UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED OCTOBER 31, 2004
COMMISSION FILE NUMBER 000-50421
CONN'S, INC.
(Exact name of registrant as specified in its charter)
A DELAWARE CORPORATION 06-1672840
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
3295 COLLEGE STREET
BEAUMONT, TEXAS 77701
(409) 832-1696
(Address, including zip code, and telephone
number, including area code, of registrant's
principal executive offices)
NONE
(Former name, former address and former
fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
---- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES NO X
---- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of November 30, 2004:
CLASS OUTSTANDING
-------------------------------------- -----------
Common stock, $.01 par value per share 23,208,203
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE NO.
--------------------- --------
ITEM 1. Financial Statements............................................................1
- -------
Consolidated Balance Sheets as of January 31, 2004 and October 31, 2004.........1
Consolidated Statements of Operations for the three and nine months ended
October 31, 2003 and 2004...................................................2
Consolidated Statement of Stockholders' Equity for the nine months ended
October 31, 2004............................................................3
Consolidated Statements of Cash Flows for the nine months ended
October 31, 2003 and 2004...................................................4
Notes to Consolidated Financial Statements......................................5
ITEM 2. Management's Discussion and Analysis of Financial Condition
- ------- and Results of Operations..................................................10
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.....................23
- -------
ITEM 4. Controls and Procedures........................................................24
- -------
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings..............................................................24
- -------
ITEM 5. Other Information..............................................................24
- -------
ITEM 6. Exhibits.......................................................................24
- -------
SIGNATURE ...................................................................................25
i
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Conn's, Inc.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
January 31, October 31,
2004 2004
--------- ----------
ASSETS (unaudited)
CURRENT ASSETS
Cash and cash equivalents .................................. $ 12,942 $ 10,374
Accounts receivable, net ................................... 16,802 15,594
Interests in securitized assets ............................ 77,138 101,772
Inventories ................................................ 53,742 60,906
Deferred income taxes ...................................... 4,148 4,859
Prepaid expenses and other assets .......................... 3,031 3,515
--------- ---------
TOTAL CURRENT ASSETS .................................... 167,803 197,020
NON-CURRENT DEFERRED TAX ASSET ................................ 3,945 4,386
PROPERTY AND EQUIPMENT
Land ....................................................... 10,708 11,047
Buildings .................................................. 13,108 15,123
Equipment and fixtures ..................................... 7,574 9,429
Transportation equipment ................................... 2,845 4,357
Leasehold improvements ..................................... 48,504 55,062
--------- ---------
SUBTOTAL ................................................ 82,739 95,018
Less accumulated depreciation ................................. (27,914) (32,655)
--------- ---------
TOTAL PROPERTY AND EQUIPMENT, NET ....................... 54,825 62,363
GOODWILL, NET ................................................. 7,917 7,917
DEBT ISSUANCE COSTS AND OTHER ASSETS, NET ..................... 270 292
--------- ---------
TOTAL ASSETS ........................................... $ 234,760 $ 271,978
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Notes payable .............................................. $ -- $ 2,584
Current portion of long-term debt .......................... 338 307
Accounts payable ........................................... 26,412 29,936
Accrued expenses ........................................... 12,800 16,312
Income taxes payable ....................................... 3,528 944
Deferred income taxes ...................................... 313 448
Deferred revenue ........................................... 6,225 6,349
Fair value of derivatives .................................. 1,121 439
--------- ---------
TOTAL CURRENT LIABILITIES ............................... 50,737 57,319
LONG-TERM DEBT ................................................ 14,174 21,207
NON-CURRENT DEFERRED TAX LIABILITY ............................ 477 650
DEFERRED GAIN ON SALE OF PROPERTY ............................. 811 686
FAIR VALUE OF DERIVATIVES ..................................... 202 --
MINORITY INTEREST ............................................. 1,769 2,053
STOCKHOLDERS' EQUITY
Common stock ($0.01 par value, 40,000,000 shares authorized;
23,101,772 and 23,208,203 shares issued and outstanding
at January 31, 2004 and October 31, 2004, respectively) .. 231 232
Additional paid-in capital ................................. 82,656 83,580
Accumulated other comprehensive income ..................... 5,032 6,702
Retained earnings .......................................... 78,671 99,549
--------- ---------
TOTAL STOCKHOLDERS' EQUITY .............................. 166,590 190,063
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY............ $ 234,760 $ 271,978
========= =========
1
See notes to consolidated financial statements.
Conn's, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except earnings per share)
Three Months Ended Nine Months Ended
October 31, October 31,
--------------------- --------------------
2003 2004 2003 2004
--------- ---------- ---------- --------
REVENUES
Product sales ................................. $ 93,478 $ 104,869 $ 283,873 $ 321,677
Service maintenance agreement commissions (net) 4,764 5,399 14,435 16,835
Service revenues .............................. 4,735 4,853 14,111 14,002
--------- --------- --------- ---------
Total net sales ............................ 102,977 115,121 312,419 352,514
Finance charges and other ..................... 14,413 17,789 42,887 51,874
--------- --------- --------- ---------
TOTAL REVENUES ............................. 117,390 132,910 355,306 404,388
COST AND EXPENSES
Cost of goods sold, including warehousing
and occupancy costs ......................... 72,687 82,523 222,558 253,002
Cost of parts sold, including warehousing
and occupancy costs ......................... 1,038 1,159 3,091 3,354
Selling, general and administrative expense ... 33,405 37,738 97,559 110,121
Provision for bad debts ....................... 1,215 1,373 3,403 4,022
--------- --------- --------- ---------
TOTAL COST AND EXPENSES .................... 108,345 122,793 326,611 370,499
--------- --------- --------- ---------
OPERATING INCOME ................................. 9,045 10,117 28,695 33,889
Interest expense ................................. 789 615 4,004 1,764
--------- --------- --------- ---------
INCOME BEFORE MINORITY INTEREST AND INCOME TAXES . 8,256 9,502 24,691 32,125
Minority interest in limited partnership ......... -- 113 -- 359
--------- --------- --------- ---------
INCOME BEFORE INCOME TAXES ....................... 8,256 9,389 24,691 31,766
Provision for income taxes
Current ....................................... 2,599 3,637 8,221 12,672
Deferred ...................................... 334 (563) 540 (1,784)
--------- --------- --------- ---------
TOTAL PROVISION FOR INCOME TAXES ........... 2,933 3,074 8,761 10,888
--------- --------- --------- ---------
NET INCOME ....................................... 5,323 6,315 15,930 20,878
Less preferred dividends ......................... 587 -- 1,759 --
--------- --------- --------- ---------
NET INCOME AVAILABLE FOR COMMON SHAREHOLDERS ..... $ 4,736 $ 6,315 $ 14,171 $ 20,878
========= ========= ========= =========
EARNINGS PER SHARE
Basic ......................................... $ 0.28 $ 0.27 $ 0.85 $ 0.90
Diluted ....................................... $ 0.28 $ 0.27 $ 0.85 $ 0.88
AVERAGE COMMON SHARES OUTSTANDING
Basic ......................................... 16,720 23,206 16,720 23,175
Diluted ....................................... 16,720 23,681 16,720 23,716
See notes to consolidated financial statements.
2
Conn's, Inc.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Nine Months Ended October 31, 2004
(unaudited)
(in thousands except descriptive shares)
Accum.
Other
Common Stock Compre-
---------------------- hensive Paid in Retained
Shares Amount Income Capital Earnings Total
----------- ---------- ---------- --------- ----------- ---------
BALANCE JANUARY 31, 2004 ......... 23,102 $ 231 $ 5,032 $ 82,656 $78,671 $ 166,590
Exercise of options to acquire
106,052 shares of common
stock .......................... 106 1 - 852 - 853
Issuance of 5,560 shares of
common stock under
Employee Stock Purchase
Plan ........................... 5 - - 72 - 72
Forfeiture of 5,181 shares of
restricted common stock ........ (5) - - - - -
Net income ........................ - - - - 20,878 20,878
Reclassification adjustments
on derivative instruments
(net of tax of $ 295) .......... - - 541 - - 541
Adjustment of fair value of
securitized assets (net of
tax of $ 615), net of reclass-
ification adjustments of
$7,184 (net of tax of $3,919) .. - - 1,129 - - 1,129
---------
Total comprehensive income ........ 22,548
----------- ---------- ----------- --------- ----------- ---------
BALANCE OCTOBER 31, 2004 .......... 23,208 $ 232 $ 6,702 $ 83,580 $99,549 $ 190,063
=========== ========== =========== ========= =========== =========
See notes to consolidated financial statements.
3
Conn's, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Nine Months Ended
October 31,
--------------------
2003 2004
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ............................................ $ 15,930 $ 20,878
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation ....................................... 4,900 6,236
Amortization ....................................... 132 104
Provision for bad debts ............................ 3,403 4,022
Promotional credit discounts (net) ................. -- 1,307
Accretion from interests in securitized assets ..... (9,285) (11,103)
Provision for deferred income taxes ................ 540 (1,784)
Loss from sale of property and equipment ........... 64 111
Gains from derivatives (net) ....................... (768) (48)
Minority interest in SRDS .......................... -- 284
Change in operating assets and liabilities:
Accounts receivable ................................ (3,275) (16,082)
Inventory .......................................... (8,286) (7,164)
Prepaid expenses and other assets .................. 409 (484)
Accounts payable ................................... 6,084 3,524
Accrued expenses ................................... 2,117 3,512
Income taxes payable ............................... 435 (2,556)
Deferred revenue ................................... (773) 124
Other current liabilities .......................... 34 --
-------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES ............. 11,661 881
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment .................... (6,260) (14,957)
Proceeds from sale of property ........................ 1,289 1,072
-------- --------
NET CASH USED IN INVESTING ACTIVITIES ................. (4,971) (13,885)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from stock issued under employee benefit plans -- 925
Net borrowing (payments) under bank credit facilities . (2,942) 9,638
Payments on term note ................................. (2,250) --
Increase in debt issuance costs ....................... (203) (75)
Payment of promissory notes ........................... (1,457) (52)
-------- --------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES.... (6,852) 10,436
-------- --------
NET CHANGE IN CASH .................................... (162) (2,568)
CASH AND CASH EQUIVALENTS
Beginning of the year ................................. 2,448 12,942
-------- --------
END OF PERIOD ......................................... $ 2,286 $ 10,374
======== ========
See notes to consolidated financial statements.
