Jun 4, 2008
Executives
Timothy Frank – Chief Executive Officer Designate, President, Chief Operating Officer Michael Poppe – Chief Financial Officer, Assistant Treasurer, Controller Thomas Frank – Chairman, CEO
Analysts
Rick Nelson – Stephens, Inc. Chris for David Magee – SunTrust Robinson Humphrey Anthony Lebiedzinski – Sidoti & Co.
Laura Champine – Morgan Keegan Bill Massey – Adage Capital Management Alexandra Jennings – Greenlight Capital Neil McConnell – Walker Smith Capital Claire Davis – Perennial Advisors
Operator
Good morning and thank you for holding. Welcome to the Conn’s, Inc.
conference call to discuss earnings for the first quarter ended April 30, 2008. My name is Audra and I will be your operator today.
During the presentation all participants will be in a listen-only mode. After the speakers’ remarks you will be invited to participate in a question-and-answer session.
As a reminder this conference is being recorded. Your speakers today are Mr.
Timothy Frank, the Company’s CEO Designate, President and COO and Mr. Michael Poppe, the Company’s Chief Financial Officer.
Additionally joining us for the call is Mr. Thomas Frank, Sr., Chairman of the Board of Conn’s and its CEO.
I would now like to turn the conference over to Mr. Poppe.
Please go ahead Sir.
Michael Poppe
Thank you Audra. Good morning everyone and thank you for joining us.
I am speaking to you today from Conn’s corporate offices in Beaumont, Texas. You should have received a copy of our earnings release dated June 4, 2008, distributed before the market opened this morning which describes our earnings and other financial information for the quarter ended April 30, 2008.
If for some reason, you did not receive a copy of the release you can download it from our website at www.conns.com. I must remind you that some of the statements made in this call are forward-looking statements within the meaning of the Securities and Exchange Act of 1934.
These forward-looking statements represent the Company’s present expectations or beliefs concerning future events. The Company cautions that such statements are necessarily based on certain assumptions which are subject to risks and uncertainties which could cause actual results to differ materially from those indicated today.
I would now like to turn the call over to today’s host, Tim Frank, Conn’s CEO Designate, President and COO. Tim?
Timothy Frank
Thank you Mike. Good morning and thank you for joining us today.
Mike, Tommy and I are going to speak to our sales, financial performance, the current status of our credit and financing operations, the recently announced management transitions as well as our outlook for the remainder of fiscal 2009. Net sales for the quarter were up by 7.6% while same store sales increased by 1%.
Consumer electronics and laptops led the growth in our business while opportunities still exist in appliances. We had mixed results in appliances finishing down 4.4%.
Preliminary results for May show net sales up 13.7% and same store sales increased by 5.7%. Appliance sales in May increased 12% driven by special purchases and window air conditioners.
In our electronics business for the quarter LCD unit sales were up 167% and retail sales for this category were up 198% over the prior year. We expect these trends to continue.
We remain very price competitive in the market in part due to our national buying group, NATM, as well as recent special purchases from our vendors. Special purchase opportunities arise when other retailers cancel orders with vendors after the product has been manufactured.
Conn’s is known for having an appetite for purchasing these products which aids the vendor and allows us to purchase product well below the normal cost. This allows us to advertise and sell the product below the market and maintain reasonable margins.
We are able to move quickly and purchase cancelled orders on a regular basis. In many cases the product is assembled in Mexico and shipped to our Texas warehouses.
This also aids the vendor in transportation and logistics costs as we are generally the closest retailer. Nationally Americans are driving less and staying home more.
We believe that this recent trend and the federal mandate for digital conversion coming up in just over 7 months will continue to drive major electronics sales. We have also begun to see the impact of recent government-issued stimulus checks.
These monies are a help to both retail and credit sales. The overall impact is helpful but not a primary driver of business at this time.
Furniture for the quarter was down 6.2% while bedding was up 10.6%. Preliminary results for May were up 2% for furniture indicating that the improved brand mix of Lane, Broyhill and Franklin are beginning to take hold.
In addition our buys of furniture from China and Taiwan continue to do well. The bedding business continues to show improvements as we have moved from a one-brand store to a multiple brand format which includes Simmons, Serta, Spring Air and Comforpedic.
In May we added two new stores bringing the total count to 71. During the quarter we also had two store relocations.
As a reminder from the last call, six of the seven new stores that were opened this past year were opened in the last six months allowing us to have the benefit of these stores for a longer period of this year. The Oklahoma location continues to perform at the higher end of our expectations for a new store.
