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 July 31, 2005 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 of (I.R.S. Employer
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 X NO
---- ----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of August 26, 2005:
Class Outstanding
- ------------------------------------------------ -----------------------
Common stock, $.01 par value per share 23,424,836
TABLE OF CONTENTS
-----------------
PART I. FINANCIAL INFORMATION Page No.
--------------------- --------
Item 1. Financial Statements...........................................................................1
- -------
Consolidated Balance Sheets as of January 31, 2005 and July 31, 2005...........................1
Consolidated Statements of Operations for the three and six months ended
July 31, 2004 and 2005.....................................................................2
Consolidated Statement of Stockholders' Equity for the six months ended
July 31, 2005..............................................................................3
Consolidated Statements of Cash Flows for the six months ended
July 31, 2004 and 2005.....................................................................4
Notes to Consolidated Financial Statements.....................................................5
Item 2. Management's Discussion and Analysis of Financial Condition
- ------ and Results of Operations.................................................................12
Item 3. Quantitative and Qualitative Disclosures About Market Risk....................................27
- -------
Item 4. Controls and Procedures.......................................................................27
- -------
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................................................27
- -------
Item 4. Submission of Matters to a Vote of Security Holders...........................................27
- ------
Item 5. Other Information.............................................................................28
- -------
Item 6. Exhibits......................................................................................28
- -------
SIGNATURE ..............................................................................................29
i
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Conn's, Inc.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
January 31, July 31,
2005 2005
-------- --------
Assets (unaudited)
Current assets
Cash and cash equivalents .................................................................. $ 7,027 $ 19,049
Accounts receivable, net ................................................................... 26,135 20,822
Interests in securitized assets ............................................................ 105,159 115,393
Inventories ................................................................................ 62,346 60,846
Deferred income taxes ...................................................................... 4,901 6,613
Prepaid expenses and other assets .......................................................... 3,356 2,578
-------- --------
Total current assets .................................................................... 208,924 225,301
Non-current deferred income tax asset ......................................................... 1,523 2,315
Property and equipment
Land ....................................................................................... 2,919 4,701
Buildings .................................................................................. 8,068 8,163
Equipment and fixtures ..................................................................... 10,036 11,775
Transportation equipment ................................................................... 4,419 2,949
Leasehold improvements ..................................................................... 56,926 63,051
-------- --------
Subtotal ................................................................................ 82,368 90,639
Less accumulated depreciation ................................................................. (34,658) (38,419)
-------- --------
Total property and equipment, net ....................................................... 47,710 52,220
Goodwill, net ................................................................................. 9,617 9,617
Debt issuance costs and other assets, net ..................................................... 229 160
-------- --------
Total assets ........................................................................... $268,003 $289,613
======== ========
Liabilities and Stockholders' Equity
Current liabilities
Notes payable .............................................................................. $5,500 $-
Current portion of long-term debt .......................................................... 29 18
Accounts payable ........................................................................... 26,912 33,510
Accrued compensation and related expenses .................................................. 6,221 10,425
Accrued expenses ........................................................................... 13,662 14,171
Deferred income taxes ...................................................................... 966 570
Deferred revenues and allowances ........................................................... 7,383 8,403
Fair value of derivatives .................................................................. 177 -
-------- --------
Total current liabilities ............................................................... 60,850 67,097
Long-term debt ................................................................................ 5,003 -
Non-current deferred income tax liability ..................................................... 704 820
Deferred gain on sale of property ............................................................. 644 560
Stockholders' equity
Preferred stock ($0.01 par value, 1,000,000 shares authorized;
none issued or outstanding) ................................................................ - -
Common stock ($0.01 par value, 40,000,000 shares authorized;
23,267,596 and 23,388,235 shares issued and outstanding
at January 31, 2005 and July 31, 2005, respectively) ..................................... 233 234
Additional paid-in capital ................................................................. 84,257 85,347
Accumulated other comprehensive income ..................................................... 7,516 7,633
Retained earnings .......................................................................... 108,796 127,922
-------- --------
Total stockholders' equity .............................................................. 200,802 221,136
-------- --------
Total liabilities and stockholders' equity ........................................... $268,003 $289,613
======== ========
See notes to consolidated financial statements.
1
Conn's, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except earnings per share)
Three Months Ended Six Months Ended
July 31, July 31,
------------------- -------------------
2004 2005 2004 2005
--------- --------- --------- ---------
Revenues
Product sales ............................................................. $ 108,305 $130,867 $216,808 $258,142
Service maintenance agreement commissions, net ............................ 5,776 7,848 11,436 14,732
Service revenues .......................................................... 4,770 5,134 9,149 9,909
--------- --------- --------- ---------
Total net sales ........................................................ 118,851 143,849 237,393 282,783
Finance charges and other ................................................. 17,750 20,526 34,085 39,755
--------- --------- --------- ---------
Total revenues ......................................................... 136,601 164,375 271,478 322,538
Cost and expenses
Cost of goods sold, including warehousing
and occupancy costs ...................................................... 85,704 103,579 170,479 204,496
Cost of parts sold, including warehousing
and occupancy costs ...................................................... 1,092 1,236 2,195 2,461
Selling, general and administrative expense ............................... 37,521 44,700 72,383 84,182
Provision for bad debts ................................................... 1,227 443 2,649 1,595
--------- --------- --------- ---------
Total cost and expenses ................................................ 125,544 149,958 247,706 292,734
--------- --------- --------- ---------
Operating income ............................................................. 11,057 14,417 23,772 29,804
Interest expense, net ........................................................ 567 59 1,149 414
--------- --------- --------- ---------
Income before minority interest and income taxes ............................. 10,490 14,358 22,623 29,390
Minority interest in limited partnership ..................................... 131 - 246 -
--------- --------- --------- ---------
Income before income taxes ................................................... 10,359 14,358 22,377 29,390
Provision for income taxes
Current ................................................................... 4,352 5,564 9,035 13,107
Deferred .................................................................. (783) (530) (1,221) (2,843)
--------- --------- --------- ---------
Total provision for income taxes ....................................... 3,569 5,034 7,814 10,264
--------- --------- --------- ---------
Net income ................................................................... $ 6,790 $ 9,324 $ 14,563 $ 19,126
========= ========= ========= =========
Earnings per share
Basic ..................................................................... $ 0.29 $ 0.40 $ 0.63 $ 0.82
Diluted ................................................................... $ 0.29 $ 0.39 $ 0.61 $ 0.80
Average common shares outstanding
Basic ..................................................................... 23,179 23,366 23,163 23,337
Diluted ................................................................... 23,801 24,114 23,769 23,987
See notes to consolidated financial statements.
2
Conn's, Inc.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Six Months Ended July 31, 2005
(unaudited)
(in thousands except descriptive shares)
Accum.
Other
Common Stock Compre- Additional
------------ hensive Paid-in Retained
Shares Amount Income Capital Earnings Total
------- ------ ------- -------- --------- ---------
Balance January 31, 2005 ......................................... 23,268 $ 233 $ 7,516 $84,257 $108,796 $200,802
Exercise of options to acquire
114,820 shares of common stock ................................ 114 1 - 1,003 - 1,004
Issuance of 5,820 shares of
common stock under
Employee Stock Purchase Plan .................................. 6 - - 87 - 87
Net income ....................................................... - - - - 19,126 19,126
Reclassification adjustments on
derivative instruments
(net of tax of $86) ........................................... - - 160 - - 160
Adjustment of fair value of securitized
assets (net of tax of $27), net of
reclassification adjustments of
$4,621 (net of tax of $2,499) ................................. - - (43) - - (43)
---------
Total comprehensive income ....................................... 19,243
------- ------ ------- --------- --------- ---------
Balance July 31, 2005 ............................................ 23,388 $ 234 $7,633 $85,347 $127,922 $221,136
======= ====== ======= ========= ========= =========
See notes to consolidated financial statements.