4
CONN'S , INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
OCTOBER 31, 2004
1. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION. The accompanying unaudited, condensed, consolidated
financial statements have been prepared in accordance with accounting principles
generally accepted in the United States for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by accounting principles generally accepted in the United States for complete
financial statements. The accompanying financial statements reflect all
adjustments that are, in the opinion of management, necessary for a fair
statement of the results for the interim periods presented. All such adjustments
are of a normal recurring nature. Operating results for the three and nine
months ended October 31, 2004 are not necessarily indicative of the results that
may be expected for the year ending January 31, 2005. The financial statements
should be read in conjunction with the Company's (as defined below) audited
consolidated financial statements and the notes thereto included in the
Company's Annual Report on Form 10-K filed on April 16, 2004.
The Company's balance sheet at January 31, 2004 has been derived from the
audited financial statements at that date but does not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial presentation. Please see the
Company's Form 10-K for the fiscal year ended January 31, 2004 for a complete
presentation of the audited financial statements at that date, together with all
required footnotes, and for a complete presentation and explanation of the
components and presentations of the financial statements.
PRINCIPLES OF CONSOLIDATION. The consolidated financial statements include
the accounts of Conn's, Inc. and its subsidiaries, limited liability companies
and limited partnerships, all of which are wholly-owned (the "Company"). All
material intercompany transactions and balances have been eliminated in
consolidation. The consolidated financial statements additionally include the
financial statements of a single purpose entity meeting one or more of the
standards of Financial Accounting Standards Board ("FASB") Interpretation No.
46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES, AN INTERPRETATION OF ACCOUNTING
RESEARCH BULLETIN NO. 51 ("FIN 46"), as described below.
The Company enters into securitization transactions to sell its retail
installment and revolving customer receivables. These securitization
transactions are accounted for as sales in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 140, ACCOUNTING FOR TRANSFERS AND
SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENT OF LIABILITIES, because the
Company has relinquished control of the receivables. Additionally, the Company
has transferred such receivables to a qualifying special purpose entity
("QSPE"). Accordingly, neither the transferred receivables nor the accounts of
the QSPE are included in the consolidated financial statements of the Company.
IMPLEMENTATION OF FIN 46. In January 2003, the FASB issued FIN 46 that
requires the consolidation of entities in which a company absorbs a majority of
the entity's expected losses, receives a majority of the entity's expected
residual returns, or both, as a result of ownership, contractual or other
financial interests in the entity. Currently, a company generally consolidates
entities when it has a controlling financial interest through ownership of a
majority voting interest in the entity. Although the Company itself does not
have a controlling financial interest in Specialized Realty Development
Services, LP ("SRDS"), SRDS is owned by various members of management and
individual investors of the Stephens Group, Inc. SRDS owns five retail stores
that it leases to the Company at October 31, 2004. The Company evaluated the
effects of the issuance of FIN 46 on the accounting for its leases with SRDS
and, as a result, determined that it is appropriate to consolidate the balance
sheets of SRDS with the balance sheets of the Company as of January 31, 2004 and
October 31, 2004. Additionally, commencing February 1, 2004 (the beginning of
the Company's 2005 fiscal year), the Company has determined that it is
appropriate to consolidate the operations of SRDS with those of the Company. The
primary effect of the consolidation on the Company's balance sheet at January
31, 2004 and October 31, 2004 was to increase cash, net property, debt and
minority interests by the amounts listed in the following table (dollars in
thousands):
5
CONN'S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
2004 2004
---------- ---------
Increase in cash ................................................... $ 1,024 $ 478
Increase in property and equipment, net ............................ 15,166 16,735
Increase in debt ................................................... 14,421 15,160
Increase in minority interests ..................................... 1,769 2,053
The primary effect of the consolidation on the Company's Statements of
Operations for the three and nine months ended October 31, 2004 was to
reclassify approximately $408,000 and $1.2 million, respectively, of store lease
expense to depreciation expense, interest expense and minority interest.
The Company has no financial obligation to the lenders for the outstanding
debt of SRDS.
USE OF ESTIMATES. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
EARNINGS PER SHARE. In accordance with SFAS No. 128, EARNINGS PER SHARE,
the Company calculates basic earnings per share by dividing net income by the
weighted average number of common shares outstanding. Diluted earnings per share
include the dilutive effects of any stock options granted calculated under the
treasury method. Because there were no options outstanding in the prior year
interim periods that were valued in excess of the grant price, there were no
such shares included in the diluted outstanding share total. The following table
sets forth the shares outstanding for the earnings per share calculations:
Three Months Ended Nine Months Ended
October 31, October 31,
--------------------------- -----------------------------
2003 2004 2003 2004
------------- ------------- ------------- --------------
Common stock outstanding, beginning of period ............ 16,719,990 23,187,688 16,719,990 23,101,772
Weighted average common stock issued in stock
option exercises ....................................... - 19,227 - 73,620
Weighted average common stock issued to employee
stock purchase plan .................................... - 1,099 - 841
Weighted average number of restricted shares forfeited ... - (1,727) - (1,295)
------------- ------------- ------------- --------------
Shares used in computing basic earnings per share ........ 16,719,990 23,206,287 16,719,990 23,174,938
Dilutive effect of stock options, net of assumed
repurchase of treasury stock ............................ - 474,313 - 540,605
------------- ------------- ------------- --------------
Shares used in computing diluted earnings per share 16,719,990 23,680,600 16,719,990 23,715,543
============= ============= ============= ==============
GOODWILL. Goodwill represents primarily the excess of purchase price over
the fair market value of net assets acquired. Effective February 1, 2002, the
Company adopted the provisions of SFAS No. 142, GOODWILL AND OTHER INTANGIBLE
ASSETS, whereby goodwill is no longer amortized, but rather the Company assesses
the potential future impairment of goodwill on an annual basis, or at any other
time when impairment indicators exist. The Company concluded that at January 31,
2004 and October 31, 2004 no impairment of goodwill existed.
STOCK-BASED COMPENSATION. As permitted by SFAS No. 123, ACCOUNTING FOR
STOCK-BASED COMPENSATION, the Company follows the intrinsic value method of
accounting for stock-based compensation issued to employees, as prescribed by
Accounting Principles Board ("APB") Opinion No. 25, ACCOUNTING FOR STOCK ISSUED
TO EMPLOYEES, and related interpretations. Since all options outstanding at
October 31, 2004 were granted at or above fair value at the date of grant, no
compensation expense has been recognized under the Company's stock option plan
for any of the financial statements presented. Additionally, as the employee
stock purchase plan is a qualified plan, no compensation expense has been
recognized in the financial statements presented.
6
CONN'S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
If compensation expense for the Company's stock option and employee stock
purchase plans had been recognized using the fair value method of accounting
under SFAS No. 123, net income available for common stockholders for the three
months ended October 31, 2003 and 2004 would have decreased by 1.8% and 5.6%,
respectively, and net income available for common stockholders for the nine
months ended October 31, 2003 and 2004 would have decreased by 1.8% and 4.8%,
respectively. For post-IPO stock option grants, the Company has used the
Black-Scholes model to determine fair value. Prior to the IPO, the fair value of
the options issued was estimated using the minimum valuation option-pricing
model. The following table presents the impact to earnings per share as if the
Company had adopted the fair value recognition provisions of SFAS No. 123
(dollars in thousands except per share data):
Three Months Ended Nine Months Ended
October 31, October 31,
----------------------- -----------------------
2003 2004 2003 2004
---------- ---------- ---------- ----------
Net income available for common stockholders as reported . $ 4,736 $ 6,315 $ 14,171 $ 20,878
Stock-based compensation, net of tax, that would have
been reported under SFAS 123 ........................... (84) (356) (253) (995)
---------- ---------- ---------- ----------
Pro forma net income ..................................... $ 4,652 $ 5,959 $ 13,918 $ 19,883
========== ========== ========== ==========
Earnings per share-as reported:
Basic .................................................. $ 0.28 $ 0.27 $ 0.85 $ 0.90
Diluted ................................................ $ 0.28 $ 0.27 $ 0.85 $ 0.88
Pro forma earnings per share:
Basic .................................................. $ 0.28 $ 0.26 $ 0.83 $ 0.86
Diluted ................................................ $ 0.28 $ 0.25 $ 0.83 $ 0.84
APPLICATION OF APB 21 TO CASH OPTION PROGRAMS THAT EXCEED ONE YEAR IN
DURATION: In February 2004, the Company began offering promotional credit
payment plans on certain products that extend beyond one year. In accordance
with APB 21, INTEREST ON RECEIVABLES AND PAYABLES, such sales are discounted to
their fair value resulting in a reduction in sales and receivables and the
amortization of the discount amount over the term of the deferred interest
payment plan. The difference between the gross sale and the discounted amount is
reflected as a reduction of Product sales in the consolidated statements of
operations and the amount of the discount being amortized in the current period
is recorded in Finance charges and other. For the three and nine months ended
October 31, 2004, Product sales were reduced by $829,000 and $1,759,000,
respectively, and Finance charges and other was increased by $280,000 and
$452,000, respectively, to effect the adjustment to fair value and to reflect
the appropriate amortization of the discount.
RECLASSIFICATIONS. Certain reclassifications have been made in the prior
year's financial statements to conform to current year's presentation.
2. SUPPLEMENTAL DISCLOSURE OF REVENUE AND COMPREHENSIVE INCOME
A summary of the classification of the amounts included as Finance charges
and other is as follows (in thousands):
Three Months Ended Nine Months Ended
October 31, October 31,
----------------------------- --------------------------------
2003 2004 2003 2004
------------- -------------- --------------- ---------------
Securitization income ............................. $ 9,318 $12,267 $ 29,271 $ 35,892
Income from receivables not sold .................. 221 585 630 1,352
Insurance commissions ............................. 3,684 3,741 10,296 11,449
Other ............................................. 1,190 1,196 2,690 3,181
------------- -------------- --------------- ---------------
Finance charges and other ........................ $ 14,413 $17,789 $ 42,887 $ 51,874
============= ============== =============== ===============
7
CONN'S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The components of total comprehensive income for the three and nine months
ended October 31, 2003 and 2004 are presented in the table below:
Three Months Ended Nine Months Ended
October 31, October 31,
-------------------------- --------------------------------------
2003 2004 2003 2004
----------- ------------ ---------------- -----------------
Net income ............................................ $5,323 $6,315 $ 15,930 $ 20,878
Unrealized gain on derivative instruments, net ........ 220 280 2,019 836
Taxes on unrealized gain on derivatives ............... (79) (99) (727) (295)
Adjustment of fair value of securitized assets ........ 348 421 722 1,744
Taxes on adjustment of fair value ..................... (125) (148) (260) (615)
----------- ------------ ---------------- -----------------
Total comprehensive income ............................ $5,687 $6,769 $ 17,684 $ 22,548
=========== ============ ================ =================
3. FAIR VALUE OF DERIVATIVES
The Company held interest rate swaps and collars with notional amounts
totaling $70.0 million and $20.0 million as of October 31, 2003 and 2004,
respectively, with terms extending to April, 2005, and were held for the purpose
of hedging against variable interest rate risk, primarily related to cash flows
from the Company's interest-only strip as well as variable rate debt.