Two additional new stores are planned for this fiscal year in Oklahoma. We are on track to open seven new stores plus completing three relocations this year for a total of ten stores this current year which would bring our total count to 76 stores.
We are reviewing our store opening plans for next year in light of the current financial market conditions and our conservative capital management. Gross margin was down 320 basis points from 38.5% to 35.3% primarily due to a very competitive retail market and an accounting fair value adjustment.
We expect that product gross margins will begin to face easier comparatives in July. Our earnings were impacted by a $3.1 million fair value adjustment due to capital market conditions, not as a result of Company performance.
Mike will discuss this in greater detail later. Some of the gross margin decline was offset by a 120 basis point reduction in SG&A expense.
The fair value adjustment negatively impacted our SG&A savings by 40 basis points. The cost control initiatives that drove this reduction continue to be very active in our Company.
This includes reductions in personnel based on attrition and performance and a review of all costs within our Company. As an example, as a standard practice executives must present multiple cost savings upon entry of any corporate meeting.
The benefits of the reduction in SG&A expense should hold throughout the remainder of this fiscal year. These positive effects will combine with lower gross margin comparatives in July.
Efficiencies continue to build in our business from improved management involvement as well as increased leverage on infrastructure including advertising costs. Our inventory for the quarter was up 9.4% with the addition of seven new stores from the same time last year and the volume increase of 7.6%.
We have not purchased any more stock in the first quarter and do not expect to purchase stock in the near future. This decision is based on our conservative cash management philosophy.
As we look at our credit performance there was a net charge off of 3.2% for the quarter consistent with our previously announced expectations. The trend, however, is going in the right direction as the April charge off number was 2.7%.
We expect to achieve another year of net write off’s at or below 3%. Delinquencies are down 6.4% from the 7.6% reported at January 31, 2008.
Delinquencies are up slightly from the same period last year from 6% to 6.4% or 40 basis points. Due to the fair value accounting impact in this quarter we are revising guidance at $1.76 to $1.86.
Again, Mike will give further insight into our guidance shortly. The position changes that occurred yesterday afternoon are the result of years of transition.
Tommy has given over 50 years of service to our Company and we are all very thankful that he is remaining involved in our day-to-day operations. These title changes, CEO Designate, President of Credit and President of Retail including the CFO position that Mike took this year indicate the vote of confidence the Board has in our longstanding team.
I see these changes as very positive because the Company is growing our leadership internally and our leader Tommy will continue to be involved with us in shaping the future success of Conn’s. I’m now going to turn the program back over to Mike so that he can share additional financial information with you.
Michael Poppe
Thank you Tim. The performance of our core operations this quarter gives us two solid quarters back to back.
Our ability to deliver this earnings performance in the first quarter excluding the impact of fair value accounting was due to our ability to drive same store sales growth and control expenses delivering a 120 basis point decrease in SG&A as a percent of revenue, an expansion of the 50 basis point improvement we saw in the fourth quarter. Total revenues were up 6.5% to $218.6 million made up of an increase in net sales of 7.6% partially offset by a decrease in finance charges and other of $460,000.
The decrease in finance charges and other was driven by a $3.1 million fair value adjustment that I’ll discuss in a minute. As Tim mentioned net sales growth was driven by strong sales in consumer electronics especially LCD televisions, computers and video game equipment.
Finance charges and other decreased despite continued growth and consistent performance in the credit portfolio. The growth in the portfolio and lower short-term borrowing rates drove total servicing fees received, gains on sales of receivables and interest earned on our retained interest up 13.6%.
However, the $3.1 million reduction in the fair value of our interests and securitized assets more than offset these increases. The fair value adjustment is primarily the result of an increase in the discount rate used in the discounted cash flow valuation due to continued volatility in the financial markets as we have not changed our expectations about the future performance of credit operations.
As a result of this increase in the discount rate the fair value of our interest in securitized assets is now only approximately $2.1 million greater than our book basis. Relative to credit portfolio performance in the quarter the net credit charge off rate for the quarter was 3.2% up from 2.7% for the prior year.
However, the 3.2% charge off rate was in line with our previously stated expectations. Also, the 60-day delinquency rate was down seasonally from 7.6% at January 31 to 6.4% and is only slightly higher than the 6.0% delinquency rate at April 30, 2007.