3
Conn's, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Six Months Ended
July 31,
-----------------
2004 2005
------- -------
Cash flows from operating activities
Net income .......................................................................................... $14,563 $19,126
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation ..................................................................................... 3,972 5,407
Amortization ..................................................................................... 15 (131)
Provision for bad debts .......................................................................... 2,649 1,595
Discounts on promotional credit .................................................................. 757 536
Accretion from interests in securitized assets ................................................... (7,636) (7,120)
Provision for deferred income taxes .............................................................. (1,221) (2,843)
Loss (Gain) from sale of property and equipment .................................................. (14) 34
Loss (Gain) from derivatives ..................................................................... (36) 69
Changes in operating assets and liabilities:
Accounts receivable .............................................................................. (13,687) 33
Inventory ........................................................................................ (4,085) 1,500
Prepaid expenses and other assets ................................................................ 905 778
Accounts payable ................................................................................. 6,409 6,598
Accrued expenses ................................................................................. (389) 4,713
Income taxes payable ............................................................................. (1,807) -
Deferred revenue and allowances .................................................................. 201 1,101
------- -------
Net cash provided by operating activities ........................................................... 596 31,396
------- -------
Cash flows from investing activities
Purchase of property and equipment .................................................................. (9,047) (9,964)
Proceeds from sale of property ...................................................................... 15 13
------- -------
Net cash used in investing activities ............................................................... (9,032) (9,951)
------- -------
Cash flows from financing activities
Proceeds from stock issued under employee benefit plans,
including tax benefit ............................................................................... 687 1,091
Net borrowings (payments) under lines of credit ..................................................... 1,049 (10,500)
Increase in debt issuance costs ..................................................................... (70) -
Payment of promissory notes ......................................................................... (34) (14)
------- -------
Net cash provided by (used in) financing activities ................................................. 1,632 (9,423)
------- -------
Impact on cash of consolidation of SRDS ............................................................. 190 -
------- -------
Net change in cash .................................................................................. (6,614) 12,022
Cash and cash equivalents
Beginning of the year ............................................................................... 12,942 7,027
------- -------
End of period ....................................................................................... $6,328 $19,049
======= =======
See notes to consolidated financial statements.
4
Conn's, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
July 31, 2005
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 six month
periods ended July 31, 2005 are not necessarily indicative of the results that
may be expected for the year ending January 31, 2006. 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 5, 2005.
The Company's balance sheet at January 31, 2005 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, 2005 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. The resulting assets are
valued on a revolving pool basis. 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.
Application of FIN 46. In January 2003, the Financial Accounting Standards
Board issued Interpretation No. 46, Consolidation of Variable Interest Entities,
An Interpretation of Accounting Research Bulletin No. 51, or FIN 46. FIN 46
requires entities, generally, to be consolidated by a company when it has a
controlling financial interest through ownership, direct or indirect, of a
majority voting interest in an entity with which it conducts business. The
Company evaluated the effects of the issuance of FIN 46 on the accounting for
its leases with Specialized Realty Development Services, LP ("SRDS") and
determined that it was appropriate to consolidate the balance sheet of SRDS with
the Company as of January 31, 2004. As of January 31, 2005, the Company no
longer leased any of its facilities from SRDS and therefore FIN 46 no longer
applies and the Company no longer consolidates SRDS's balance sheet or statement
of operations. However, the operations of SRDS are consolidated with those of
the Company commencing on February 1, 2004 through the last effective date of
the Company's leases with SRDS of January 30, 2005. The effect of such
consolidation on the Company's Statement of Operations for the three months
ended July 31, 2004 was to reduce "Selling, general and administrative expense"
by $0.3 million, to increase "Interest expense" by $0.2 million and to reduce
"Income before income taxes" by $0.1 million for "Minority interest in limited
partnership". The effect of such consolidation on the Company's Statement of
Operations for the six months ended July 31, 2004 was to reduce "Selling,
general and administrative expense" by $0.6 million, to increase "Interest
expense" by $0.4 million and to reduce "Income before income taxes" by $0.2
million for "Minority interest in limited partnership". The Company had no
exposure to losses incurred by SRDS.
5
Conn's, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued
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. The following table sets forth the shares outstanding for the
earnings per share calculations:
Three Months Ended Six Months Ended
July 31, July 31,
---------------------- ----------------------
2004 2005 2004 2005
----------- ----------- ----------- -----------
Common stock outstanding, beginning of period 23,172,798 23,351,044 23,101,772 23,267,596
Weighted average common stock issued in stock
option exercises 5,813 13,699 60,725 67,066
Weighted average common stock issued to employee
stock purchase plan 780 1,040 394 2,451
----------- ----------- ----------- -----------
Shares used in computing basic earnings per share 23,179,391 23,365,783 23,162,891 23,337,113
Dilutive effect of stock options, net of assumed
repurchase of treasury stock 621,344 747,971 606,127 649,688
----------- ----------- ----------- -----------
Shares used in computing diluted earnings per share 23,800,735 24,113,754 23,769,018 23,986,801
=========== =========== =========== ===========
Goodwill. Goodwill represents 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 at January 31, 2005 and
July 31, 2005 that 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 July
31, 2005 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 July 31, 2004 and 2005 would have decreased by 3.7% and 3.5%,
respectively; net income available for common stockholders for the six months
ended July 31, 2004 and 2005 would have decreased by 3.2% and 3.4%,
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. Fair value compensation expense for the employee stock purchase plan was
computed as the 15% discount from fair market value the employee receives when
purchasing the shares. 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 Six Months Ended
July 31, July 31,
----------------- ----------------
2004 2005 2004 2005
---------- ------- -------- --------
Net income available for common stockholders as reported ........................... $6,790 $9,324 $14,563 $19,126
Stock-based compensation, net of tax, that would have
been reported under SFAS 123 ....................................................... (252) (330) (473) (654)
------- ------- -------- --------
Pro forma net income ............................................................... $6,538 $8,994 $14,090 $18,472
======= ======= ======== ========
Earnings per share-as reported:
Basic .............................................................................. $ 0.29 $ 0.40 $ 0.63 $ 0.82
Diluted ............................................................................ $ 0.29 $ 0.39 $ 0.61 $ 0.80
Pro forma earnings per share:
Basic .............................................................................. $ 0.28 $ 0.38 $ 0.61 $ 0.79
Diluted ............................................................................ $ 0.27 $ 0.37 $ 0.59 $ 0.77
Application of APB 21 to Promotional Credit 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 months ended July 31,
2004 and 2005, Product sales were reduced by $716,000 and $1.0 million,
respectively, and Finance charges and other was increased by $143,000 and
$577,000, respectively, to effect the adjustment to fair value and to reflect
the appropriate amortization of the discount. For the six months ended July 31,
2004 and 2005, Product sales were reduced by $929,000 and $1.6 million,
respectively, and Finance charges and other was increased by $172,000 and $1.1
million, respectively, to effect the adjustment to fair value and to reflect the
appropriate amortization of the discount
Recent Accounting Pronouncements. In December 2004, SFAS No. 123R,
Share-Based Payment, was issued. The statement is a revision of SFAS No. 123 and
supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. This
statement establishes standards for accounting for transactions in which an
entity exchanges its equity instruments for goods or services. It also addresses
transactions in which an entity incurs liabilities in exchange for goods or
services that are based on the fair value of the entity's equity instruments or
that may be settled by the issuance of those equity instruments. The statement
focuses primarily on accounting for transactions in which an entity obtains
employee services in share-based payment transactions, and does not change the
previous accounting guidance for share-based payment transactions with parties
other than employees. This statement requires a public entity to measure the
cost of employee services received in exchange for an award of equity
instruments based on the grant-date fair value of the award and record that cost
over the period during which the employee is required to provide service in
exchange for the award. Additionally, employee services received in exchange for
liability awards will be measured at fair value and re-measured at each
reporting date, with changes in the fair value recorded as compensation cost
over that period.