In fiscal 2003, hedge accounting was discontinued for $80.0 million of
swaps previously designated as hedges and in fiscal 2004, hedge accounting was
discontinued for the remaining $20.0 million of swaps. In accordance with SFAS
No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, at the
time hedge accounting was discontinued, the Company began to recognize changes
in fair value of the swaps as a reduction to interest expense and to amortize
the amount of accumulated other comprehensive loss related to those derivatives
as interest expense over the period that the forecasted transactions affected
the consolidated statements of operations. During the three and nine months
ended October 31, 2004, the Company reclassified $280,000 and $836,000,
respectively, of losses previously recorded in accumulated other comprehensive
income into the consolidated statements of operations and recorded $(263,000)
and $(884,000), respectively, of interest reductions in the consolidated
statement of operations because of the change in fair value of the swaps.
Prior to discontinuing hedge accounting, the Company recorded hedge
ineffectiveness in each period, which arose from differences between the
interest rate stated in the derivative instrument and the interest rate upon
which the underlying hedged transaction was based. Ineffectiveness totaled
$(670,000) and $(768,000), respectively, for the three and nine months ended
October 31, 2003 and is reflected in Interest expense in the consolidated
statements of operations.
4. AMENDMENT TO BANK CREDIT FACILITY
During the current fiscal year, the Company reduced its revolving line of
credit from $40.0 million to $30.0 million through an amendment executed April
21, 2004. The amendment also relaxed certain financial covenants and reduced the
pricing options for both the stand-by fee and the interest rate on outstanding
balances. Subsequent to the period presented in these financial statements, on
November 15, 2004, the Company entered a Second Amendment to Credit Agreement
that extended the maturity date of its Revolving Bank Credit Facility to October
31, 2007, increased the amount of the Facility to $35,000,000 and added a
sublimit for Standby Letters of Credit of $5,000,000. In connection with the
execution of this Second Amendment, the Company also entered a Letter of Credit
Agreement providing for the $5,000,000 sublimit for Standby and Import Letters
of Credit.
5. AMENDMENT TO ABS FOR PROMOTIONAL CREDIT SALES
On October 29, 2004, through its QSPE, the Company entered a "First
Supplemental Indenture" amending the "Base Indenture" dated September 1, 2002
(as amended, supplemented and otherwise modified through the date of the First
Supplemental Indenture). This amendment allows the Company to include certain
retail installment contracts and revolving charge agreement receivables,
including the Company's cash option and deferred interest receivables for terms
up to thirty-six months in the eligible asset base of its asset backed
securitization financing arrangements, providing partial funding of these
receivables. These cash option and deferred interest receivables are limited to
30% of all eligible receivables with deferred interest receivables limited to
10% of all eligible receivables.
8
CONN'S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
6. LETTERS OF CREDIT
The Company had outstanding unsecured letters of credit aggregating $11.8
million and $11.9 million at January 31, 2004 and October 31, 2004,
respectively, which secure a portion of the QSPE's asset-backed securitization
program and the deductible under the Company's insurance program and to secure
international product purchases. The maximum potential amount of future payments
under these letters of credit is considered to be the aggregate face amount of
each letter of credit commitment, which total $14.2 million as of October 31,
2004.
As part of the asset-backed securitization program, the Company arranged
for the issuance of a stand-by letter of credit in the amount of $10.0 million
to provide assurance to the trustee of the asset-backed securitization program
that funds collected by the Company would be remitted as required under the base
indenture and other related documents. The letter of credit has a term of one
year and expires in August 2005, at which time the Company expects to renew such
obligation. The letter of credit is callable, at the option of the trustee, if
the Company does not honor its obligation to remit funds under the basic
indenture and other related documents. The Company also has an obligation to
maintain the current letters of credit and to provide additional letters of
credit under its insurance program in amounts considered sufficient by the
carrier to cover expected losses of claims that remain open after the expiration
of the initial policy coverage period. Letters of credit in the amount of $1.8
million at October 31, 2004 are callable, at the option of the insurance
company, if the Company does not honor its requirement to fund deductible
amounts as billed.
Included in the above, the Company obtained a commitment in June 2004 for
$1.5 million in trade letters of credit to secure product purchases under an
international arrangement. At October 31, 2004, there was $55,000 drawn under
this commitment.
In connection with the execution of the Company's Second Amendment, on
November 15, 2004 the Company entered a Letter of Credit Agreement providing for
a $5,000,000 sublimit for Standby and Import Letters of Credit.
7. CONTINGENCIES
In December 2002, Martin E. Smith, as named plaintiff, filed a lawsuit
against the Company in the state district court in Jefferson County, Texas, that
attempts to create a class action for breach of contract and violations of state
and federal consumer protection laws arising from the terms of the Company's
service maintenance agreements. The lawsuit alleges an inappropriate overlap in
the product warranty periods provided by the manufacturer and the periods
covered by the service maintenance agreements that the Company sells. The
lawsuit seeks unspecified actual damages as well as an injunction against the
Company's current practices and extension of affected service contracts. The
Company believes that the warranty periods covered in its service maintenance
agreements are consistent with industry practice. The Company also believes that
it is premature to predict whether class action status will be granted or, if
granted, the outcome of this litigation. There is not currently a basis on which
to estimate a range of potential loss in this matter.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements. We sometimes use words
such as "believe," "may," "will," "estimate," "continue," "anticipate,"
"intend," "expect," "project" and similar expressions, as they relate to us, our
management and our industry, to identify forward-looking statements.
Forward-looking statements relate to our expectations, beliefs, plans,
strategies, prospects, future performance, anticipated trends and other future
events. We have based our forward-looking statements largely on our current
expectations and projections about future events and financial trends affecting
our business. Actual results may differ materially. Some of the risks,
uncertainties and assumptions about us that may cause actual results to differ
from these forward-looking statements include, but are not limited to:
o the success of our growth strategy and plans regarding opening new
stores and entering adjacent and new markets, including our plans to
continue expanding into the Dallas/Fort Worth Metroplex and the south
Texas Rio Grande Valley;
o our ability to update or expand existing stores;
o our ability to estimate required capital expenditures and costs
related to the opening of new stores or to update or expand existing
stores;
o our cash flows from operations, borrowings from our revolving line of
credit and proceeds from securitizations to fund our operations, debt
repayment and expansion;
o technological and market developments, growth trends and projected
sales in the home appliance and consumer electronics industry,
including digital products like DVD players, HDTV, digital radio, home
networking devices and other new products, and our ability to
capitalize on such growth;
o the potential for price erosion or lower unit sales points that could
result in declines in revenues
o changes in laws and regulations and/or interest, premium and
commission rates allowed by regulators on our credit, credit insurance
and service maintenance agreements as allowed by those laws and
regulations;
o our relationships with key suppliers;
o the adequacy of our distribution and information systems and
management experience to support our expansion plans;
o the accuracy of our expectations regarding competition and our
competitive advantages;
o the accuracy of our expectations regarding the similarity or
dissimilarity of our existing markets as compared to new markets we
enter; and
o the outcome of litigation affecting our business.
Additional important factors that could cause our actual results to differ
materially from our expectations are discussed under "Risk Factors" in our Form
10-K filed with the Securities Exchange Commission on April 16, 2004. In light
of these risks, uncertainties and assumptions, the forward-looking events and
circumstances discussed in this report might not happen.
The forward-looking statements in this report reflect our views and
assumptions only as of the date of this report. We undertake no obligation to
update publicly or revise any forward-looking statements, whether as a result of
new information, future events or otherwise, except as required by law.
10
All forward-looking statements attributable to us, or to persons acting on
our behalf, are expressly qualified in their entirety by these cautionary
statements.
GENERAL
The following discussion and analysis is intended to provide you with a
more meaningful understanding of our financial condition and performance in the
indicated periods, including an analysis of those key factors that contributed
to our financial condition and performance and that are, or are expected to be,
the key drivers of our business.
We are a specialty retailer that sells major home appliances, including
refrigerators, freezers, washers, dryers and ranges, a variety of consumer
electronics, including projection, plasma and LCD televisions, camcorders, VCRs,
DVD players and home theater products, lawn and garden products and bedding,
including frames and mattresses. We also sell home office equipment, including
computers and computer accessories and continue to introduce additional product
categories for the consumer and home to help increase same store sales and to
respond to our customers' product needs. We require all our sales associates to
be knowledgeable in all of our products, but to specialize in certain specific
product categories.
We currently operate 49 retail locations in Texas and Louisiana, and expect
to open two additional stores in the Dallas/Fort Worth Metroplex during the last
quarter of this fiscal year. We also expect to combine the operations of our San
Antonio discount center with another local store during the fourth quarter.
Unlike many of our competitors, we provide in-house credit options for our
customers. Historically, we have financed over 56% of our retail sales. We
finance a large portion of our customer receivables through an asset-backed
securitization facility, and we derive servicing fee income and interest income
from these assets. As part of our asset-backed securitization facility, we have
created a qualifying special purpose entity, which we refer to as the QSPE or
the issuer, to purchase customer receivables from us and to issue asset-backed
and variable funding notes to third parties. We transfer receivables, consisting
of retail installment contracts and revolving accounts extended to our
customers, to the issuer in exchange for cash and subordinated securities. To
finance its acquisition of these receivables, the issuer has issued notes to
third parties. During the current quarter, we amended our asset-backed
securitization facility to include certain promotional receivables which were
previously considered ineligible under our facility.
We also derive revenues from repair services on the products we sell and
from product delivery and installation services we provide to our customers.
Additionally, acting as an agent for unaffiliated companies, we sell credit
insurance and service maintenance agreements to protect our customers from
credit losses due to death, disability, involuntary unemployment and property
damage and product failure. We also derive revenues from the sale of extended
service maintenance agreements to protect the customers after the original
manufacturer's warranty or service maintenance agreement has expired.
EXECUTIVE OVERVIEW
This narrative is intended to provide an executive level overview of our
operations for the three and nine months ended October 31, 2004. A detailed
explanation of the changes in our operations for these periods as compared to
the prior year is included beginning on page 15. As explained in that section,
our pretax income for the quarter ended October 31, 2004 increased approximately
13.7%, primarily as a result of higher revenues and gross margin dollars, lower
selling, general and administrative expenses and lower interest expense as a
percentage of revenues. Pretax income for the nine months ended October 31, 2004
increased 28.7% due to higher revenues and gross margin dollars, lower selling,
general and administrative expenses as a percentage of revenues and lower
interest expense. Some of the more specific issues that impacted our operating
and pretax income are:
o Same store sales for the quarter and year-to-date grew 1.5% and 4.0%,
respectively, over the same periods for the prior year. We believe that we
were able to achieve this favorable increase by continuing the emphasis of
sales of our primary product categories, by focusing specifically on our
track sales, and by taking the opportunity to promote bedding and lawn and
garden products. It is our strategy to continue this combination of
emphasizing our primary product categories and focusing on specialty
product categories throughout the balance of fiscal 2005.