The percent of the portfolio re-aged at April 30 dropped to 15.5% as compared to 16.6% at year-end and 16.8% last April. I should note that we made a minor adjustment to the calculation of the re-aged percentage to be more consistent with others in the industry.
The change was applied to all prior periods and did not have a significant impact on the reported amounts. They decreased by only 20-30 basis points.
Our total gross margin declined by 320 basis points. This is primarily due to a 270 basis point reduction in product gross margin which drove 220 basis points of the total gross margin decline.
The drop in our product gross margins versus the prior year period was due primarily to the highly competitive retail market we operated in during the quarter and a change in our product mix as consumer electronics became a larger proportion of product sales relative to higher margin appliance sales. The fair value adjustment drove 90 basis points of the total gross margin decline.
As I mentioned previously, SG&A expenses decreased by 120 basis points as a percentage of revenues. This decrease was driven primarily by lower payroll and payroll related expenses in absolute dollars and as a percent of revenue.
The ratio of SG&A as a percent of revenues would have shown an additional 40 basis points of improvement had the fair value adjustment not been required. While the net interest income has dropped as invested cash balances in the prior year were used to execute our stock buyback program, current quarter reported diluted earnings per share benefited by about $0.02 due to the repurchase program.
Net other income declined as we had recognized $800,000 in gains on the sales of two store locations in the prior year which benefited prior year earnings per share by approximately $0.02. While our core operations turned in a solid performance this quarter net income declined approximately $2.4 million to $10.6 million driven primarily by the $2 million fair value adjustment net of tax and the reductions in net interest income and net other income.
Earnings per diluted share decreased to $0.47 net of a $0.09 per share reduction due to the fair value adjustment from $0.54 in the prior year. As a reminder, the fair value adjustments are non-cash and not a result of changes in the underlying economics or expected cash flows of the credit portfolio.
Taking all of the adjustments discussed above into account, we believe we grew earnings per share by approximately 4% in a very challenging economic environment. Turning to our liquidity and cash flow we generated $39.5 million in cash flow from operations for the quarter ended April 30, 2008 compared to cash used of $5.6 million in the prior year period.
Both periods were impacted by the timing of inventory receipts and payments by the QSPE on its 2002 series of bonds. The current year period was impacted by the receipt of inventory later in the quarter which increased payable balances and decreased investment in accounts receivable due to the QSPE’s payoff of its 2002 series of bonds.
The payoff of the bonds resulted in an increase in the effective funding rate since January 31 as additional collateral became available for borrowing under the QSPE’s variable funding note facility. The improved funding rate and release of cash reserved balances related to the 2002 series of bonds positively impacted operating cash flows by approximately $9.9 million.
An additional $6 million was available to be drawn under the variable funding note facility at April 30. The prior year period was negatively impacted by the timing of receipts of inventory and the effect of pay downs of the 2002 series of bonds which reduced the effective funding rate during that quarter.
Cash used in investing activities totaled $5.3 million in the current year period for investments in property and equipment. This compared to $6 million provided a year ago as proceeds of $8.7 million from sales of property offset $2.7 million invested in property and equipment.
Financing activities provided $242,000 in the current year from proceeds of stock issued under employee benefit plans compared with cash used of $4.1 million in the prior year primarily for purchases of Treasury stock of $4.6 million and net of proceeds form issuances of stock under employee benefit plans. We have no bank debt on our balance sheet and after completing expansion of our syndicated credit facility on March 26 we have $105.6 million net of letters of credit available under our revolving lines of credit to be drawn for working capital or capital expenditure needs.
Given the ongoing volatility in the securitization market we are unsure at this time when we might be able to complete a fixed rate term bond issuance. However, we are continuing to review available options for financing our receivables portfolio with our financial advisors and expect to complete financing arrangements in the coming months.
Additionally, we expect the borrowing costs under these new or revised facilities to be higher than we are currently experiencing under the QSPE’s variable funding note or our revolving bank facility. At this time we believe the QSPE and the Company have sufficient combined liquidity to maintain consistent operations for at least 12 months.
The sources of this liquidity at April 30, 2008 included: $41.3 million of invested cash available to the Company, $105.6 million available under the Company’s revolving credit facility which mature in 2010 and $115 million of available capacity under the QSPE’s existing variable funding note. However, at this time due to the temporary nature of $150 million of the QSPE funding structure we do not expect to be able to renew more than $100 million of the $250 million trench of the variable funding note maturing this July.