7
Conn's, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued
This statement applies to all awards granted after the required effective
date and to awards modified, repurchased or cancelled after that date. The
cumulative effect of initially applying this statement, if any, is recognized as
of the required effective date. As of the required effective date, all public
entities will apply this statement using a modified version of prospective
application, which requires recognition of compensation cost on or after the
required effective date for the portion of outstanding awards for which the
requisite service has not yet been rendered. For periods before the required
effective date, entities may elect to apply a modified version of retrospective
application under which financial statements for prior periods are adjusted on a
basis consistent with the pro forma disclosures required for those periods by
Statement No. 123. This statement was originally effective for public companies,
beginning with the first interim or annual period beginning after June 15, 2005.
However, in April 2005, the Securities and Exchange Commission changed the
required effective date for public companies to the first fiscal year beginning
after June 15, 2005. The Company is currently analyzing the impact this
statement will have on its consolidated results of operations and its financial
position.
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
The following is a summary of the classification of the amounts included as
Finance charges and other for the three and six months ended July 31, 2004 and
2005 (in thousands):
Three Months Ended Six Months Ended
July 31, July 31,
------------------ ----------------
2004 2005 2004 2005
-------- -------- ------- --------
Securitization income ......................................................... $11,922 $14,744 $22,745 $27,782
Income from receivables not sold .............................................. 300 304 595 584
Insurance commissions ......................................................... 4,450 4,292 8,761 8,958
Other ......................................................................... 1,078 1,186 1,984 2,431
-------- -------- -------- --------
Finance charges and other ..................................................... $17,750 $20,526 $34,085 $39,755
======== ======== ======== ========
The components of total comprehensive income for the three and six months
ended July 31, 2004 and 2005 are presented in the table below (in thousands):
Three Months Ended Six Months Ended
July 31, July 31,
------------------ ----------------
2004 2005 2004 2005
-------- -------- ------- --------
Net income .................................................................... $6,790 $9,324 $14,563 $19,126
Unrealized gain on derivative instruments ..................................... 278 - 556 246
Taxes on unrealized gain on derivatives ....................................... (98) - (196) (86)
Adjustment of fair value of securitized assets ................................ 521 1,530 1,323 (70)
Taxes on adjustment of fair value ............................................. (184) (533) (467) 27
------- -------- -------- --------
Total comprehensive income .................................................... $7,307 $10,321 $15,779 $19,243
======= ======== ======== ========
During the three months ended July 31, 2005, the Company revised its
assumption for credit losses to 3.0%, from 3.4%, to more closely reflect its
historical loss experience over the past twelve months. This change had the
impact of increasing the fair value of the Interests in securitized assets and
had no impact on Income before income taxes. The Company's credit losses are
computed net of all recoveries. Credit losses in the future will be impacted by
the average age of the loans in the revolving loan pool, the economic
environment in the regions we serve and the effectiveness of our loan
underwriting and collection efforts. If the average age of the loans in the
revolving loan pool increases, economic conditions in our markets decline or our
underwriting or collection efforts become less effective, we would expect our
estimate for credit losses to increase.
8
Conn's, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued
3. Supplemental Disclosure Regarding Managed Receivables
The following tables present quantitative information about the receivables
portfolios managed by the Company (in thousands):
Total Principal Principal Amount
Amount of 60 Days
Receivables or More Past Due (1)
------------------- -----------------
January 31, July 31, January 31, July 31,
2005 2005 2005 2005
--------- --------- -------- --------
Primary portfolio:
Installment ....................................................... $328,042 $352,785 $16,636 $16,140
Revolving ......................................................... 30,210 36,777 867 924
--------- --------- -------- --------
Subtotal ..................................................................... 358,252 389,562 17,503 17,064
Secondary portfolio:
Installment ....................................................... 70,448 83,126 5,640 5,951
--------- --------- -------- --------
Total receivables managed .................................................... 428,700 472,688 23,143 23,015
Less receivables sold ........................................................ 419,172 462,940 21,540 21,408
--------- --------- -------- --------
Receivables not sold ......................................................... 9,528 9,748 $1,603 $1,607
======== ========
Non-customer receivables ..................................................... 16,607 11,074
--------- ---------
Total accounts receivable, net ..................................... $26,135 $20,822
========= =========
Average Balances Net Credit Losses (2)
------------------- --------------------
Three Months Ended Three Months Ended
July 31, July 31,
------------------- ---------------
2004 2005 2004 2005
--------- --------- ------- -------
Primary portfolio:
Installment ....................................................... $285,108 $344,728
Revolving ......................................................... 23,946 33,237
--------- ---------
Subtotal ..................................................................... 309,054 377,965 $2,266 $3,084
Secondary portfolio:
Installment ....................................................... 62,802 80,632 692 418
--------- --------- ------- -------
Total receivables managed .................................................... 371,856 458,597 2,958 3,502
Less receivables sold ........................................................ 362,537 449,081 2,626 3,450
--------- --------- ------- -------
Receivables not sold ......................................................... $9,319 $9,516 $332 $52
========= ========= ======= =======
9
Conn's, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued
Average Balances Net Credit Losses (2)
------------------- --------------------
Six Months Ended Six Months Ended
July 31, July 31,
------------------- ---------------
2004 2005 2004 2005
--------- --------- ------- -------
Primary portfolio:
Installment ....................................................... $279,428 $338,315
Revolving ......................................................... 23,981 32,025
--------- ---------
Subtotal ..................................................................... 303,409 370,340 $4,990 $5,739
Secondary portfolio:
Installment ....................................................... 60,933 77,679 1,328 1,039
--------- --------- ------- -------
Total receivables managed .................................................... 364,342 448,019 6,318 6,778
Less receivables sold ........................................................ 354,941 438,533 5,649 6,536
--------- --------- ------- -------
Receivables not sold ......................................................... $9,401 $9,486 $669 $242
========= ========= ======= =======
(1) Amounts are based on end of period balances. The principal amount 60 days
or more past due relative to total receivables managed is not necessarily
indicative of relative balances expected at other times during the year due
to seasonal fluctuations in delinquency,
(2) Amounts represent total loan loss provision, net of recoveries, on total
receivables.
4. Fair Value of Derivatives
The Company held interest rate swaps and collars with notional amounts
totaling $20.0 million as of July 31, 2004, which expired on April 15, 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 2004, hedge accounting was discontinued for the $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 months ended July 31, 2004 and 2005, the Company reclassified
$278,000 and $0, respectively, of losses previously recorded in accumulated
other comprehensive income into the consolidated statements of operations and
recorded $(316,000) and $0, respectively, of interest reductions in the
consolidated statements of operations because of the change in fair value of the
swaps. During the six months ended July 31, 2004 and 2005, the Company
reclassified $556,000 and $246,000, respectively, of losses previously recorded
in accumulated other comprehensive income into the consolidated statements of
operations and recorded $(621,000) and $(177,000), respectively, of interest
reductions in the consolidated statements of operations because of the change in
fair value of the swaps.
5. Letters of Credit
The Company utilizes unsecured letters of credit to secure a portion of the
QSPE's asset-backed securitization program, deductibles under the Company's
insurance programs and international product purchases. At January 31, 2005 and
July 31, 2005, the Company had outstanding unsecured letters of credit of $12.1
million and $12.4 million, respectively. These letters of credit were issued
under the three following facilities:
o The Company has a $5.0 million sublimit provided under its revolving
line of credit for stand-by and import letters of credit. At July 31,
2005, $1.9 million of letters of credit were outstanding and callable
at the option of the Company's insurance carrier if the Company does
not honor its requirement to fund deductible amounts as billed under
its insurance program.
o The Company has arranged for a $10.0 million stand-by letter of credit
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 expiring in August 2005, which
the Company is in the process of renewing.