11
o Our entry into the Dallas/Fort Worth market and our opening of our new
store in McAllen, Texas this quarter provided both a positive impact on our
revenues, but had a negative impact on our margins as a percentage of
revenue. Approximately $11.3 million and $29.0 million, respectively, of
our product sales increase for the quarter and year-to-date resulted from
the opening of six new stores in these markets, including two in this
quarter. However, our operating margins were negatively impacted as we
initially incurred substantial startup costs in personnel and advertising
to insure that our initial entry into the market areas was well received.
Our plans provide for the opening of two additional stores in the
Dallas/Fort Worth market during the balance of fiscal 2005.
o Part of our increase in same store sales during the quarter and
year-to-date resulted from the continuation of deferred interest payment
and no interest plans on certain products that extend beyond one year. In
accordance with APB No. 21, such sales have been discounted to their fair
value, resulting in a reduction in both sales and receivables, and the
discount amount is being amortized into income in Finance charges and other
over the applicable term of the deferred payment plan. For the three and
nine months ended October 31, 2004, such extended deferred interest payment
and no interest plans generated $9.8 million and $21.5 million,
respectively, in gross product sales. We reduced Product sales by $829,000
and $1,759,000, respectively, to effect the adjustment to fair value, and
increased Finance charges and other by $280,000 and $452,000, respectively,
to reflect the appropriate amortization of the discount amount. We expect
to continue to offer this type of extended term promotional credit in the
future.
o Our gross margin for the quarter decreased from 37.2% to 37.0%, primarily
as a result of changes in product mix and increased selling discounts. Our
gross margin for the nine months ended October 31, 2004 increased from
36.5% to 36.6% primarily as a result of our ability to drive same store
sales in the quarter ended April 30, 2004 without the need to deeply
discount prices as we did in the prior year.
o Part of our improvement in operations for the three and nine months ended
October 31, 2004 resulted from our ability to reduce Selling, general and
administrative (SG&A) expenses as a percent of revenues. We decreased SG&A
expense from 28.5% to 28.4% for the three months ended October 31, 2004 and
we reduced SG&A from 27.5% to 27.2% for the nine months ended October 31,
2004. These improvements resulted primarily from decreases in lease
expense, amortization and net advertising expense that were partially
offset by higher employee benefits costs and general insurance costs.
o Our operating margin was also positively impacted in the current quarter
and for the nine months ended October 31, 2004 by approximately 0.2% and
0.2%, respectively, as a result of the implementation of FASB
Interpretation No. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES, AN
INTERPRETATION OF ACCOUNTING RESEARCH BULLETIN NO. 51 ("FIN 46"). FIN 46
had the impact of reclassifying approximately $329,000 and $1.0 million,
respectively, of occupancy expense from SG&A expense to Interest expense
and Minority interest in limited partnership in the current quarter and
nine months ended October 31, 2004. As a result of FIN 46, beginning
February 1, 2004, we eliminate the pretax operating profit contributed from
the consolidation of SRDS through the Minority interest line item in our
Consolidated Statements of Operations.
o As a result of the completion of our initial public offering, we were able
to utilize the net proceeds of the offering to retire substantially all of
our balance sheet debt (not including any debt of SRDS, which is reflected
in the consolidated financial statements as a result of FIN 46) and thereby
significantly reduce our Interest expense in the current quarter and the
nine months ended October 31, 2004.
OPERATIONAL CHANGES AND RESULTING OUTLOOK
We opened a new store in McAllen, Texas in early September 2004. We
believe that this store represents an opportunity to compete in a market that is
substantially underserved. We also believe that the McAllen location will allow
us to investigate serving other customers along the Texas/Mexico border.
12
The consumer electronics industry depends on new products to drive same
store sales increases. Typically, these new products, such as digital
televisions (E.G., plasma, LCD, and DLP) and DVD players, are introduced at
relatively high price points that are then gradually reduced as the product
becomes more mainstream. To sustain positive same store sales growth, unit sales
must increase at a rate greater than the decline in product prices. The
affordability of the product helps the unit sales growth.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
In applying the accounting policies that we use to prepare our consolidated
financial statements, we necessarily make accounting estimates that affect our
reported amounts of assets, liabilities, revenues and expenses. Some of these
accounting estimates require us to make assumptions about matters that are
highly uncertain at the time we make the accounting estimates. We base these
assumptions and the resulting estimates on authoritative pronouncements,
historical information and other factors that we believe to be reasonable under
the circumstances, and we evaluate these assumptions and estimates on an ongoing
basis. We could reasonably use different accounting estimates, and changes in
our accounting estimates could occur from period to period, with the result in
each case being a material change in the financial statement presentation of our
financial condition or results of operations. We refer to accounting estimates
of this type as "critical accounting estimates." We believe that the critical
accounting estimates discussed below are among those most important to an
understanding of our consolidated financial statements as of October 31, 2004.
TRANSFERS OF FINANCIAL ASSETS. We transfer customer receivables to the QSPE
that issues asset-backed securities to third party lenders using these accounts
as collateral, and we continue to service these accounts after the transfer. We
recognize the sale of these accounts when we relinquish control of the
transferred financial asset in accordance with SFAS No. 140, ACCOUNTING FOR
TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENT OF LIABILITIES.
As we transfer the accounts, we record an asset representing the interest only
strip which is the difference between the average interest earned on customer
accounts and the cost associated with financing and servicing the transferred
accounts, including a provision for bad debts associated with the transferred
accounts discounted to a market rate of interest. The gain or loss recognized on
these transactions is based on our best estimates of key assumptions, including
forecasted credit losses, payment rates, forward yield curves, costs of
servicing the accounts and appropriate discount rates. The use of different
estimates or assumptions could produce different financial results. For example,
if we had assumed a 10.0% reduction in net interest spread (which might be
caused by rising interest rates or reductions in rates charged on the accounts
transferred), our interest in securitized assets would have been reduced by $4.2
million as of October 31, 2004, which may have an adverse effect on earnings. We
recognize income from our interest in these transferred accounts as gains on the
transfer of the asset, interest income and servicing fees. This income is
recorded as Finance charges and other in our consolidated statements of
operations. If the assumption used for estimating credit losses were changed by
0.5% from 3.5% to 4.0%, the impact to recorded Finance charges and other would
have been a reduction in revenues and pretax income of $1.5 million.
DEFERRED TAX ASSETS. We have significant net deferred tax assets
(approximately $8.1 million as of October 31, 2004), which are subject to
periodic recoverability assessments. Realization of our net deferred tax assets
may be dependent upon whether we achieve projected future taxable income. Our
estimates regarding future profitability may change due to future market
conditions, our ability to continue to execute at historical levels and our
ability to continue our growth plans. These changes, if any, may require
material adjustments to these deferred tax asset balances. For example, if we
had assumed that the future tax rate at which these deferred items would reverse
was 34.5% rather than 35.3%, we would have reduced the net deferred tax asset
account and net income by approximately $185,000.
INTANGIBLE ASSETS. We have significant intangible assets related primarily
to goodwill and the costs of obtaining various loans and funding sources. The
determination of related estimated useful lives and whether or not these assets
are impaired involves significant judgments. We test for potential impairment of
goodwill annually based on judgments regarding ongoing profitability and cash
flow of the underlying assets. Our testing includes using judgments to estimate
the separate operations of our insurance agency and secondary credit portfolio,
including allocations for interest, overhead and taxes. Once these separate
operations have been determined, we apply a multiple of earnings based on
existing market conditions and estimated operating cash flow and compare the
resulting estimated entity values to the recorded goodwill. Changes in strategy
or market conditions could significantly impact these judgments and require
adjustments to recorded asset balances. For example, if we had reason to believe
that our recorded goodwill had become impaired due to decreases in the fair
market value of the underlying business, we would have to take a charge to
income for that portion of goodwill that we believe is impaired. Our goodwill
balance at October 31, 2004 was $7.9 million.
13
PROPERTY, PLANT AND EQUIPMENT. Our accounting policies regarding land,
buildings, and equipment include judgments regarding the estimated useful lives
of such assets, the estimated residual values to which the assets are
depreciated, and the determination as to what constitutes increasing the life of
existing assets. These judgments and estimates may produce materially different
amounts of depreciation and amortization expense that would be reported if
different assumptions were used. These judgments may also impact the need to
recognize an impairment charge on the carrying amount of these assets as the
cash flows associated with the assets are realized. In addition, the actual life
of the asset and residual value may be different from the estimates used to
prepare financial statements in prior periods.
REVENUE RECOGNITION. Revenues from the sale of retail products are
recognized at the time the product is delivered to the customer. Such revenues
are recognized net of any adjustments for sales incentive offers such as
discounts, coupons, rebates, or other free products or services and discounts of
promotional credit sales that will extend beyond one year. We sell service
maintenance agreements and credit insurance contracts on behalf of unrelated
third parties. For contracts where the third parties are the obligors on the
contract, commissions are recognized in revenues at the time of sale, and in the
case of retrospective commissions, at the time that they are earned. Where we
sell service maintenance renewal agreements in which we are deemed to be the
obligor on the contract at the time of sale, revenue is recognized ratably, on a
straight-line basis, over the term of the service maintenance agreement. These
service maintenance agreements are renewal contracts that provide our customers
protection against product repair costs arising after the expiration of the
manufacturer's warranty and the third party obligor contracts. These agreements
typically range from 12 months to 36 months. These agreements are separate units
of accounting under Emerging Issues Task Force No. 00-21, REVENUE ARRANGEMENTS
WITH MULTIPLE DELIVERABLES. The amount of service maintenance agreement revenue
deferred at October 31, 2004 and January 31, 2004 was $3.1 million and $3.1
million, respectively, and is included in Deferred revenue in the accompanying
balance sheets.
VENDOR ALLOWANCES. We receive funds from vendors for price protection,
product rebates, marketing and training and promotion programs which are
recorded on the accrual basis as a reduction to the related product cost or
advertising expense according to the nature of the program. We accrue rebates
based on the satisfaction of terms of the program and sales of qualifying
products even though funds may not be received until the end of a quarter or
year. If the programs are related to product purchases, the allowances, credits
or payments are recorded as a reduction of product cost; if the programs are
related to promotion or marketing of the product, the allowances, credits, or
payments are recorded as a reduction of advertising expense in the period in
which the expense is incurred.
