales declined 200 basis points year-over-year. This was in large part due to lower catalog direct mail costs associated with a double digit decrease in catalog circulation, partially offset by an increase in digital marketing spend. We anticipate continuing to strategically shift some of our overall marketing spends towards digital media as the conversion metrics are positive and it is driving increased eCommerce penetration, eCommerce penetration in Q2 increased 600 basis points over the same period last year.

Following the exit of the six brands announced earlier this year, the execution of our focused brand strategy is also showing positive results. This is exemplified by another favorable quarter at Appleseed's where we saw an improvement in both revenue and EBITDA. The combination of a carefully planned 12% reduction in print advertising, merchandise assortment improvements and new creative, contributed to these positive results.

We are also encouraged by the solid top line growth despite the meaningful pullback on print, which we believe affirms the strategic initiatives we have been implementing over the past few quarters.

Furthermore, as another element of a more focused brand initiative, we are executing multi-channel marketing strategy to retain customers from the exited brands, targeted catalogs, postcards and e-mails along with website links, invite customers to find many of their favourite products on the go-forward brands websites. We are seeing some favorable crossover traffic, particularly at Appleseed's and will be able to provide more details in the coming quarters.

Overall, with greater focus on each of the go-forward brands, we will be able to better execute on the vision for each brand. We expect to drive improved performance through enhanced product assortment, and more effective marketing strategies. This includes, improving the customer's web and mobile experiences to drive higher conversion rates. To enable these capabilities, we need to move the go-forward brands to a common and upgraded eCommerce platform. And I'm pleased to report, we remain on track to make this transition later this fall.

As a follow on to the successful initial testing of personalization initiatives at Northstar, we will be expanding similar program to the Orchard portfolio once the upgraded web platform is in place.

In closing, we expect to finalize our three year strategic plan later this year. This plan will encompass strategies to drive improved performance in our core business processes, while also serving as a roadmap to how we intend to capitalize on new growth opportunities. We have a differentiated business model that enables us to offer a compelling value proposition to our value minded customers, and believe that the execution of this plan will lead to long term profitable growth and deliver enhanced value to our stakeholders.

Now, I'd like to turn the call over to Pete to review our financials for Q2 in more detail. Pete?

[Pete Michielutti, Chief Financial Officer]

Thanks Bruce and good morning everyone. As it has already been noted, in my commentary we'll exclude liquidation efforts on the exited brands unless otherwise stated. Starting on Slide three of the presentation materials, which highlight the results for Bluestem brands on an as reported basis.

Net sales decreased 13.5% to $365.4 million compared to the second quarter of 2018. Excluding exited brands, net sales decreased 9.7%. Sales were negatively impacted by several factors including fewer active customers related to actions taken to reduce unprofitable catalog circulation, the continued tightening of credit underwriting strategies and a reduction in new customer acquisition sales volume related to reduce circulation.

Adjusted gross profit decreased 120 basis points to 46.6% primarily due to demand driving promotional discounts in the Orchard portfolio. Adjusted selling and marketing expenses as a percent of net sales decreased 150 basis points to 21.8% due to the elimination of less productive catalog circulation as part of our strategy to improve marketing productivity and profitability across all brands, but primarily within the Orchard portfolio.

Excluding the impact of servicing rights valuations, net credit expense of $23.2 million improved by $6.2 million due to lower merchant discount rate as a result of a stabilized credit portfolio related to on-going credit underwriting improvements, and API changes made in prior periods.

As a result, the go-forward contribution margin increased 80 basis points as a percent of net sales compared to the second quarter of 2018. Adjusted for stock compensation expense, restructuring costs and other cost G&A expenses decreased 5.3% to $42 million primarily due to lower compensation and benefits costs.

The adjusted EBITDA which gives us effective items I just mentioned as well as again servicing rates declined $6.5 million to $25.1 million.