10
Conn's, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued
o The Company obtained a $1.5 million commitment for trade letters of
credit to secure product purchases under an international arrangement.
At July 31, 2005, $497,000 of letters of credit were outstanding under
this commitment. The letter of credit commitment has expired and the
Company is in the process of renewing the agreement.
The maximum potential amount of future payments under these letter of credit
facilities is considered to be the aggregate face amount of each letter of
credit commitment, which total $16.5 million as of July 31, 2005.
6. Contingencies
Legal Proceedings. The Company is involved in routine litigation incidental
to its business from time to time. Currently, the Company does not expect the
outcome of any of this routine litigation to have a material effect on its
financial condition or results of operations. However, the results of these
proceedings cannot be predicted with certainty, and changes in facts and
circumstances could impact the Company's estimate of reserves for litigation.
Service Maintenance Agreement Obligations. In November 2002, FASB
Interpretation No. 45, Guarantor's Accounting and Disclosure Requirement for
Guarantees, Including Indirect Guarantees of Indebtedness of Other, was issued.
Among other things, this interpretation requires enhanced disclosures made by a
guarantor about its obligations under certain guarantees it has issued. The
Company sells service maintenance agreements under which it is the obligor for
payment of qualifying claims. The Company is responsible for administering the
program, including setting the pricing of the agreements sold and paying the
claims. The typical term for these agreements is between 12 and 36 months. The
pricing is set based on historical claims experience and expectations about
future claims. While the Company is unable to estimate maximum potential claim
exposure, it has a history of overall profitability upon the ultimate resolution
of agreements sold. The revenues related to the agreements sold are deferred at
the time of sale and recorded in revenues in the statement of operations over
the life of the agreements. The revenues deferred related to these agreements
totaled $3.9 million and $4.0 million, respectively, as of January 31, 2005 and
July 31, 2005, and are included on the face of the balance sheet in Deferred
revenues and allowances.
11
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 obtain capital for 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 rising interest rates may increase our cost of borrowing or reduce
securitization income;
o technological and market developments, growth trends and projected
sales in the home appliance and consumer electronics industry,
including digital products like HDTV, 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 increasing oil and gas prices could adversely affect our customers'
shopping decisions and patterns;
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 potential for market share erosion that could result in reduced
revenues;
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 5, 2005. In light of
these risks, uncertainties and assumptions, the forward-looking events and
circumstances discussed in this report might not happen.
12
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.
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, DLP and LCD televisions, camcorders,
VCRs, DVD players, portable audio and home theater products, lawn and garden
products, mattresses and furniture. 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 of all of our products, but to specialize
in certain specific product categories.
We currently operate 54 retail locations in Texas and Louisiana, and expect
to open two to four additional stores during the current fiscal year. We plan to
open and operate an expanded distribution center in the Dallas/Fort Worth market
beginning in the third quarter of this fiscal year, which will serve that
immediate market and permit us to explore markets within a 200+ mile radius of
such facility.
Unlike many of our competitors, we provide flexible in-house credit options
for our customers. In the last three years, we financed, on average,
approximately 56% of our retail sales through our internal credit programs. 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 and revolving account receivables, 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.
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 not covered by a manufacturers' warranty. We also
derive revenues from the sale of extended service maintenance agreements, under
which we are the primary obligor, to protect the customers after the original
manufacturer's warranty or service maintenance agreement has expired.
Our business is somewhat seasonal, with a greater portion of our revenues
realized during the quarter ending January 31, due to the holiday selling
season, the major collegiate bowl season and the National Football League
playoffs and Super Bowl. Additionally, we generally realize a greater portion of
our pretax and net income during the quarters ended January 31 and April 30, due
to the factors discussed above and the impact of our promotional efforts during
these periods.
13
Executive Overview
This narrative is intended to provide an executive level overview of our
operations for the three and six months ended July 31, 2005. A detailed
explanation of the changes in our operations for these periods as compared to
the prior year is included beginning on page 17. As explained in that section,
our pretax income for the quarter and the six months ended July 31, 2005
increased approximately 38.6% and 31.3%, respectively, primarily as a result of
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 grew 12.1% and for the six months
same store sales grew 10.0% over the same period for the prior year.
We believe that we were able to achieve this favorable increase by
continuing our emphasis on sales of our primary product categories,
with the appliance and the consumer electronics categories being key
drivers during both periods. 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 2006.
o Our entry into the Dallas/Fort Worth and the South Texas markets had a
positive impact on our revenues. Approximately $17.1 million and $29.9
million of our product sales increase for the quarter and six months
ended July 31, 2005, respectively, resulted from the opening of nine
new stores in these markets, since February 2004. Our plans provide
for the opening of additional stores in existing markets during the
balance of fiscal 2006 as we focus on opportunities in markets in
which we have existing infrastructure.
o Part of our increase in same store sales during the quarter resulted
from the continuation of deferred interest and "same as cash" plans on
certain products that extend beyond one year. For the three months and
six months ended July 31, 2005, $11.2 million and $17.9 million,
respectively, in gross product sales were financed by extended
deferred interest and "same as cash" plans. 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 36.5% to 36.2% for the
three months ended July 31, 2005 when compared to the same period in
the prior year, primarily as a result of reduced insurance sales
penetration. Our gross margin for the six months decreased from 36.4%
to 35.8% for the six months ended July 31, 2005 when compared to the
same period in the prior year, primarily due to price discounting
during the first quarter of fiscal year 2006 and reduced insurance
commissions during the second quarter of fiscal year 2006.
o Operating margin, on the other hand, increased from 8.1% to 8.8% for
the three months ended July 31, 2005 when compared to the same period
in the prior year due in part to our ability to reduce Selling,
general and administrative (SG&A) expenses as a percent of revenues.
The reduced SG&A expenses as a percent of revenues also benefited the
operating margin for the six months ended July 31, 2005 which
increased to 9.2% from 8.7% during the same period in the prior year.
During the three months ended July 31, 2005, we decreased SG&A expense
as a percent of revenues to 27.2% from 27.5% when compared to the
prior year, primarily from decreases in payroll and payroll related
expenses and net advertising expense as a percent of revenues.
Partially offsetting these reductions were higher occupancy costs and
general insurance costs. Additionally, our operating margin benefited
from a decrease in the Provision for bad debts as a percent of
revenues from 0.9% to 0.3%. The trends for the six months ended July
31, 2005 are consistent with those discussed for the three months
ended July 31, 2005.
14
Operational Changes and Resulting Outlook
During the quarter, we opened two new stores in the Dallas/Fort Worth
market and one in Harlingen, Texas just after the end of the quarter. We
continue to be satisfied with the results in the Dallas/Fort Worth market and
continue to expand the number of stores and plan to add additional distribution
capability in the next few weeks. We opened a new store in McAllen, Texas in
early September 2004 and it has performed above our expectations. We believe
that this South Texas market is substantially underserved and provides great
potential for our company and are expecting good performance from the new store
in Harlingen, Texas. We have several other locations in Texas, Louisiana and
neighboring states that we believe are promising and are in various stages of
development for opening either in the current fiscal year or the next.
The consumer electronics industry depends on new products to drive
increased consumer interest. 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. However, as a result
of relatively short product life cycles in the consumer electronics industry,
which limit the amount of time available for sales volumes to increase, combined
with rapid price erosion in the industry, retailers are challenged to maintain
overall gross margin levels and positive same store sales. This has historically
been our experience and we continue to adjust our marketing strategies to
address this challenge through the introduction of new product categories and
new products within our existing categories.
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 July 31, 2005.
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 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 (on
a revolving pool basis) 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 based on actual portfolio
experience over the past twelve months, 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 $4.3 million as of July 31, 2005, 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 3.0% to 3.5%, the impact to recorded Finance charges and other
would have been a reduction in revenues and pretax income of $1.8 million.