14
RESULTS OF OPERATIONS
The following table sets forth certain statement of operations information
as a percentage of total revenues for the periods indicated:
Three Months Ended Nine Months Ended
October 31, October 31,
------------------ ---------------------
2003 2004 2003 2004
------- -------- ------- ---------
Revenues:
Product sales .................................... 79.6% 78.9% 79.9% 79.5%
Service maintenance agreement commissions (net) .. 4.1 4.1 4.1 4.2
Service revenues ................................. 4.0 3.6 3.9 3.5
----- ----- ----- -----
Total net sales ................................ 87.7 86.6 87.9 87.2
Finance charges and other ........................ 12.3 13.4 12.1 12.8
----- ----- ----- -----
Total revenues ............................ 100.0 100.0 100.0 100.0
Costs and expenses:
Cost of goods sold, including warehousing
and occupancy cost ............................... 61.9 62.1 62.6 62.6
Cost of parts sold, including warehousing
and occupancy cost ............................... 0.9 0.9 0.9 0.8
Selling, general and administrative expense ...... 28.5 28.4 27.5 27.2
Provision for bad debts .......................... 1.0 1.0 1.0 1.0
----- ----- ----- -----
Total costs and expenses .................. 92.3 92.4 92.0 91.6
----- ----- ----- -----
Operating income ................................. 7.7 7.6 8.0 8.4
Interest expense ................................. 0.7 0.4 1.1 0.4
----- ----- ----- -----
Earnings before income taxes and minority interest 7.0 7.2 6.9 8.0
Minority interest ................................ 0.0 0.1 0.0 0.1
----- ----- ----- -----
Earnings before income taxes ..................... 7.0 7.1 6.9 7.9
Provision for income taxes ....................... 2.5 2.3 2.5 2.7
----- ----- ----- -----
Net income ....................................... 4.5% 4.8% 4.4% 5.2%
===== ===== ===== =====
The table above identifies several changes in our operations for the
current quarter and nine months ended, including changes in revenue and expense
categories expressed as a percentage of revenues for Cost of goods and parts
sold, Selling, general and administrative expense and Interest expense. These
changes are discussed in the Executive Overview section on page 11 and in more
detail in the discussion of operating results beginning in the analysis below.
Same store sales growth is calculated by comparing the reported sales by
store for all stores that were open throughout a period to reported sales by
store for all stores that were open throughout the prior period. Sales from
closed stores have been removed from each period. Sales from relocated stores
have been included in each period because each store was relocated within the
same general geographic market. Sales from expanded stores have been included in
each period.
The presentation of gross margins may not be comparable to other retailers
since we include the cost of our in-home delivery service as part of selling,
general and administrative expense. Similarly, we include the cost related to
operating our purchasing function in Selling, general and administrative
expense. It is our understanding that other retailers may include such costs as
part of their cost of goods sold.
THREE MONTHS ENDED OCTOBER 31, 2004 COMPARED TO THREE MONTHS ENDED
OCTOBER 31, 2003
REVENUES. Total revenues increased by $15.5 million, or 13.2%, from $117.4
million for the three months ended October 31, 2003 to $132.9 million for the
three months ended October 31, 2004. The increase was attributable to increases
in net sales of $12.1 million, or 11.8%, and $3.4 million, or 23.4%, in finance
charges and other revenue. Of the $12.1 million increase in net sales, $1.5
million resulted from a same store sales increase of 1.5%, $11.4 million was
generated by seven retail locations that were not open for three consecutive
months in each period, $(829,000) resulted from discounts of promotional credit
sales and $118,000 resulted from a net increase in service revenues. Of the
$12.1 million increase in net sales, $11.4 million was attributable to increases
in product sales and $753,000 was attributable to net changes in service
maintenance agreement commissions and service revenues. Of the $11.4 million
increase in product sales, approximately $3.4 million was attributable to
increases in unit sales and approximately $8.0 million was attributable to
increases in unit price points. Increased sales in bedding, computers and other
new product categories included in the track accounted for much of the increase
in same store sales.
15
The following table presents the makeup of net sales by product category in
each quarter, including service maintenance agreement commissions and service
revenues, expressed both in dollar amounts and as a percent of total net sales.
Classification of sales has been adjusted from previous filings to break out the
track area as a separate category.
Three Months Ended October 31,
----------------------------------------------------------
2003 2004 Percent
---------------------------- ----------------------------- Increase
Category Amount Percent Amount Percent (Decrease)
-------------- ------------ -------------- ------------- --------------
Major home appliances ................... $ 38,627 37.5% $ 40,197 34.9 % 4.1 %
Consumer electronics .................... 30,868 30.0 35,814 31.1 16.0 (1)
Track ................................... 16,015 15.6 18,965 16.5 18.4 (2)
Delivery/installation ................... 1,702 1.7 1,777 1.5 4.4 (3)
Lawn and garden ......................... 2,593 2.5 2,632 2.3 1.5 (4)
Bedding ................................. 1,796 1.7 2,872 2.5 59.9 (5)
Other ................................... 1,877 1.8 2,612 2.3 39.2
-------------- ------------ -------------- ------------- --------------
Total product sales ................ 93,478 90.8 104,869 91.1 12.2
Service maintenance agreement
commissions ............................. 4,764 4.6 5,399 4.7 13.3
Service revenues ........................ 4,735 4.6 4,853 4.2 2.5
-------------- ------------ -------------- ------------- --------------
Total net sales .................... $102,977 100.0% $115,121 100.0% 11.8%
============== ============ ============== ============= ==============
- ----------------------------------
(1) This increase is consistent with overall increase in product sales and
improved unit prices.
(2) The increases are primarily due to the new emphasis on track sales.
(3) The increase is primarily due to a price increase charged to the customer
for delivery service.
(4) The lower increase is reflective of the seasonal nature of this product
category.
(5) This increase reflects the emphasis on this emerging product category and
the change in vendor relationships.
Revenue from Finance charges and other increased by approximately $3.4
million, or 23.4%, from $14.4 million for the three months ended October 31,
2003 to $17.8 million for the three months ended October 31, 2004. This increase
in revenue resulted primarily from increases in securitization income of $3.0
million, increases in amortization of discounted promotional credit sales of
$280,000 and increases in insurance commissions and other revenues of $147,000 .
These increases are attributable to higher product sales and increases in our
retained interest in assets transferred to the QSPE.
COST OF GOODS SOLD. Cost of goods sold, including warehousing and occupancy
cost, increased by $9.8 million, or 13.5%, from $72.7 million for the three
months ended October 31, 2003 to $82.5 million for the three months ended
October 31, 2004. This increase was generally consistent with the 12.2% increase
in net product sales during the three months ended October 31, 2004, although
cost of products sold increased from 77.8% of net product sales in the quarter
ended October 31, 2003 to 78.7% for the quarter ended October 31, 2004. We
attribute this product gross margin decrease to more aggressive price
discounting that was used to drive same store sales.
16
COST OF PARTS SOLD. Cost of parts sold, including warehousing and occupancy
cost, increased approximately $121,000, or 11.7%, for the three months ended
October 31, 2004 as compared to the three months ended October 31, 2003 due to
increases in parts sales.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE. While Selling, general and
administrative expense increased by $4.3 million, or 13.0%, from $33.4 million
for the three months ended October 31, 2003 to $37.7 million for the three
months ended October 31, 2004, it decreased as a percentage of total revenue
from 28.5% to 28.4%. The decrease in expense as a percentage of total revenues
for this category resulted primarily from decreased payroll, telephone and
equipment lease expense that were partially offset by higher employee benefits
and general insurance costs.
PROVISION FOR BAD DEBTS. The provision for bad debts on receivables
retained by the Company and not transferred to the QSPE increased by $158,000,
or 13.0%, during the three months ended October 31, 2004 as compared to the
three months ended October 31, 2003, primarily as a result of increases in the
portfolio balances.
INTEREST EXPENSE. Interest expense decreased by $174,000, or 22.1%, from
$789,000 for the three months ended October 31, 2003 to $615,000 for the three
months ended October 31, 2004. The net decrease in interest expense was
attributable to the following factors:
o the decrease in our average outstanding debt from $43.6 million to $3.7
million (not including the impact of FIN 46 consolidation of $14.9 million,
see below) resulted in a decrease in interest expense of approximately
$467,000;
that was offset by the following increases:
o the increase in interest rates and commitment fees of $64,000; and
o expiration of $50.0 million in our interest rate hedges and the
discontinuation of hedge accounting for derivatives resulted in a net
increase in interest expense of approximately $13,000; and
o the implementation of FIN 46 resulted in the reclassification of $216,000
in expenses previously reflected as occupancy cost in Selling, general and
administrative expense to Interest expense.
MINORITY INTEREST. As a result of FIN 46, beginning February 1, 2004, we
eliminate the pretax operating profit contributed from the consolidation of SRDS
through the minority interest line item in our consolidated statement of
operations.
PROVISION FOR INCOME TAXES. The provision for income taxes increased by
$141,000, or 4.8%, from $2.9 million for the three months ended October 31, 2003
to $3.1 million for the three months ended October 31, 2004. This increase
varied from the increase in pretax income of 13.7% during the three months ended
October 31, 2004 due primarily to adjustments in the current liability account
through the tax provision to true-up the 2004 fiscal year provision with the
actual return filed which caused the effective tax rate to decrease from 35.5%
in fiscal 2004 to 32.7% in fiscal 2005.
NET INCOME. As a result of the above factors, net income increased $1.0
million, or 18.6%, from $5.3 million for the three months ended October 31, 2003
to $6.3 million for the three months ended October 31, 2004. Income available
for the common stockholder increased $1.6 million, or 33.3%, from $4.7 million
to $6.3 million, during the three months ended October 31, 2004 as compared to
the three months ended October 31, 2003, resulting from improvements in
operations and the elimination of preferred stock dividends of $587,000 that
were paid in the prior year. The elimination of the preferred dividends in 2004
fiscal year resulted from the impact of the initial public offering when all
preferred stock was redeemed for cash or was converted into common shares.
NINE MONTHS ENDED OCTOBER 31, 2004 COMPARED TO NINE MONTHS ENDED
OCTOBER 31, 2003
REVENUES. Total revenues increased by $49.1 million, or 13.8%, from $355.3
million for the nine months ended October 31, 2003 to $404.4 million for the
nine months ended October 31, 2004. The increase was attributable to increases
in net sales of $40.1 million, or 12.8%, and $9.0 million, or 21.0%, in finance
charges and other revenue. Of the $40.1 million increase in net sales, $12.4
million resulted from a same store sales increase of 4.0%, $29.6 million was
generated by seven retail locations that were not open for nine consecutive
months in each period, $(1.8 million) resulted from discounts of promotional
credit sales and $(109,000) resulted from a net decrease in service revenues. Of
the $40.1 million increase in net sales, $37.8 million was attributable to
increases in product sales and $2.3 million was attributable to net changes in
service maintenance agreement commissions and service revenues. Of the $37.8
million increase in product sales, approximately $15.8 million was attributable
to increases in unit sales and approximately $22.0 million was attributable to
increases in unit price points. Increased sales in bedding, lawn and garden,
computers and other new product categories included in the track accounted for
much of the increase in same store sales.