As such, given the $200 million variable funding note trench committed until 2012 and assuming we renew $100 million of the maturing trench or complete a replacement financing arrangement for a similar amount then the current variable funding note balance of $335 million would have to be reduced by $35 million. Had a renewal or replacement financing arrangement been in place at April 30, 2008 we would have had $146.9 million of funding capacity from our cash balances and revolving credit facilities before repayment of the $35 million leaving us $111.9 million for future growth.
At a 15% growth rate we would use approximately $100 million of our funding capacity to fund growth in the portfolio over the next 12 months. In addition to the funding capacity discussed above among other sources we have future cash flow from operations, flexible inventory payment terms, the ability to modify certain capital investment programs and other funding alternatives.
As Tim discussed, because of the non-cash fair value adjustment this quarter we revised our EPS guidance for fiscal year 2009 to a range of $1.76 to $1.86 per diluted share excluding future potential fair value adjustments. This adjustment is not a result of changes in our expectations about the performance of our core operations.
As we indicated on our year-end conference call we expected first quarter comparison to be the most difficult and while we performed well this quarter we remain cautious about the remainder of the year due to the uncertainty in the economy and the financial markets. All of this analysis and much more is available on our form 10Q for the quarter ended April 30, 2008 to be filed with the Securities and Exchange Commission later today.
Tim that concludes our prepared remarks. If you are ready we will open up the lines for questions.
Timothy Frank
Sounds good Mike.
Operator
(Operator Instructions) Your first question comes from the line of Rick Nelson – Stephens, Inc.
Rick Nelson – Stephens, Inc.
Can you address what you anticipate the spread to be on this $100 million renewal?
Michael Poppe
What I’ll tell you right now Rick is as of now the variable funding note is 80 basis points over commercial paper. Our existing revolving bank facility the range is 125-175.
We do expect that the spreads will be north of those two facilities but exactly where it’s going to land we are still working on that.
Rick Nelson – Stephens, Inc.
Is there any way to put a range around it?
Michael Poppe
It would be so big Rick I don’t think it would be valuable to you.
Rick Nelson – Stephens, Inc.
I wanted to follow-up on sales strength in May. How much of that is driven by opportunistic purchases and is that growth sustainable in your view?
Timothy Frank
Rick it is sort of hard to categorize although I think on the appliance side when you look at the 12% increase probably about half that 12% is from special purchase behavior and the other half of that 12% is from window AC units. That being said it is sustainable.
There is always special purchase opportunities right now because of economic conditions throughout the country and so we are in a much higher environment. But if they were to reduce it would probably be a good thing because it would mean there was more of a stabilization of the market.
But there is always some special purchase opportunity.
Rick Nelson – Stephens, Inc.
Your EPS estimates, what sort of account guidance goes along with that?
Michael Poppe
We’re staying in the low to mid single-digits consistent with our historical performance and what we talked about on the last call.
Rick Nelson – Stephens, Inc.
Just to follow back up on this revolver that is coming due. Is that contemplated in your guidance or is there a potential for a revision when it gets completed?
Michael Poppe
We have contemplated borrowing cost increases in our guidance, Rick, but certainly there could be revisions if it comes in significantly different than our expectations.
Rick Nelson – Stephens, Inc.
The product margin erosion of 270 basis points in the quarter driven by mix. Am I to assume that appliance sales continue to be soft and that margin pressure will continue over the near-term but then as the comparisons get easier in the back end of the year the gross margin pressures would ease?
Timothy Frank
I think I agree with almost everything you said except really we were up, unless I misunderstood you, we were up in appliances so is it more competitive? Yes.
Is it a softer market for the markets we operate in? It really depends on our execution and the continued, as you pointed out, the availability of the special purchases.
We have competitors out there like Sears that are getting extremely price competitive when they offer more 15% off on three appliances or more. Special purchases allow us a way to combat that.
So we will continue that.
Michael Poppe
Thank you Rick. If we can move onto the next caller and make sure we give everybody an opportunity this morning.
Operator
The next question comes from the line of Chris for David Magee – SunTrust Robinson Humphrey.
Chris for David Magee – SunTrust Robinson Humphrey
I had a question about the new stores. You mentioned that the Oklahoma store in particular was at the higher end of expectations.
I was wondering if you could comment on any of the other new locations.
Timothy Frank
Yes we have two more locations coming up at Edmonds and then at Walnut Square and we’re very much looking forward to opening those stores. It has been a very positive market for us.