15
Deferred Tax Assets. We have significant net deferred tax assets
(approximately $7.5 million as of July 31, 2005), which are subject to periodic
recoverability assessments. Realization of our net deferred tax assets may be
dependent upon our ability to offset reversals against prior taxable income,
changes in tax rates or our future taxable income. Changes in these assumptions,
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 35.1%, we would have reduced the net
deferred tax asset account and net income by approximately $129,000.
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 estimated, 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 July 31, 2005 was $9.6 million.
Property and Equipment. Our accounting policies regarding land, buildings,
equipment and leasehold improvements 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 July 31, 2005 and January 31, 2005 was $4.0 million and $3.9
million, respectively, and is included in Deferred revenues and allowances 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.
16
Recent Accounting Pronouncements. In December 2004, Statement of Financial
Accounting Standards No. 123R, Share-Based Payment, was issued. This statement
establishes standards for accounting for transactions in which an entity
exchanges its equity instruments for goods or services, focusing primarily on
accounting for transactions in which an entity obtains an employee's services.
The statement requires a public entity to measure the cost of employee services
received in exchange for an award of equity instruments, based on the grant-date
fair value of the award, and record that cost over the period during which the
employee is required to provide service in exchange for the award. Additionally,
the statement provides multiple options for adopting the requirements of the
standard. We are currently analyzing the impact this statement will have on our
consolidated results of operations and our financial position. We are required
under existing accounting standards to provide supplemental disclosure in the
footnotes to our financial statements as if our financial statements had been
prepared using the fair value method of accounting for stock based compensation.
See Note 1 to our financial statements for additional information.
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 Six Months
Ended Ended
July 31, July 31,
------------- -------------
2004 2005 2004 2005
------ ------ ------ ------
Revenues:
Product sales .............................................................. 79.3 % 79.6 % 79.9 % 80.0 %
Service maintenance agreement commissions (net) ............................ 4.2 4.8 4.2 4.6
Service revenues ........................................................... 3.5 3.1 3.3 3.1
------ ------ ------ ------
Total net sales .......................................................... 87.0 87.5 87.4 87.7
Finance charges and other .................................................. 13.0 12.5 12.6 12.3
------ ------ ------ ------
Total revenues ...................................................... 100.0 100.0 100.0 100.0
Costs and expenses:
Cost of goods sold, including warehousing
and occupancy cost ......................................................... 62.7 63.0 62.8 63.4
Cost of parts sold, including warehousing
and occupancy cost ......................................................... 0.8 0.7 0.8 0.8
Selling, general and administrative expense ................................ 27.5 27.2 26.7 26.1
Provision for bad debts .................................................... 0.9 0.3 1.0 0.5
------ ------ ------ ------
Total costs and expenses ............................................ 91.9 91.2 91.3 90.8
------ ------ ------ ------
Operating income ........................................................... 8.1 8.8 8.7 9.2
Interest expense, net ...................................................... 0.4 0.1 0.4 0.1
------ ------ ------ ------
Income before minority interest and income taxes ........................... 7.7 8.7 8.3 9.1
Minority interest in limited partnership ................................... 0.1 0.0 0.1 0.0
------ ------ ------ ------
Income before income taxes ................................................. 7.6 8.7 8.2 9.1
Provision for income taxes ................................................. 2.6 3.0 2.9 3.2
------ ------ ------ ------
Net income ................................................................. 5.0 % 5.7 % 5.3 % 5.9 %
====== ====== ====== ======
The table above identifies several changes in our operations for the
current quarter, including changes in revenue and expense categories expressed
as a percentage of revenues. These changes are discussed in the Executive
Overview section on page 14 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 year 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.
17
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 July 31, 2005 Compared to Three Months Ended July 31, 2004
Revenues. Total revenues increased by $27.8 million, or 20.3%, from $136.6
million for the three months ended July 31, 2004 to $164.4 million for the three
months ended July 31, 2005. The increase was attributable to increases in net
sales of $25.0 million, or 21.0%, and $2.8 million, or 15.6%, in finance charges
and other revenue.
The $25.0 million increase in net sales was made up of the following:
o a $13.8 million same store sales increase of 12.1%. Increased sales of
appliances, consumer electronics and furniture accounted for most of
the increase in same store sales,
o an $11.1 million increase generated by seven retail locations that
were not open for three consecutive months in each period, net of
reductions related to the closing of one location,
o a $286,000 decrease resulted from an increase in discounts of
promotional credit sales, and
o a $363,000 increase resulted from an increase in service revenues.
The components of the $25.0 million increase in net sales, were a $22.6
million increase in product sales and a $2.4 million net increase in service
maintenance agreement commissions and service revenues. The $22.6 million
increase in product sales resulted from the following:
o approximately $13.7 million was attributable to increases in unit
sales, due to increased appliances, consumer electronics, furniture
and track sales, and
o approximately $8.9 million was attributable to increases in unit price
points. The price point impact was driven primarily by consumers
selecting higher priced consumer electronics products, as the new
technology becomes more affordable. Also, contributing to the price
point impact were higher prices on appliances.
18
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 ensure
comparability between the categories.
Three Months Ended July 31,
-----------------------------------------------
2004 2005 Percent
--------------------- -------------------------
Category Amount Percent Amount Percent Increase
----------- --------- ----------- ------------- -----------
Major home appliances ........... $44,846 37.7 % $53,624 37.3 % 19.6 % (1)
Consumer electronics ............ 32,692 27.5 39,728 27.6 21.5 (1)
Track ........................... 18,643 15.7 21,501 14.9 15.3 (1)
Delivery ........................ 1,937 1.6 2,317 1.6 19.6 (2)
Lawn and garden ................. 5,507 4.6 5,779 4.0 4.9 (3)
Bedding ......................... 2,596 2.2 3,097 2.2 19.3 (1)
Furniture ....................... 1,260 1.1 3,771 2.6 199.3 (4)
Other ........................... 824 0.7 1,050 0.7 27.4
----------- --------- ----------- ------------- -----------
Total product sales ........ 108,305 91.1 130,867 90.9 20.8
Service maintenance agreement
commissions .................... 5,776 4.9 7,848 5.5 35.9
Service revenues ................ 4,770 4.0 5,134 3.6 7.6
----------- --------- ----------- ------------- -----------
Total net sales ............ $118,851 100.0 % $143,849 100.0 % 21.0 %
=========== ========= =========== ============= ===========
- ---------------------------------
(1) These increases are consistent with overall increase in product sales
and improved unit prices.
(2) This increase is due primarily to the increase in total product sales.
(3) Extremely dry weather negatively impacted our sales in this category.
(4) This increase is due to the increased emphasis on the sales of
furniture, primarily sofas, recliners and entertainment centers, and
new product lines added to this category.
Revenue from Finance charges and other increased by approximately $2.7
million, or 15.6%, from $17.8 million for the three months ended July 31, 2004
to $20.5 million for the three months ended July 31, 2005. This increase in
revenue resulted primarily from increases in securitization income of $2.8
million. These increases are attributable to higher product sales and increases
in our retained interest in assets transferred to the QSPE, due primarily to
increases in the transferred balances. During the quarter ended July 31, 2005,
we changed our process related to selling credit insurance on promotional credit
programs resulting in a decline in insurance sales penetration. While we expect
this reduced penetration level to continue to impact insurance commission
revenues in the short term, ultimately we expect this change to result in
increased insurance commission revenues in the future.
Cost of Goods Sold. Cost of goods sold, including warehousing and occupancy
cost, increased by $17.9 million, or 20.9%, from $85.7 million for the three
months ended July 31, 2004 to $103.6 million for the three months ended July 31,
2005. This increase was generally consistent with the 20.8% increase in net
product sales during the three months ended July 31, 2005. Cost of products sold
was 79.1% of net product sales in the quarter ended July 31, 2004 and the
quarter ended July 31, 2005.