17
The following table presents the makeup of net sales by product category in
each period, including service maintenance agreement commissions and service
revenues, expressed both in dollar amounts and as a percent of total net sales.
Classifications of sales have been adjusted from previous filings to break out
the track area as a separate category.
Nine Months Ended October 31,
-----------------------------------------------------------
2003 2004 Percent
---------------------------- ----------------------------- Increase
Category Amount Percent Amount Percent (Decrease)
-------------- ----------- -------------- ------------- ---------------
Major home appliances ............... $119,330 38.2 % $126,651 35.9% 6.1%
Consumer electronics ................ 92,782 29.7 106,125 30.1 14.4
Track ............................... 46,084 14.8 56,009 15.9 21.5 (1)
Delivery/installation ............... 4,854 1.5 5,562 1.5 14.6 (2)
Lawn and garden ..................... 10,423 3.3 12,686 3.6 21.7 (3)
Bedding ............................. 4,615 1.5 7,737 2.2 67.6 (3)
Other ............................... 5,785 1.9 6,907 2.0 19.4
-------------- ----------- -------------- ------------- ---------------
Total product sales ............ 283,873 90.9 321,677 91.2 13.3
Service maintenance agreement
commissions ......................... 14,435 4.6 16,835 4.8 16.6
Service revenues .................... 14,111 4.5 14,002 4.0 (0.8)
-------------- ----------- -------------- ------------- ---------------
Total net sales ................ $312,419 100.0% $352,514 100.0% 12.8 %
============== =========== ============== ============= ===============
- ----------------------------------
(1) The increases are primarily due to the new emphasis on track sales.
(2) The increase is primarily due to a price increase charged to the customer
for delivery service.
(3) The increase is primarily due to continuing maturity of this new product
category and the continued sales emphasis on this product category.
Revenue from Finance charges and other increased by approximately $9.0
million, or 21.0%, from $42.9 million for the nine months ended October 31, 2003
to $51.9 million for the nine months ended October 31, 2004. This increase in
revenue resulted primarily from increases in securitization income of $6.6
million, amortization of discounted promotional credit sales of $452,000, and
increases in insurance commissions and other revenues of $1.9 million. These
increases are attributable to higher product sales and increases in assets
transferred to the QSPE.
COST OF GOODS SOLD. Cost of goods sold, including warehousing and occupancy
cost, increased by $30.4 million, or 13.7%, from $222.6 million for the nine
months ended October 31, 2003 to $253.0 million for the nine months ended
October 31, 2004. This increase was generally consistent with the 13.3% increase
in net product sales during the nine months ended October 31, 2004. Cost of
products sold increased from 78.4% of net product sales in the nine months ended
October 31, 2003 to 78.7% for the nine months ended October 31, 2004.
COST OF PARTS SOLD. Cost of parts sold, including warehousing and occupancy
cost, increased approximately $263,000, or 8.5%, for the nine months ended
October 31, 2004 as compared to the nine months ended October 31, 2003 due to
increased parts sales.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE. While Selling, general and
administrative expense increased by $12.5 million, or 12.9%, from $97.6 million
for the nine months ended October 31, 2003 to $110.1 million for the nine months
ended October 31, 2004, it decreased as a percentage of total revenue from 27.5%
to 27.2%. The decrease in expense as a percentage of total revenues for this
period results primarily from decreased payroll, telephone and equipment leases
that were partially offset by higher employee benefits, professional services
and general insurance costs.
18
PROVISION FOR BAD DEBTS. The provision for bad debts, which represents
customer receivables that were not transferred to the QSPE, increased by
$619,000, or 18.2%, during the nine months ended October 31, 2004 as compared to
the nine months ended October 31, 2003. In the prior year, bad debt expense was
reduced by a $300,000 adjustment based on prior experience. Much of the increase
in the current year was driven by this prior year reversal. Otherwise, the
increase in the current year is more consistent with the growth in the
portfolio.
INTEREST EXPENSE. Interest expense decreased by $2.2 million, or 55.9%,
from $4.0 million for the nine months ended October 31, 2003 to $1.8 million for
the nine months ended October 31, 2004. The net decrease in interest expense was
attributable to the following factors:
o the expiration of $30.0 million of our interest rate hedges in April 2003
and the expiration of $50.0 million of our interest rate hedges in November
2003 and the discontinuation of hedge accounting for derivatives resulted
in a net decrease of $1.4 million from the prior period; and
o the decrease in our average outstanding debt from $46.6 million to $1.5
million (when ignoring the impact of FIN 46 consolidation of $14.8 million,
see below) resulted in a decrease in interest expense of approximately $1.7
million;
that were offset by the following increases:
o the increase in interest rates and commitment fees of $241,000; and
o the implementation of FIN 46 resulted in reclassification of $645,000 in
expenses previously reflected as occupancy cost in Selling, general and
administrative expense to Interest expense.
MINORITY INTEREST. As a result of FIN 46, beginning February 1, 2004, we
eliminate the pretax operating profit contributed from the consolidation of SRDS
through the minority interest line item in our consolidated statement of
operations.
PROVISION FOR INCOME TAXES. The provision for income taxes increased by
$2.1 million, or 24.3%, from $8.8 million for the nine months ended October 31,
2003 to $10.9 million for the nine months ended October 31, 2004. This increase
was generally consistent with the increase in pretax income of 28.7% during the
nine months ended October 31, 2004. Effective tax rates decreased from 35.5% in
fiscal 2004 to 34.3% in fiscal 2005 primarily due as a result of a true-up of
the 2004 fiscal year tax provision.
NET INCOME. As a result of the above factors, net income increased $5.0
million, or 31.1%, from $15.9 million for the nine months ended October 31, 2003
to $20.9 million for the nine months ended October 31, 2004. Income available
for the common stockholder increased $6.7 million, or 47.3%, from $14.2 million
to $20.9 million, during the nine months ended October 31, 2004 as compared to
the nine months ended October 31, 2003, resulting from improvements in
operations and the elimination of preferred stock dividends of $1.8 million that
were paid in the prior year. The elimination of the preferred dividends in 2004
fiscal year resulted from the impact of the initial public offering when all
preferred stock was redeemed for cash or was converted into common shares.
LIQUIDITY AND CAPITAL RESOURCES
CURRENT ACTIVITIES
Historically we have financed our operations through a combination of cash
flow generated from operations, and external borrowings, including primarily
bank debt and asset-backed securitization facilities. As of January 31, 2004, we
had $40.0 million under the revolving line of credit (based on qualifying
assets) and $8.0 million under our unsecured bank line of credit available to us
for general corporate purposes. As of April 21, 2004, we had successfully
reduced the revolving line of credit to $30.0 million in exchange for an
amendment to our bank credit facility that reduced interest rates, standby rates
and commitment fees among other concessions.
19
On November 15, 2004, we entered a Second Amendment to its Credit Agreement
that extended the maturity date of its Revolving Bank Credit Facility to October
31, 2007, increased the amount of the Facility to $35,000,000 and added a
sublimit for Standby Letters of Credit of $5,000,000. In connection with the
execution of this Second Amendment, we also entered a Letter of Credit Agreement
providing for the $5,000,000 sublimit for Standby and Import Letters of Credit.
A summary of the significant financial covenants that govern our bank
credit facility compared to our actual compliance status at October 31, 2004, is
presented below:
Required
Minimum/
Actual Maximum
------------- -------------
Debt service coverage ratio must exceed required minimum 3.04 to 1.00 2.00 to 1.00
Total leverage ratio must be lower than required maximum 1.99 to 1.00 3.00 to 1.00
Consolidated net worth must exceed required minimum $182,002,000 $100,605,922
Charge-off ratio must be lower than required maximum 0.02 to 1.00 0.05 to 1.00
Extension ratio must be lower than required maximum 0.02 to 1.00 0.04 to 1.00
Delinquency ratio must be lower than required maximum 0.08 to 1.00 0.12 to 1.00
Note: All terms in the above table are defined by the bank credit facility
and may or may not agree directly to the financial statement captions in
this document.
We will continue to finance our operations and future growth through a
combination of cash flow generated from operations and external borrowings,
including primarily bank debt and the QSPE's asset-backed securitization
facilities. Based on our current operating plans, we believe that cash generated
from operations, available borrowings under our bank credit facility and
unsecured credit line, and access to the unfunded portion of the variable
funding portion of the QSPE's asset-backed securitization program will be
sufficient to fund our operations, store expansion and updating activities and
capital programs through at least January 31, 2006. However, there are several
factors that could decrease cash provided by operating activities, including:
o reduced demand for our products;
o more stringent vendor terms on our inventory purchases;
o increases in product cost that we may not be able to pass on to our
customers;
o reductions in product pricing due to competitor promotional activities;
o changes in inventory requirements based on longer delivery times of the
manufacturers or other requirements which would negatively impact our
delivery and distribution capabilities;
o increases in the retained portion of our receivables portfolio under our
current QSPE's asset-backed securitization program as a result of changes
in performance;
o inability to expand our capacity for financing our receivables portfolio
under new or replacement QSPE asset-backed securitization programs or a
requirement that we retain a higher percentage of the credit portfolio
under such new programs;
o increases in program costs (interest and administrative fees relative to
our receivables portfolio associated with the funding of our receivables);
and
o increases in personnel costs required for us to stay competitive in our
markets.
During the nine months ended October 31, 2004, net cash provided by
operating activities decreased $10.8 million from $11.7 million provided in the
2003 period to $881,000 provided in the 2004 period. The net decrease in cash
provided from operations resulted primarily from the expansion of promotional
credit programs over one year old that were only partially funded through the
asset backed securitization program, increased payment of income taxes and
timing differences in payment of accounts payable. We expect to continue to
increase our use of promotional credit. We believe that the available balances
under our bank credit facility and asset-backed securitization program are
sufficient to fund the increase in receivables or any increase in credit
enhancement that we expect through the end of fiscal 2006. This quarter we
amended our asset-backed securitization facility to include partial funding of
promotional receivables which were previously considered ineligible under our
facility.
20
As noted above, we offer promotional credit programs to certain customers
that provide for "same as cash" interest free periods of varying terms,
generally three, six, or 12 months; we recently increased these terms to include
18 or 24 months that are eligible to be partially funded through our
asset-backed securitization program. Early in the second quarter of this year,
we began offering "interest free" programs with 36-month terms that are also
eligible to be partially funded through our asset-backed securitization program.