Moving on to Slide six of the deck, net sales from the Northstar portfolio decreased $12.7 million or 5.7% versus last year’s $224.5 million due to credit line management actions taken to improve the quality of the credit portfolio, which resulted in lower circulation and accrual rates on new accounts.

Gross profit decreased $6.4 million primarily due to lower sales. Gross profit rate decreased by 40 basis points due to higher import expenses related to tariffs, higher obsolescence and shipping expense, as well as lower shipping and handling revenue, partially offset by higher markup. Sales and marketing expense decreased to half a million dollars due to lower catalog and order entry expenses.

As a percentage of net sales, sales and marketing expenses increased 60 basis points driven by decreased customer response to marketing efforts and credit underwriting measures. Net credit expense improved 210 basis points primarily from the $6.2 million decrease in the average discount rates paid on sales of schools that due to improved credit portfolio management action taken in prior periods to improve the portfolio performance through tighter underwriting as well as increasing yield. As a result, contribution margin increased 110 basis points to 18.2%.

Turning to Slide seven, the 2018 vintage continues to show improvement compared to prior years based on credit underwriting actions taken over the last several quarters. Based on early reads, we are forecasting our 2019 vintage performance to be approximately 2% to 5% better when compared to the 2018 vintage, which represent our third consecutive year of year-over-year vintage improvements.

Lower vintage losses should continue at 2019, but at a reduced pace versus the improvement seen in 2018 and 2017, as we anniversary significant actions taken in the prior periods. Delinquency rates were up slightly in the quarter ending at 17.6% compared to 17.5% last year due to a slower -- slowing in the denominator as a result of lower new originations in Q2.

As I discussed last quarter, we are being more conservative for the credit line assignments and credit line increase strategies. As the delinquency trends continue to stabilize, we're encouraged about the direction we are headed with the credit risk portfolio and look forward to continued improvements.

Risk adjusted margin before the merchant fee improved by 90 basis points during the second quarter of 2019, which are the results for our overall progress towards a healthier credit portfolio.

Turning to Slide eight, Orchard portfolio net sales excluding the impact of exited brands this year and last declined $22.2 million or 13.2% due to a fewer active customers given by a reduction catalog circulation as part of our strategy to improve marketing productivity and overall profitability.

Gross margin declined 110 basis points to 50.4% primarily due to increased promotional discounts to drive demand. Sales and marketing expense decreased $20.1 million or 200 basis points due to the elimination of less productive catalog circulation as part of our strategy to improve marketing productivity and profitability as well as the closing of six brands.

As a result, contribution dollars of $6.0 [ph] $7.3 million was lower than last year which reflected a 90-basis point margin improvements. In the third quarter, we will begin to lap the marketing productivity actions which will offer easier comparisons to the prior year.

Turning to Slide nine, selected balance sheet and covenant compliance information, we ended the quarter with $177.1 million in merchandise inventories, inventories were down 8% year-over-year primarily due the elimination of exited brands partially offset by lower sales. We ended the quarter with a leverage ratio of 3.02 times well under the covenant requirement of 4.5 times.

These covenants reflect 12-trailing month lender adjusted EBITDA of $148 million and lender net debt of $446.1 million. At the end of the quarter, lender liquidity was $50.2 million compared to the covenant requirement of $40 million, which reflects $4.5 million of cash and cash equivalents $45.7 million availability under our asset backed line of credit.

In conclusion, we remained focused on our initiatives to drive further stabilization of the business and return to profitable growth. With that, we'll open it up to Q&A.

Thank you. [Operator Instructions] Thank you. That concludes our question and answer session. I'll turn the floor back to Mr. Davis for any final comments.

[Eugene Davis, Executive Chairman]

Thank you. Thank you very much to all of our investors for your continued support and for attending today. We have high confidence that the company is well on its way to a successful turnaround and value creation under Bruce’s leadership. And we look forward to bring more and more exciting news over the next several weeks, and over the next quarter. Thank you everybody for your time and attention. Thank you, operator.

[Operator]

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.