Chris for David Magee – SunTrust Robinson Humphrey
But as far as the new store productivity on some of the new stores that opened is the productivity at some of the new stores that opened last year? How are they performing relative to plan?
Timothy Frank
They are all, I would say, consistent with our expectations at this point.
Chris for David Magee – SunTrust Robinson Humphrey
The sequential improvement we see in the delinquency rate, is that something you would expect to continue to improve going forward? What are you seeing with your collections efforts?
Michael Poppe
If you look back over time, Chris, delinquency fluctuates seasonally and we always get meaningful drops in the first quarter. We had as good of if not one of the best drops in the first quarter we’ve had in a long time.
So we had very good performance. But do not look for meaningful improvement over what you saw at April 30.
Typically we have slight increases throughout the next couple of quarters and then again it will drop again at the beginning of next year.
Operator
The next question comes from the line of Anthony Lebiedzinski – Sidoti & Co.
Anthony Lebiedzinski – Sidoti & Co.
The same store sales comment you had regarding May, how does that compare to May 2007? Also as a follow-up to that, as you can see the same store sales for the second quarter last year were up 5% so I’m just wondering how does the quarter look from a comparative point of view for the rest of the quarter?
Michael Poppe
For May same store sales last year were essentially flat. They were up 0.3%.
I apologize Anthony…could you repeat the second part of your question?
Anthony Lebiedzinski – Sidoti & Co.
It seems like based on your comment based on the comps last year were flat. But for the entire quarter you reported a 5% same store sales increase.
So it seems like the comparisons will get more difficult as the quarter progresses?
Timothy Frank
Yes, in June I show…these are operational reports and they are a little different than the financials. I show 8% and in July I show 7%.
One of the things that is happening that is different to this year is we are selling a lot more air conditioner units, at least out of the gate for this quarter, and I would hope that would continue.
Anthony Lebiedzinski – Sidoti & Co.
Also, when you look at the first quarter product margin performance how much would you say if you look at the product margin is down 270 basis points. How much would you attribute that to the mix shift and how much of it was do you think because of competitive pressures?
Timothy Frank
The majority would be primarily competitive pressures but obviously the change to higher LCD sales which is a good thing puts pressure and also we had an increase in laptop sales of just over 12%.
Anthony Lebiedzinski – Sidoti & Co.
Also, the delinquencies as you mentioned earlier were up year-over-year. What would you say is the main reason for that do you think as far as the delinquencies and charge off’s increasing year-over-year?
Michael Poppe
Keep in mind Anthony delinquency at year-end was January/January was 100 basis points higher this year than last year and so now that gap is only 40 basis points. So we made significant improvement in that area.
So we would say that is a very good trend and what you are seeing is very positive. Then the charge off’s as we talked about on the year-end call we expected about a 3.2% charge off rate this quarter and we see that number coming down and as Tim indicated we had a 2.7% charge off rate in the month of April in the quarter.
Anthony Lebiedzinski – Sidoti & Co.
I think earlier you had said the delinquencies kind of fluctuate because of seasonal things. Is it because some of your customers get income tax refunds and they use that to pay down their outstanding balances.
Is that the case? What would you attribute the seasonality changes in the delinquencies…
Michael Poppe
That is one of the primary drivers. I would also tell you as color commentary this May we were able to bring down delinquency although slightly and that is the first time in seven years that a May trend went down.
That is again part of the seasonality so we had improved efficiencies and I would also say some of these stimulus checks probably helped. The tax refunds are definitely part of that.
Thomas Frank
You should also comment on that re-aged being down because that tends to increase delinquency a little.
Timothy Frank
As Mike reported I think the re-aged is down over 100 basis points. Isn’t that right?
Michael Poppe
That is correct.
Thomas Frank
As that re-aging goes down you may have a little increase from that 6% to 6.4% just based on the fact we did not re-age as much of our portfolio which is also a positive thing.
Operator
The next question comes from the line of Laura Champine – Morgan Keegan.
Laura Champine – Morgan Keegan
I just wanted to make sure I understood what was going on with QSPE financing. So now you are contemplating just renewing $100 million of what had been $250 million on the QSPE’s variable funding?
Is that accurate?
Michael Poppe
That is one of the things on the table. We don’t think the $150 million is really going to be available.
That was a temporary bridge to help us as we worked through the struggles in the market last year. We’ve got the $100 million option plus we are looking at other potential financing alternatives.