The three, six, 12, 18 and 24 month "same as cash" promotional accounts are
eligible for securitization up to the limits provided for in our securitization
agreements. This limit is currently 30.0% of eligible securitized receivables.
The percentage of eligible securitized receivables represented by promotional
receivables was 13.4% and 21.0% as of October 31, 2003 and October 31, 2004,
respectively. This increase was the result of sales with the use of promotional
credit versus lower prices at retail. If we exceed this 30.0% limit, we would be
required to use some of our other capital resources to carry the unfunded
balances of the receivables for the promotional period. The weighted average
promotional period was 10.7 months and 12.9 months for promotional receivables
outstanding as of October 31, 2003 and October 31, 2004, respectively. The
weighted average remaining term on those same promotional receivables was 7.1
months and 9.0 months, respectively. While overall these promotional receivables
have a much shorter weighted average term than non-promotional receivables, we
receive less income as a result of a reduced net interest margin used in the
calculation of the gain on the sale of receivables. As a result, the existence
of the interest free extended payment terms negatively impacts the gains as
compared to other receivables.
Net cash used by investing activities increased by $8.9 million, from $5.0
million for the nine months ended October 31, 2003 to $13.9 million for the nine
months ended October 31, 2004. The increase in cash used in investing activities
resulted primarily from an increase in the purchase of property and equipment of
$8.7 million and a decrease in the proceeds from the sale of property of
$217,000. The increase in cash expended for property and equipment resulted
primarily from the opening of three new stores in the Dallas/Fort Worth market
and one new store in McAllen, Texas, the reformatting of our stores to increase
focus on track operations and the acquisition of another store location in the
Dallas/Fort Worth market that will be opened early next year. Based on current
plans, we expect to continue to increase expenditures for property and equipment
in the balance of fiscal 2005 as we open additional stores and complete our
track reformatting.
Net cash provided by financing activities increased by $17.3 million from
($6.9) million for the nine months ended October 31, 2003 to $10.4 million for
the nine months ended October 31, 2004. The increase in cash provided by
financing activities resulted primarily from reductions in payments on various
debt instruments of $6.6 million, the borrowing of $9.6 million from our
revolving credit facilities and the proceeds received from the issuance of
common stock under our benefit plans of $925,000. The reduction of payments on
debt is due to the substantial reduction of debt from the proceeds of the IPO in
the fourth quarter of the prior year.
OFF-BALANCE SHEET FINANCING ARRANGEMENTS
Since we extend credit in connection with a large portion of our retail,
service maintenance and credit insurance sales, we have created a qualified
special purpose entity, which we refer to as the QSPE or the issuer, to purchase
customer receivables from us and to issue asset-backed and variable funding
notes to third parties to obtain cash for these purchases. We transfer
receivables, consisting of retail installment contracts and revolving accounts
extended to our customers, to the issuer in exchange for cash and unsecured
promissory notes. To finance its acquisition of these receivables, the issuer
has issued the notes and bonds described below to third parties. The unsecured
promissory notes issued to us are subordinate to these third party notes and
bonds.
21
At October 31, 2004, the issuer had issued two series of notes and bonds: a
Series A variable funding note in the amount of $250 million purchased by Three
Pillars Funding Corporation and three classes of Series B bonds in the aggregate
amount of $200 million. Private institutional investors, primarily insurance
companies, purchased the Series B bonds at a weighted fixed rate of 5.1%.
We continue to service the transferred accounts for the QSPE, and we
receive a monthly servicing fee, so long as we act as servicer, in an amount
equal to .0025% multiplied by the average aggregate principal amount of
receivables serviced plus the amount of average aggregate defaulted receivables.
The issuer records revenues equal to the interest charged to the customer on the
receivables less losses, the cost of funds, the program administration fees paid
in connection with either Three Pillars Funding Corporation or the Series B bond
holders, and the servicing fee.
The Series A variable funding note permits the issuer to borrow funds up to
$250 million to purchase receivables from us, thereby functioning as a "basket"
to accumulate receivables. When borrowings under the Series A variable funding
note approach $250 million, the issuer intends to refinance the receivables by
issuing a new series of bonds and to use the proceeds to pay down the
outstanding balance of the Series A variable funding note, so that the basket
will once again become available to accumulate new receivables. As of October
31, 2004, borrowings under the Series A variable funding note were $98.5
million.
We are not directly liable to the lenders under the asset-backed
securitization facility. If the issuer is unable to repay the Series A note and
Series B bonds due to its inability to collect the transferred customer
accounts, the issuer could not pay the subordinated notes it has issued to us in
partial payment for transferred customer accounts, and the Series B bond holders
could claim the balance in its restricted cash account. We are also contingently
liable under a $10.0 million letter of credit that secures our performance of
our obligations or services under the servicing agreement as it relates to the
transferred assets that are part of the asset-backed securitization facility.
The issuer is subject to certain affirmative and negative covenants
contained in the transaction documents governing the Series A variable funding
note and the Series B bonds, including covenants that restrict, subject to
specified exceptions: the incurrence of non-permitted indebtedness and other
obligations and the granting of additional liens; mergers, acquisitions,
investments and disposition of assets; and the use of proceeds of the program.
The issuer also makes representations and warranties relating to compliance with
certain laws, payment of taxes, maintenance of its separate legal entity,
preservation of its existence, protection of collateral and financial reporting.
In addition, the program requires the issuer to maintain a minimum net worth.
A summary of the significant financial covenants that govern the issuer's
asset-backed credit facility compared to actual compliance status at October 31,
2004, is presented below:
Required
Minimum/
Actual Maximum
------------------- -------------------
Issuer interest must exceed required minimum $37.7 million $32.0 million
Gross loss rate must be lower than required maximum 3.4% 10.0%
Net portfolio yield must exceed required minimum 10.0% 2.0%
Payment rate must exceed required minimum 6.8% 3.0%
Note: All terms in the above table are defined by the asset backed credit
facility and may or may not agree directly to the financial statement
captions in this document.
Events of default under the Series A variable funding note and the Series B
bonds, subject to grace periods and notice provisions in some circumstances,
include, among others: failure of the issuer to pay principal, interest or fees;
violation by the issuer of any of its covenants or agreements; inaccuracy of any
representation or warranty made by the issuer; certain servicer defaults;
failure of the trustee to have a valid and perfected first priority security
interest in the collateral; default under or acceleration of certain other
indebtedness; bankruptcy and insolvency events; failure to maintain certain loss
ratios and portfolio yield; change of control provisions and certain other
events pertaining to us. The issuer's obligations under the program are secured
by the receivables and proceeds.
22
SECURITIZATION FACILITIES
We finance most of our customer receivables through asset-backed
securitization facilities
| ------------------------------
| Series A Note
| -----------> $250 million
| Credit Rating: P1/A2
| Three Pillars Funding Corp.
CUSTOMER RECEIVABLES | ------------------------------
--------------------- -------------> ----------------------- |
Retail Qualifying |
Sales Special Purpose |
Entity Entity <--------|
("QSPE") |
--------------------- <------------ ----------------------- |
| -------------------------------
1. Cash Proceeds | Series B Bonds
2. Subordinated Securities | $200 million
3. Right to Receive Cash Flows | Private Institutional
Equal to Interest Rate Spread | -----------> Investors
| Class A: $120 mm (Aaa)
| Class B: $57.8 mm (A2)
| Class C: $22.2 mm (Baa2)
| -------------------------------
Both the bank credit facility and the asset-backed securitization program
are significant factors relative to our ongoing liquidity and our ability to
meet the cash needs associated with the growth of our business. Our inability to
use either of these programs because of a failure to comply with their covenants
would adversely affect our continued growth. Funding of current and future
receivables under the QSPE's asset-backed securitization program can be
adversely affected if we exceed certain predetermined levels of re-aged
receivables, size of the secondary portfolio, the amount of promotional
receivables, write-offs, bankruptcies or other ineligible receivable amounts. If
the funding under the QSPE's asset-backed securitization program was reduced or
terminated, we would have to draw down our bank credit facility more quickly
than we have estimated.
On October 29, 2004, through our QSPE, we entered a "First Supplemental
Indenture" amending the "Base Indenture" dated September 1, 2002 (as amended,
supplemented and otherwise modified through the date of the First Supplemental
Indenture). This amendment allows us to include certain retail installment
contracts and revolving charge agreement receivables, including cash option and
deferred interest receivables for terms up to thirty-six months in the eligible
asset base of its asset backed securitization financing arrangements, providing
partial funding of these receivables. These cash option and deferred interest
receivables are limited to 30% of all eligible receivables with deferred
interest receivables limited to 10% of all eligible receivables.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest rates under our bank credit facility (as amended November 15,
2004) are variable and are determined, at our option, as the base rate, which is
the greater of prime rate or federal funds rate plus 0.50% plus the base rate
margin, which ranges from 0.00% to 0.75%, or LIBOR plus the LIBOR margin, which
ranges from 1.00% to 2.00%. Accordingly, changes in the prime rate, the federal
funds rate or LIBOR, which are affected by changes in interest rates generally,
will affect the interest rate on, and therefore our costs under, our bank credit
facility. We are also exposed to interest rate risk associated with our interest
only strip and the subordinated securities we receive from our sales of
receivables to the QSPE.
23
We held interest rate swaps and collars with notional amounts totaling
$20.0 million as of January 31, 2004 and October 31, 2004, with terms extending
through April, 2005, and which were held for the purpose of hedging against
variable interest rate risk, primarily related to cash flows from our
interest-only strip as well as our variable rate debt. There have been no
material changes in our interest rate risks since January 31, 2004.
ITEM 4. CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer, regarding the effectiveness of our disclosure controls and
procedures (as defined in 15d-15(e) of the Securities Exchange Act of 1934 (the
"Exchange Act") as of the end of the period covered by this quarterly report.
Based on that evaluation, our management, including our Chief Executive Officer
and our Chief Financial Officer, concluded that our disclosure controls and
procedures are effective in timely alerting them to material information
relating to our Company (including its consolidated subsidiaries) required to be
included in our periodic filings with the Securities and Exchange Commission.
There have been no changes in our internal control over financial reporting that
occurred during the quarter ended October 31, 2004 that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In December 2002, Martin E. Smith, as named plaintiff, filed a lawsuit
against us in the state district court in Jefferson County, Texas, that attempts
to create a class action for breach of contract and violations of state and
federal consumer protection laws arising from the terms of our service
maintenance agreements. The lawsuit alleges an inappropriate overlap in the
warranty periods provided by the manufacturers of our products and the periods
covered by the service maintenance agreements that we sell. The lawsuit seeks
unspecified actual damages as well as an injunction against our current
practices and extension of affected service contracts. We believe that the
warranty periods provided by our service maintenance agreements are consistent
with industry practice. We believe that it is premature to predict whether class
action status will be granted or, if it is granted, the outcome of this
litigation. There is not currently a basis on which to estimate a range of
potential loss in this matter.