Cost of Parts Sold. Cost of parts sold, including warehousing and occupancy
cost, increased approximately $145,000, or 13.3%, for the three months ended
July 31, 2005 as compared to the three months ended July 31, 2004, due to
increases in parts sales.
Selling, General and Administrative Expense. While Selling, general and
administrative expense increased by $7.2 million, or 19.1%, from $37.5 million
for the three months ended July 31, 2004 to $44.7 million for the three months
ended July 31, 2005, it decreased as a percentage of total revenue from 27.5% to
27.2%. The decrease in expense as a percentage of total revenues resulted
primarily from decreased payroll and payroll related expenses and net
advertising expense, as a percent of revenues, that were partially offset by
higher occupancy costs and general insurance costs.
19
Provision for Bad Debts. The provision for bad debts on receivables
retained by the Company and not transferred to the QSPE and other non-credit
portfolio receivables decreased by $784,000, or 63.9%, during the three months
ended July 31, 2005 as compared to the three months ended July 31, 2004,
primarily as a result of changes in the loss history and provision adjustments,
based on favorable loss experience during the last twelve months, and revised
loss allocations between receivables retained by us and those transferred to the
QSPE, which were offset in Finance charges and other. See Note 3 to the
financial statements for information regarding the performance of the credit
portfolio.
Interest Expense, net. Net interest expense decreased by $508,000, or
89.6%, from $567,000 for the three months ended July 31, 2004 to $59,000 for the
three months ended July 31, 2005. The net decrease in interest expense was
attributable to the following factors:
o expiration of $20.0 million in our interest rate hedges and the
discontinuation of hedge accounting for derivatives resulted in a net
decrease in interest expense of approximately $257,000; and
o the deconsolidation of SRDS (previously consolidated as a VIE
according to FIN 46) resulted in a decrease of interest expense of
$215,000,
The remaining decrease in interest expense of $36,000 resulted from lower
average outstanding debt balances and higher interest income from invested
funds.
Minority Interest. As a result of FIN 46, for the quarter ended July 31,
2004, we eliminated the pretax operating profit contributed from the
consolidation of SRDS through the minority interest line item in our
consolidated statement of operations (see Note 1 of Notes to the Financial
Statements).
Provision for Income Taxes. The provision for income taxes increased by
$1.5 million, or 41.0%, from $3.5 million for the three months ended July 31,
2004 to $5.0 million for the three months ended July 31, 2005, consistent with
the increase in pretax income of 38.6%.
Net Income. As a result of the above factors, Net income increased $2.5
million, or 37.3%, from $6.8 million for the three months ended July 31, 2004 to
$9.3 million for the three months ended July 31, 2005.
Six Months Ended July 31, 2005 Compared to Six Months Ended July 31, 2004
Revenues. Total revenues increased by $51.0 million, or 18.8%, from $271.5
million for the six months ended July 31, 2004 to $322.5 million for the six
months ended July 31, 2005. The increase was attributable to increases in net
sales of $45.4 million, or 19.1%, and $5.7 million, or 16.6%, in finance charges
and other revenue.
The $45.4 million increase in net sales was made up of the following:
o a $22.2 million increase resulted from a same store sales increase of
10.0%. Increased sales of appliances, consumer electronics, computers
and other product categories included in the track, and furniture
accounted for most of the increase in same store sales,
o a $23.1 million increase generated by nine retail locations that were
not open for six consecutive months in each period, net of reductions
related to the closing of one location,
o a $668,000 decrease resulted from an increase in discounts of
promotional credit sales, and
o a $760,000 increase resulted from an increase in service revenues.
The components of the $45.4 million increase in net sales were a $41.3
million increase in product sales and a $4.1 million net increase in service
maintenance agreement commissions and service revenues. The $41.3 million
increase in product sales resulted from the following:
o approximately $24.9 million was attributable to increases in unit
sales, due to increased appliances, track, furniture, and consumer
electronics sales, and
20
o approximately $16.4 million was attributable to increases in unit
price points. The price point impact was driven primarily by consumers
selecting higher priced consumer electronics products, as the new
technology becomes more affordable.
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 ensure
comparability between the categories.
Six Months Ended July 31,
-----------------------------------------------
2004 2005 Percent
--------------------- -------------------------
Category Amount Percent Amount Percent Increase
----------- --------- ----------- ------------- -----------
Major home appliances ........... $86,808 36.6 % $100,122 35.5 % 15.3 % (1)
Consumer electronics ............ 70,314 29.6 83,382 29.5 18.6 (1)
Track ........................... 36,684 15.5 44,653 15.8 21.7 (1)
Delivery ........................ 3,785 1.6 4,338 1.5 14.6
Lawn and garden ................. 10,052 4.2 11,062 3.9 10.0
Bedding ......................... 4,864 2.0 6,004 2.1 23.4 (2)
Furniture ....................... 2,801 1.2 6,767 2.4 141.6 (3)
Other ........................... 1,500 0.6 1,814 0.6 20.9 (1)
----------- --------- ----------- ------------- -----------
Total product sales ........ 216,808 91.3 258,142 91.3 19.1
Service maintenance agreement
commissions .................... 11,436 4.8 14,732 5.2 28.8
Service revenues ................ 9,149 3.9 9,909 3.5 8.3
----------- --------- ----------- ------------- -----------
Total net sales ............ $237,393 100.0 % $282,783 100.0 % 19.1 %
=========== ========= =========== ============= ===========
- ---------------------------------
(1) These increases are consistent with overall increase in product sales
and improved unit prices.
(2) This increase reflects the emphasis on this emerging product category
and the change in vendor relationships.
(3) This increase is due to the increased emphasis on the sales of
furniture, primarily sofas, recliners and entertainment centers, and
new product lines added to this category.
Revenue from Finance charges and other increased by approximately $5.7
million, or 16.6%, from $34.1 million for the six months ended July 31, 2004 to
$39.8 million for the six months ended July 31, 2005. This increase in revenue
resulted primarily from increases in securitization income of $5.0 million, and
increases in insurance commissions and other revenues of $644,000. These
increases are attributable to higher product sales and increases in our retained
interest in assets transferred to the QSPE, due primarily to increases in the
transferred balances.
Cost of Goods Sold. Cost of goods sold, including warehousing and occupancy
cost, increased by $34.0 million, or 20.0%, from $170.5 million for the six
months ended July 31, 2004 to $204.5 million for the six months ended July 31,
2005. This increase was generally consistent with the 19.1% increase in net
product sales during the six months ended July 31, 2005. Cost of products sold
was 78.6% of net product sales in the six months ended July 31, 2004 and 79.2%
in the six months ended July 31, 2005. The decline was due to price discounting
during the first quarter of fiscal 2006 to drive same store sales.
Cost of Parts Sold. Cost of parts sold, including warehousing and occupancy
cost, increased approximately $266,000, or 12.1%, for the six months ended July
31, 2005 as compared to the six months ended July 31, 2004, due to increases in
parts sales.
Selling, General and Administrative Expense. While Selling, general and
administrative expense increased by $11.8 million, or 16.3%, from $72.4 million
for the six months ended July 31, 2004 to $84.2 million for the six months ended
July 31, 2005, it decreased as a percentage of total revenue from 26.7% to
26.1%. The decrease in expense as a percentage of total revenues resulted
primarily from decreased payroll and payroll related expenses and net
advertising expense, as a percent of revenues, that were partially offset by
higher occupancy costs and general insurance costs.
21
Provision for Bad Debts. The provision for bad debts on receivables
retained by the Company and not transferred to the QSPE and other non-credit
portfolio receivables decreased by $1.1 million, or 39.8%, during the six months
ended July 31, 2005 as compared to the six months ended July 31, 2004, primarily
as a result of changes in the loss history and provision adjustments based on
favorable loss experience during the last twelve months, and revised loss
allocations between receivables retained by us and those transferred to the
QSPE, which were offset in Finance charges and other. See Note 3 to the
financial statements for information regarding the performance of the credit
portfolio.