Laura Champine – Morgan Keegan
So for the moment that is $150 million less in potential funding which you don’t feel you’ll necessarily need to replace.
Michael Poppe
Correct, which as I walked through in my comments without that $150 million we still have ample liquidity to fund 15% growth in the portfolio before we even talk about using cash flow from operations or other funding alternatives.
Laura Champine – Morgan Keegan
Then on your inventory levels I did notice they grew faster than your sales did in the quarter. Is that driven by product cost inflation or a change in mix?
How do you feel about those inventory levels as we move into the summer?
Timothy Frank
There was a slight increase. I think with the new stores it is within range.
Certainly we can manage it a little bit tighter but there is a point at which you start having out-of-stocks but I think overall it is fine and there is probably some potential improvements there.
Operator
The next question comes from the line of Bill Massey – Adage Capital Management.
Bill Massey – Adage Capital Management
Mike you mentioned on the balance sheet the write off in the change of [inaudible] and it gets you within I think you said $2 million of the book value?
Michael Poppe
Yes, of our book basis. Correct.
Bill Massey – Adage Capital Management
I just want to get a little clarity so I can understand it a little better. My assumption and tell me if I’m wrong is that book value or book basis is really almost an irrelevant number when you actually are adjusting based on the cost of capital.
Just say if the cost of capital were to continue to spiral up you might continue to write down that asset to a low book value? Or for accounting purposes does book value sort of stop a write down for some change in the accounting fee that I’m just not familiar with?
Michael Poppe
You are correct. It could end up if the market continues the path it has been on the past few quarters it could be written down below book value.
I think the point we want to make with that is there are not significant gains to be recorded to be earned in future periods. We basically are booking the earnings as receivables to pay down.
Bill Massey – Adage Capital Management
That is kind of what was my follow-up question. What you are really saying is the book basis is cash.
There is not a lot of assumption in it, right? Let me just clarify that statement.
Can you tell me how quickly or what the sort of rate of turn of that book is? In other what is the longest dated outset in that book?
Is it 30 days? In the calculation of book value.
Michael Poppe
In the receivables portfolio the longest term contracts are 36 months but the portfolio turns on an average 14-16 time period.
Bill Massey – Adage Capital Management
14-16 month time period did you say?
Michael Poppe
Yes. The portfolio average turnover for the portfolio.
Bill Massey – Adage Capital Management
So the book value is just the remaining interest. It is not like you have taken some incremental level of conservatism in classifying what is actually the book value; it is just the remaining balance?
Michael Poppe
Book value is just our residual interest in the portfolio, receivables minus the borrowed balances at the QSPE.
Bill Massey – Adage Capital Management
On the sort of gain spread or whatever you would characterize the valuation over book, how many times in your company’s history have you seen the spread essentially reduced to nothing and typically where does the spread, and I don’t know if you want to say normalize, but typically I presume it is a spread value you carry on the balance sheet that is pretty stable obviously notwithstanding extreme environments like the one we are in right now. Can you just paint a picture of how you guys are thinking about the fact that this thing has just basically been written down to book and just put that in the context of your operating history?
Michael Poppe
I guess I’d start off with is fair value accounting is only about a year and a half old for us at this point. But we have valued the asset at fair value under the rules that were existing at the time we went public.
[Inaudible] we were discounting at a low 13-14% kind of weighted average discount rate and we are at about a 19% discount rate today.
Bill Massey – Adage Capital Management
Has your discount rate typically stayed…I’m sort of assuming your cost of money if you are at a mid teens discount rate your cost of money might have been historically mid 20’s or low 20’s so you had a net spread 800-1,000 basis points as sort of a standard operating procedure. Is it pretty rare that your spread would actually compress to what I’m assuming is only a few hundred basis points without obviously without changing the cost of money to consumers?
That seems pretty exceptional.
Michael Poppe
Let me make sure I understand your question because keep in mind the discount rate is not our cost to capital. It is a market driven formula.
Bill Massey – Adage Capital Management
I guess what I’m wondering is if the cost that you charge your consumers, if we assume that over time is in the low 20’s, just my assumption, and it is a relatively sticky number compared to the changes in the discount rate we’re observing right now…the discount rate is normally in the low teens and now it has gone as high as 19, I guess my question is if your spread between what you would discount the asset at and what you would actually produce in terms of yield on the asset has always been, even though those aren’t related numbers, has always been about 1,000 basis points and now it is 300-400 typically I guess my question is would that cause a change in the cost of money to the consumer or would you assume that the discount rate would tend to come back to a more normal level over time? Do you see what I’m asking?