We are involved in routine litigation incidental to our business from time
to time. We do not expect the outcome of any of this routine litigation to have
a material effect on our financial condition or results of operations.
ITEM 5. OTHER INFORMATION
There have been no material changes to the procedures by which security
holders may recommend nominees to our board of directors since we last provided
disclosure in response to the requirements of Item 7(d)(2)(ii)(G) of Schedule
14A.
ITEM 6. EXHIBITS
The exhibits required to be furnished pursuant to Item 6 of Form 10-Q are
listed in the Exhibit Index filed herewith, which Exhibit Index is incorporated
herein by reference.
24
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
CONN'S, INC.
By: /S/ C. WILLIAM FRANK
-----------------------------------
C. William Frank
Executive Vice President and
Chief Financial Officer
(PRINCIPAL FINANCIAL OFFICER AND
DULY AUTHORIZED TO SIGN THIS
REPORT ON BEHALF OF THE
REGISTRANT)
Date: December 3, 2004
25
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- -------- -----------
2 Agreement and Plan of Merger dated January 15, 2003, by and among
Conn's, Inc., Conn Appliances, Inc. and Conn's Merger Sub, Inc.
(incorporated herein by reference to Exhibit 2 to Conn's, Inc.
registration statement on Form S-1 (file no. 333-109046)).
3.1 Certificate of Incorporation of Conn's, Inc. (incorporated herein by
reference to Exhibit 3.1 to Conn's, Inc. registration statement on Form
S-1 (file no. 333-109046)).
3.1.1 Certificate of Amendment to the Certificate of Incorporation of Conn's,
Inc. filed on June 3, 2004 (incorporated herein by reference to Exhibit
3.1.1 of Conn's quarterly report on Form 10-Q for the quarter ended
April 30, 2004).
3.2 Bylaws of Conn's, Inc. (incorporated herein by reference to Exhibit 3.2
to Conn's, Inc. registration statement on Form S-1 (file no.
333-109046)).
3.2.1 Amendment to the Bylaws of Conn's, Inc. (incorporated herein by
reference to Exhibit 3.2.1 of Conn's quarterly report on Form 10-Q for
the quarter ended April 30, 2004).
4.1 Specimen of certificate for shares of Conn's, Inc.'s common stock
(incorporated herein by reference to Exhibit 4.1 to Conn's, Inc.
registration statement on Form S-1 (file no. 333-109046)).
10.1 Amended and Restated 2003 Incentive Stock Option Plan (incorporated
herein by reference to Exhibit 10.1 to Conn's, Inc. registration
statement on Form S-1 (file no. 333-109046)).
10.1.1 Amendment to the Conn's, Inc. Amended and Restated 2003 Incentive Stock
Option Plan (incorporated herein by reference to Exhibit 10.1.1 of
Conn's quarterly report on Form 10-Q for the quarter ended April 30,
2004).
10.2 2003 Non-Employee Director Stock Option Plan (incorporated herein by
reference to Exhibit 10.2 to Conn's, Inc. registration statement on
Form S-1 (file no. 333-109046)).
10.3 Employee Stock Purchase Plan (incorporated herein by reference to
Exhibit 10.3 to Conn's, Inc. registration statement on Form S-1 (file
no. 333-109046)).
10.4 Conn's 401(k) Retirement Savings Plan (incorporated herein by reference
to Exhibit 10.4 to Conn's, Inc. registration statement on Form S-1
(file no. 333-109046)).
10.5 Shopping Center Lease Agreement dated May 3, 2000, by and between
Beaumont Development Group, L.P., f/k/a Fiesta Mart, Inc., as Lessor,
and CAI, L.P., as Lessee, for the property located at 3295 College
Street, Suite A, Beaumont, Texas (incorporated herein by reference to
Exhibit 10.5 to Conn's, Inc. registration statement on Form S-1 (file
no. 333-109046)).
26
10.5.1 First Amendment to Shopping Center Lease Agreement dated September 11,
2001, by and among Beaumont Development Group, L.P., f/k/a Fiesta Mart,
Inc., as Lessor, and CAI, L.P., as Lessee, for the property located at
3295 College Street, Suite A, Beaumont, Texas (incorporated herein by
reference to Exhibit 10.5.1 to Conn's, Inc. registration statement on
Form S-1 (file no. 333-109046)).
10.6 Industrial Real Estate Lease dated June 16, 2000, by and between
American National Insurance Company, as Lessor, and CAI, L.P., as
Lessee, for the property located at 8550-A Market Street, Houston,
Texas (incorporated herein by reference to Exhibit 10.6 to Conn's, Inc.
registration statement on Form S-1 (file no. 333-109046)).
10.7 Lease Agreement dated December 5, 2000, by and between Prologis
Development Services, Inc., f/k/a The Northwestern Mutual Life
Insurance Company, as Lessor, and CAI, L.P., as Lessee, for the
property located at 4810 Eisenhauer Road, Suite 240, San Antonio, Texas
(incorporated herein by reference to Exhibit 10.7 to Conn's, Inc.
registration statement on Form S-1 (file no. 333-109046)).
10.7.1 Lease Amendment No. 1 dated November 2, 2001, by and between Prologis
Development Services, Inc., f/k/a The Northwestern Mutual Life
Insurance Company, as Lessor, and CAI, L.P., as Lessee, for the
property located at 4810 Eisenhauer Road, Suite 240, San Antonio, Texas
(incorporated herein by reference to Exhibit 10.7.1 to Conn's, Inc.
registration statement on Form S-1 (file no. 333-109046)).
10.8 Lease Agreement dated August 18, 2003, by and between Robert K. Thomas,
as Lessor, and CAI, L.P., as Lessee, for the property located at
4610-12 McEwen Road, Dallas, Texas (incorporated herein by reference to
Exhibit 10.8 to Conn's, Inc. registration statement on Form S-1 (file
no. 333-109046)).
10.9 Credit Agreement dated April 24, 2003, by and among Conn Appliances,
Inc. and the Borrowers thereunder, the Lenders party thereto, JPMorgan
Chase Bank, as Administrative Agent, Bank of America, N.A., as
Syndication Agent, and SunTrust Bank, as Documentation Agent
(incorporated herein by reference to Exhibit 10.9 to Conn's, Inc.
registration statement on Form S-1 (file no. 333-109046)).
10.9.1 Amendment to Credit Agreement, dated April 7, 2004, by and among Conn
Appliances, Inc. and the Borrowers thereunder, the Lenders party
thereto, JPMorgan Chase Bank, as Administrative Agent, Bank of America,
N.A., as Syndication Agent, and SunTrust Bank, as Documentation Agent
(incorporated herein by reference to Exhibit 99.1 to Conn's current
report on Form 8-K filed on April 23, 2004).
10.9.2 Second Amendment to Credit Agreement, effective as of November 15, 2004
by and among Conn Appliances, Inc and the Borrowers thereunder, the
Lenders party thereto, JPMorgan Chase Bank, as Administrative Agent
(incorporated herein by reference to Exhibit 99.1 to Conn's current
report on Form 8-K filed on November 17, 2004).
10.9.3 Letter of Credit Agreement, effective as of November 15, 2004 by and
among Conn Appliances, Inc. and the Borrowers thereunder, the Lenders
party thereto, JPMorgan Chase Bank, as Administrative Agent
(incorporated herein by reference to Exhibit 99.2 to Conn's current
report on Form 8-K filed on November 17, 2004).
10.10 Receivables Purchase Agreement dated September 1, 2002, by and among
Conn Funding II, L.P., as Purchaser, Conn Appliances, Inc. and CAI,
L.P., collectively as Originator and Seller, and Conn Funding I, L.P.,
as Initial Seller (incorporated herein by reference to Exhibit 10.10 to
Conn's, Inc. registration statement on Form S-1 (file no. 333-109046)).
10.10.1 First Supplemental Indenture dated October 29, 2004 by and among Conn
Funding II, L.P., as Issuer and Wells Fargo Bank, National Association,
as Trustee (incorporated herein by reference to Exhibit 99.1 to Conn's
current report on Form 8-K filed November 4, 2004).
10.11 Base Indenture dated September 1, 2002, by and between Conn Funding II,
L.P., as Issuer, and Wells Fargo Bank Minnesota, National Association,
as Trustee (incorporated herein by reference to Exhibit 10.11 to
Conn's, Inc. registration statement on Form S-1 (file no. 333-109046)).
10.12 Series 2002-A Supplement to Base Indenture dated September 1, 2002, by
and between Conn Funding II, L.P., as Issuer, and Wells Fargo Bank
Minnesota, National Association, as Trustee (incorporated herein by
reference to Exhibit 10.12 to Conn's, Inc. registration statement on
Form S-1 (file no. 333-109046)).
27
10.13 Series 2002-B Supplement to Base Indenture dated September 1, 2002, by
and between Conn Funding II, L.P., as Issuer, and Wells Fargo Bank
Minnesota, National Association, as Trustee (incorporated herein by
reference to Exhibit 10.13 to Conn's, Inc. registration statement on
Form S-1 (file no. 333-109046)).
10.14 Servicing Agreement dated September 1, 2002, by and among Conn Funding
II, L.P., as Issuer, CAI, L.P., as Servicer, and Wells Fargo Bank
Minnesota, National Association, as Trustee (incorporated herein by
reference to Exhibit 10.14 to Conn's, Inc. registration statement on
Form S-1 (file no. 333-109046)).
10.15 Form of Executive Employment Agreement (incorporated herein by
reference to Exhibit 10.15 to Conn's, Inc. registration statement on
Form S-1 (file no. 333-109046)).
10.16 Form of Indemnification Agreement (incorporated herein by reference to
Exhibit 10.16 to Conn's, Inc. registration statement on Form S-1 (file
no. 333-109046)).
11.1 Statement re: computation of earnings per share is included under Note
1 to the financial statements.
31.1 Rule 13a-14(a)/15d-14(a) Certification (Chief Executive Officer) (filed
herewith).
31.2 Rule 13a-14(a)/15d-14(a) Certification (Chief Financial Officer) (filed
herewith).
32.1 Section 1350 Certification (Chief Executive Officer and Chief Financial
Officer) (furnished herewith).
99.1 Subcertification of Chief Operating Officer in support of Rule
13a-14(a)/15d-14(a) Certification (Chief Executive Officer) (filed
herewith).
99.2 Subcertification of Secretary/Treasurer in support of Rule
13a-14(a)/15d-14(a) Certification (Chief Executive Officer) (filed
herewith).
99.3 Subcertification of Chief Operating Officer and Secretary/Treasurer in
support of Section 1350 Certifications (furnished herewith).
28