Interest Expense, net. Net interest expense decreased by $735,000, or
64.0%, from $1.1 million for the six months ended July 31, 2004 to $414,000 for
the six months ended July 31, 2005. The net decrease in interest expense was
attributable to the following factors:
o expiration of $20.0 million in our interest rate hedges and the
discontinuation of hedge accounting for derivatives resulted in a net
decrease in interest expense of approximately $285,000; and
o the deconsolidation of SRDS (previously consolidated as a VIE
according to FIN 46) resulted in a decrease of interest expense of
$429,000,
The remaining decrease in interest expense of $21,000 resulted from lower
average outstanding debt balances and higher interest income from invested
funds.
Minority Interest. As a result of FIN 46, for the quarter ended July 31,
2004, we eliminated the pretax operating profit contributed from the
consolidation of SRDS through the minority interest line item in our
consolidated statement of operations (see Note 1 of Notes to the Financial
Statements).
Provision for Income Taxes. The provision for income taxes increased by
$2.5 million, or 31.4%, from $7.8 million for the six months ended July 31, 2004
to $10.3 million for the six months ended July 31, 2005, consistent with the
increase in pretax income of 31.3%.
Net Income. As a result of the above factors, Net income increased $4.5
million, or 31.3%, from $14.6 million for the six months ended July 31, 2004 to
$19.1 million for the six months ended July 31, 2005.
22
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, extended terms provided by our vendors for inventory purchases,
acquisition of inventory under consignment arrangements and transfers of
receivables to our asset-backed securitization facilities. As of July 31, 2005,
we had $33.1 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, $14.5 million under extended vendor terms for
purchases of inventory and $102.0 million in commitments available for the
transfer of receivables to our QSPE.
A summary of the significant financial covenants that govern our bank
credit facility compared to our actual compliance status at July 31, 2005, is
presented below:
Required
Minimum/
Actual Maximum
-------------- ---------------
Debt service coverage ratio must exceed required minimum 3.56 to 1.00 2.00 to 1.00
Total adjusted leverage ratio must be lower than required 1.80 to 1.00 3.00 to 1.00
maximum
Consolidated net worth must exceed required minimum $213.5 million $125.0 million
Charge-off ratio must be lower than required maximum 0.03 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 0.07 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, extended vendor terms for purchases of inventory,
acquisition of inventory under consignment arrangements 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, extended vendor terms for purchases
of inventory, acquisition of inventory under consignment arrangements 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 loss of ability to acquire inventory on consignment;
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 or types of receivables transferred
(promotional versus non-promotional);
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;
23
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 six months ended July 31, 2005, net cash provided by operating
activities increased $30.8 million from $0.6 million provided in the 2004 period
to $31.4 million provided in the 2005 period. The net increase in cash provided
from operations resulted primarily from increased net income, a smaller increase
in the retained interest in the asset backed securitization program, the timing
of payments of accounts payable and compensation, and a reduction of inventory
levels during the period, as opposed to an increase in the prior year. The
change in amounts realized from the asset backed securitization were driven by
the amendment to the program during October 2004, which resulted in allowing the
inclusion of certain promotional credit programs in the eligible asset base,
providing partial funding of these receivables. 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.
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; in fiscal year 2005 we increased these terms
to include 18 or 24 months that are eligible to be partially funded through our
asset-backed securitization program. In the second quarter of fiscal 2005, we
began offering deferred interest programs with 36-month terms. In the second
quarter of fiscal 2006, we began offering deferred interest programs with
24-month terms. The three, six, 12, 18, 24 and 36 month "same as cash"
promotional accounts and deferred interest program 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. 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 percentage of eligible securitized receivables represented by
promotional receivables was 22.4% as of July 31, 2005. At July 31, 2004, this
percentage, computed on a consistent basis with the July 31, 2005 calculation,
would have been 16.2%. This increase was the result of sales with the use of
promotional credit versus lower prices at retail. The weighted average
promotional period was 10.8 months and 12.7 months for promotional receivables
outstanding as of July 31, 2004 and 2005, respectively. The weighted average
remaining term on those same promotional receivables was 6.4 months and 8.2
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 $1.0 million, from $9.0
million for the six months ended July 31, 2004 to $10.0 million for the six
months ended July 31, 2005. The increase in cash used in investing activities
resulted primarily from an increase in the purchase of property and equipment of
$0.9 million. The cash expended for property and equipment was used primarily
for construction of new stores and the reformatting of existing stores to better
support our current product mix. Based on current plans, we expect to increase
expenditures for property and equipment in the balance of fiscal 2006 as we open
additional stores.
Net cash from financing activities decreased by $11.0 million from $1.6
million for the three months ended July 31, 2004 to ($9.4) million for the three
months ended July 31, 2005. The increase in cash used by financing activities
resulted primarily from increases in payments on various debt instruments of
$11.5 million, which was partially offset by increased proceeds from stock
issued under employee benefit plans.
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.
24
At July 31, 2005, 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 LLC and three classes of Series B bonds in the aggregate amount
of $200 million, of which $8.0 million was required to be placed in a restricted
cash account for the benefit of the bondholders. If the net portfolio yield, as
defined by the Series B agreements, falls below 5.0%, then the issuer may be
required to fund a cash reserve in addition to the $8.0 million restricted cash
account. At July 31, 2005, the net portfolio yield for purposes of this
requirement was 10.3%. 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 LLC or the Series B bond
holders, the servicing fee and additional earnings to the extent they are
available.
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 issuer borrowings under the Series A variable
funding note approach $250 million, the issuer intends to request an increase in
the Series A amount or issue a new series of bonds and use the proceeds to pay
down the then outstanding balance of the Series A variable funding note, so that
the basket will once again become available to accumulate new receivables. As of
July 31, 2005, borrowings under the Series A variable funding note were $148.0
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 $8.0 million 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.
25
A summary of the significant financial covenants that govern the Series A
variable funding note compared to actual compliance status at July 31, 2005, is
presented below:
Required
Minimum/
Actual Maximum
-------------- ---------------
Issuer interest must exceed required minimum $42.8 million $39.4 million
Gross loss rate must be lower than required maximum 3.4% 10.0%
Net portfolio yield must exceed required minimum 10.3% 2.0%
Payment rate must exceed required minimum 6.4% 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.
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.
26
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.
We held interest rate swaps and collars with notional amounts totaling
$20.0 million as of January 31, 2005, which expired on April, 15 2005. The swaps
and collars 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, 2005.
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 July 31, 2005 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
We are involved in routine litigation incidental to our business from time
to time. Currently, we do not expect the outcome of any of this routine
litigation to have a material effect on our financial condition or results of
operation. However, the results of these proceedings cannot be predicted with
certainty, and changes in facts and circumstances could impact our estimate of
reserves for litigation.
Item 4. Submission of Matters to a Vote of Security Holders
At the Annual Meeting of Stockholders held on May 26, 2005, the following
proposals were submitted to stockholders with the following results:
1. Election of five directors
Number of Shares
-----------------------------------------
For Withheld
------------------- -----------------
Marvin D. Brailsford 22,020,986 40,418
Jon E. M. Jacoby 22,019,320 42,084
Bob L. Martin 22,024,786 36,618
Scott L. Thompson 22,024,786 36,618
William T. Trawick 19,117,174 2,944,230
In addition to the above individuals, the following
individuals are directors of the Company and their
terms expire at the Company's Annual Meeting of
Stockholders in 2006: Thomas J. Frank, Sr., Douglas H.
Martin and Theodore M. Wright.
27
2. Approval of an amendment to the Executive Employment Agreement of Thomas
J. Frank, Sr. to approve the cash bonus provisions of the agreement to ensure
cash compensation paid will be deductible under Section 162(m) of the Internal
Revenue Code.