If something has got to give over time, if the new discount rate and the cost of money has actually gone up…
Thomas Frank
Let me answer that for you. The first question you asked was how many times in the past did that spread go away?
It went away essentially once under Jimmy Carter’s administration. I forget the years but essentially it went away and we were able to operate our business successfully.
In order to prevent what you just described of 200-300 basis points differential we have used caps and swaps and other devices to control or fix, if you will, our interest rate subjectivity so we would not anticipate that would get to a 200-300 basis point spread. We would use financial devices to hedge or make sure that those rates remained at a differential so that we could operate our business properly.
That has been our practice in the past and we don’t use hedging or caps or swaps as a way to create income, we use it as a way to fix costs of money. We have done it in the past and it is a vehicle that is available to us today.
Operator
The next question comes from the line of Alexander Jennings – Greenlight Capital.
Alexandra Jennings – Greenlight Capital
So just to make sure I understand as you walk through your liquidity the $41.3 million of invested cash and the $105.6 million those are both on the balance sheet and as you look forward to this $150 million potential reduction in the variable note your continued liquidity presumes that you use that on-balance sheet funding availability to work through that $150 million reduction, right?
Michael Poppe
Correct. It just shows that we have in the total company we have liquidity available to continue to run the business.
We will continue to work on other facilities as needed.
Alexandra Jennings – Greenlight Capital
So then you forecast trying to go to market in this next quarter to try to get that back off the balance sheet?
Michael Poppe
No, I don’t think we forecasted that we would try to get it back off the balance sheet in the next quarter. We are working with our financial advisors on financing alternatives that make the most sense for us and whether things are on or off balance sheet is not a key driver in our funding decisions.
Alexandra Jennings – Greenlight Capital
Can you walk me through the way you changed your re-aging calculation this quarter?
Michael Poppe
You bet. There is a subset of our bankruptcy accounts that are in the portfolio that are being included in the calculations and that is inconsistent with the way that most people calculate re-age so we pulled that subset of accounts out.
As I said it had a very minor change in the re-age percentages that we had previously reported. They dropped 20-30 basis points from what we had historically dropped.
Alexandra Jennings – Greenlight Capital
Did those bankruptcy accounts move from the re-age calculation into charge offs?
Michael Poppe
No, they are still part of the portfolio. It was just inconsistent with how others report the number.
Timothy Frank
Those were reaffirmed bankruptcies.
Alexandra Jennings – Greenlight Capital
So they went bankrupt and then they stopped paying and then they started again and now they are not considered a re-age?
Michael Poppe
Correct. They never should have been considered a re-age.
Alexandra Jennings – Greenlight Capital
Why not? Didn’t they stop paying at some point in the interim?
Michael Poppe
That doesn’t make them a re-age. A re-age is an active account that is not bankrupt that you have extended the term for whatever reason to help that customer continue to pay.
It is the standard definition.
Alexandra Jennings – Greenlight Capital
Thinking back about bringing all these accounts on the balance sheet how is that going to change the income statement accounting for them going forward?
Michael Poppe
You are presuming they come on balance sheet?
Alexandra Jennings – Greenlight Capital
I thought you said that as this portion of the variable note does not renew you expect to bring some of these receivables onto the balance sheet as your way of funding them.
Michael Poppe
We might have some of the funding on our balance sheet whether or not the receivables themselves would be on the balance sheet or not is a separate issue and it depends on what financing arrangements we end up completing.
Alexandra Jennings – Greenlight Capital
So looking forward if you do not complete a finance arrangement in this next quarter you are going to draw down on that on-balance sheet credit facility, right?
Michael Poppe
Yes, we would. After the QSPE would pay out of the collections of the receivables we would use those collections to pay on the variable funding note as it needed to be paid down to the committed amount and we would draw on our existing cash flow and available facilities for new receivables.
Alexandra Jennings – Greenlight Capital
Would that then…as you draw on your existing cash flows would that then decrease the way that finance income is recognized because you are not transferring to the QSPE but rather drawing down on your cash flows to finance?
Michael Poppe
The receivables may still be transferred to the QSPE but it may just have some different classification in the income statement. But ultimately pre-tax earnings would still be…it would just be a classification in the income statement.
If we need to talk about this more offline I would be happy to take the call later. We have a few more people in queue that would like to get in, but I’d like to go ahead and move on and give them the opportunity.
Operator
The next question comes from the line of Neil McConnell – Walker Smith Capital.
Neil McConnell – Walker Smith Capital
Just to clarify something you just say about the bankrupt accounts. Do you currently have bankrupt accounts in the current portfolio?
Michael Poppe
Yes.
Neil McConnell – Walker Smith Capital
Why aren’t those charged off?
Michael Poppe
Because they are paying typically. They are being reaffirmed or we are working with them or they are on payment plans and we are working with them to collect those balances.
Thomas Frank
Tell him the definition of reaffirmation. They’ve been to court.
Timothy Frank
Reaffirmation, these bankrupt accounts either pledged the products returned back to us or they are making a payment stream.
Neil McConnell – Walker Smith Capital
But those wouldn’t be included in the re-age bucket?
Timothy Frank
No. Again it is a court action so they are ordered to do that and it is very consistent with what we have been doing in the past.
As Mike pointed out it is 20-30 basis point impact on the re-age.
Neil McConnell – Walker Smith Capital
What percent of the total pool would be in that reaffirmation bucket?
Timothy Frank
Bankruptcies are approximately 1% of the portfolio. They are not a significant portion of the outstanding balance.
Neil McConnell – Walker Smith Capital
The guidance, the $1.76 to $1.86, getting back to Alexandra’s question as well does that assume you use the on-balance sheet cash to fund the receivables past the July time frame?
Timothy Frank
That guidance assumes that regardless of what borrowing facilities are in place we do have some increase in borrowing cost.
Neil McConnell – Walker Smith Capital
So you are accounting for an up take.
Operator
The next question comes from the line of Claire Davis – Perennial Advisors.
Claire Davis – Perennial Advisors
I wanted to ask if you can give us any color on what amount of the fair value adjustments you are expecting for the rest of the year given that we have had a couple of quarters of this so far?
Michael Poppe
Claire I would love to be able to predict that but I have no idea what the financial markets are going to provide for us over the next few quarters so that is just something that is very hard for us to estimate. When we adopted fair value accounting if someone had told us what the financial markets were going to do over the third and fourth quarters of last year and this first quarter nobody had any idea we were going to have the kind of volatility we have experienced.
So it’s just really not something we can predict since it is not based on specifically or only on company performance.
Claire Davis – Perennial Advisors
To clarify your updated guidance right now is X any future adjustments?
Michael Poppe
Right. What we’re trying to focus on is here is our expectations of core operations and we still feel good about our core operations and what fair value is will be what fair value is and we’re going to focus on running the business.
Claire Davis – Perennial Advisors
In early April Moody’s put you on watch for a possible downgrade. I was curious if you had any conversations with them or knew what the status of that was or how you anticipate that affecting your future financing options?
Michael Poppe
Certainly we are talking to them about working through their review process. Where they will ultimately end up on their decision is too early for us to tell and we may not know until they are ready to make a call.
Claire Davis – Perennial Advisors
Have they given you any indication as to what their timeline on this might be?
Michael Poppe
They have indicated that they will continue to work with us and when they feel like they know everything they need to know they will make their decision. There is no hard and fast deadline as to when they are going to conclude on their rating.
Claire Davis – Perennial Advisors
Does being on watch without any resolution in that area does that hamper your ability or dampen your ability to get financing or these options you are considering right now?
Michael Poppe
You know, the securitization market even before that issue has already been a challenge and a struggle so outside of the securitization market we are having some good conversations and have some good interest. It does make the securitization market a challenge.
Claire Davis – Perennial Advisors
When you say you are having conversations is that with your existing bond holders?
Michael Poppe
I can’t go into details right now but the conversations we are having with our financial advisors.
Thomas Frank
We have a number of alternatives.
Operator
That does conclude the question-and-answer session. Mr.
Poppe I’ll turn the conference back over to you.
Timothy Frank
I’d like to make a couple of quick closing statements. Overall we continue to see positive trends in just about every area of our business.
This is especially true in cost control initiatives, the improving credit portfolio performance and sales growth. These improvements are occurring despite the headwinds of a challenging economic environment.
I’d also like to thank Tommy for continuing to be involved very much on a day-to-day basis with our business. Tommy do you have any comments?
Thomas Frank
No. That concludes it.
Michael Poppe
This concludes our call.
Operator
This does conclude today’s conference. Thank you for your participation.