Number of Shares
--------------------------
For 21,859,131
Against 197,773
Abstain 4,500
Broker Nonvotes 0
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.
28
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/ David L. Rogers
----------------------------------
David L. Rogers
Chief Financial Officer
(Principal Financial Officer and
duly authorized to sign this
report on behalf of the
registrant)
Date: August 30, 2005
29
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) as filed with
the Securities and Exchange Commission on September 23, 2003).
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) as filed with the Securities and
Exchange Commission on September 23, 2003).
3.1.1 Certificate of Amendment to the Certificate of Incorporation of
Conn's, Inc. dated June 3, 2004 (incorporated herein by reference to
Exhibit 3.1.1 to Conn's, Inc. Form 10-Q for the quarterly period ended
July 31, 2004 (File No. 000-50421) as filed with the Commission on
June 7, 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) as filed with the Securities and Exchange Commission on
September 23, 2003).
3.2.1 Amendment to the Bylaws of Conn's, Inc. (incorporated herein by
reference to Exhibit 3.2.1 to Conn's Form 10-Q for the quarterly
period ended July 31, 2004 (File No. 000-50421) as filed with the
Commission on June 7, 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) as filed with
the Securities and Exchange Commission on October 29, 2003).
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) as filed with the
Securities and Exchange Commission on September 23, 2003).t
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
to Conn's Form 10-Q for the quarterly period ended July 31, 2004 (File
No. 000-50421) as filed with the Commission on June 7, 2004).t
10.1.2 Form of Stock Option Agreement (incorporated herein by reference to
Exhibit 10.1.2 to Conn's, Inc. Form 10-K for the annual period ended
January 31, 2005 (File No. 000-50421) as filed with the Commission on
April 5, 2005).t
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)as filed with the Securities and
Exchange Commission on September 23, 2003).t
10.2.1 Form of Stock Option Agreement (incorporated herein by reference to
Exhibit 10.2.1 to Conn's, Inc. Form 10-K for the annual period ended
January 31, 2005 (File No. 000-50421) as filed with the Commission on
April 5, 2005).t
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) as filed with the Securities and Exchange Commission
on September 23, 2003).t
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) as filed with the Securities and
Exchange Commission on September 23, 2003).t
30
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) as filed with the Securities and Exchange Commission
on September 23, 2003).
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) as filed with the
Securities and Exchange Commission on September 23, 2003).
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) as filed
with the Securities and Exchange Commission on September 23, 2003).
10.6.1 First Renewal of Lease dated November 24, 2004, 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 10.6.1 to Conn's,
Inc. Form 10-K for the annual period ended January 31, 2005 (File No.
000-50421) as filed with the Commission on April 5, 2005).
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) as filed
with the Securities and Exchange Commission on September 23, 2003).
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) as filed
with the Securities and Exchange Commission on September 23, 2003).
10.8 Lease Agreement dated June 24, 2005, by and between Cabot Properties,
Inc., as Lessor, and CAI, L.P., as Lessee, for the property located at
1132 Valwood Parkway, Carrollton, Texas (incorporated herein by
reference to Exhibit 99.1 to Conn's, Inc. Current Report on Form 8-K
(file no. 000-50421) as filed with the Securities and Exchange
Commission on June 29, 2005).
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) as filed with
the Securities and Exchange Commission on September 23, 2003).
10.9.1 First Amendment to Credit Agreement dated April 7, 2004 by and among
Conn Appliances, Inc. and CAI Credit Insurance Agency, Inc.,
collectively the Borrowers, each of the Lenders which is or may from
time to time become a party thereto, and JPMorgan Chase Bank, as
Administrative Agent (incorporated herein by reference to Exhibit 99.1
to Conn's, Inc. Current Report on Form 8-K (File No. 000-50421) as
filed with the Commission on April 23, 2004).
10.9.2 Second Amendment to Credit Agreement dated November 12, 2004 by and
among Conn Appliances, Inc. and CAI Credit Insurance Agency, Inc.,
collectively the Borrowers, each of the Lenders which is or may from
time to time become a party thereto, and JPMorgan Chase Bank, as
Administrative Agent (incorporated herein by reference to Exhibit 99.1
to Conn's, Inc. Current Report on Form 8-K (File No. 000-50421) as
filed with the Commission on November 17, 2004).
31
10.9.3 Letter of Credit Agreement dated November 12, 2004 by and between
Conn Appliances, Inc. and CAI Credit Insurance Agency, Inc., the
financial institutions listed on the signature pages thereto, and
JPMorgan Chase Bank, as Administrative Agent (incorporated herein by
reference to Exhibit 99.2 to Conn's Inc. Current Report on Form 8-K
(File No. 000-50421) as filed with the Commission 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) as filed with the Securities and Exchange Commission on
September 23, 2003).
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) as filed with the Securities and Exchange Commission on
September 23, 2003).
10.11.1 First Supplemental Indenture dated October 29, 2004 by and between
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, Inc. Current Report on Form 8-K (File No. 000-50421)
as filed with the Commission on November 4, 2004).
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) as filed with the Securities and
Exchange Commission on September 23, 2003).
10.12.1 Amendment to Series 2002-A Supplement dated March 28, 2003, 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 10.12.1 to Conn's, Inc. Form 10-K for the annual
period ended January 31, 2005 (File No. 000-50421) as filed with the
Commission on April 5, 2005).
10.12.2 Amendment No. 2 to Series 2002-A Supplement dated July 1, 2004, 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 10.12.2 to Conn's, Inc. Form 10-K for the annual
period ended January 31, 2005 (File No. 000-50421) as filed with the
Commission on April 5, 2005).
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) as filed with the Securities and
Exchange Commission on September 23, 2003).
10.13.1 Amendment to Series 2002-B Supplement dated March 28, 2003, 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 10.13.1 to Conn's, Inc. Form 10-K for the annual
period ended January 31, 2005 (File No. 000-50421) as filed with the
Commission on April 5, 2005).
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) as filed with the Securities and
Exchange Commission on September 23, 2003).
10.14.1 First Amendment to Servicing Agreement dated June 24, 2005, by and
among Conn Funding II, L.P., as Issuer, CAI, L.P., as Servicer, and
Wells Fargo Bank, National Association, as Trustee.
32
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) as filed with the Securities and
Exchange Commission on October 29, 2003).t
10.15.1 First Amendment to Executive Employment Agreement between Conn's,
Inc. and Thomas J. Frank, Sr., Approved by the stockholders May 26,
2005. t
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) as filed with the Securities and Exchange
Commission on September 23, 2003).t
10.17 2006 Bonus Program (incorporated herein by reference to Form 8-K
(file no. 000-50421) filed with the Securities and Exchange Commission
on April 4, 2005).t
10.18 Description of Compensation Payable to Non-Employee Directors
(incorporated herein by reference to Form 8-K (file no. 000-50421)
filed with the Securities and Exchange Commission on June 2, 2005).t
11.1 Statement re: computation of earnings per share is included under Note
1 to the financial statements.
21 Subsidiaries of Conn's, Inc. (incorporated herein by reference to
Exhibit 21 to Conn's, Inc. registration statement on Form S-1 (file
no. 333-109046) as filed with the Securities and Exchange Commission
on September 23, 2003).
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 by Chief Operating Officer in support of Rule
13a-14(a)/15d-14(a) Certification (Chief Executive Officer) (filed
herewith).
99.2 Subcertification by Treasurer in support of Rule 13a-14(a)/15d-14(a)
Certification (Chief Financial Officer) (filed herewith).
99.3 Subcertification by Secretary in support of Rule 13a-14(a)/15d-14(a)
Certification (Chief Executive Officer) (filed herewith).
99.4 Subcertification of Chief Operating Officer, Treasurer and Secretary
in support of Section 1350 Certifications (Chief Executive Officer and
Chief Financial Officer) (furnished herewith).
t Management contract or compensatory plan or arrangement.
33