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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
Annual Report Pursuant to Section l3 or l5(d)
of the Securities Exchange Act of l934
For the fiscal year ended January 31, 2006 Commission File Number 000-50421
CONN'S, INC.
(Exact Name of Registrant as Specified in its Charter)
A Delaware Corporation 06-1672840
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
3295 College Street
Beaumont, Texas 77701
(Address of Principal Executive Offices)
(409) 832-1696
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section l2(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
Title of Class
Common Stock, Par Value $0.01 Per Share
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. Yes [ ] No [x]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [x]
Indicate by check mark whether the registrant (l) has filed all reports
required to be filed by Section l3 or l5(d) of the Securities Exchange Act of
l934 during the preceding l2 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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (ss.229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
One): Large accelerated filer [ ] Accelerated filer [x]
Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act). Yes [ ] No [x]
The aggregate market value of the voting and non-voting common equity held
by non-affiliates as of July 29, 2005 was approximately $180,604,464 based on
the closing price of the registrant's common stock as reported on the NASDAQ
National Market.
There were 23,571,564 shares of common stock, $0.01 par value per share,
outstanding on March 27, 2006.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Definitive Proxy Statement for the Annual Meeting of
Stockholders to be held May 31, 2006 (incorporated herein by reference in Part
III).
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TABLE OF CONTENTS
Page
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PART I
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ITEM 1. BUSINESS..............................................................1
ITEM 1A. RISK FACTORS.........................................................17
ITEM 1B. UNRESOLVED STAFF COMMENTS............................................24
ITEM 2. PROPERTIES...........................................................25
ITEM 3. LEGAL PROCEEDINGS....................................................25
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..................25
PART II
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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, AND RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.................26
ITEM 6. SELECTED FINANCIAL DATA..............................................27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.....................................................28
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...........48
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA..........................49
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE......................................................75
ITEM 9A. CONTROLS AND PROCEDURES..............................................75
ITEM 9B. OTHER INFORMATION....................................................75
PART III
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ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT...................76
ITEM 11. EXECUTIVE COMPENSATION...............................................76
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS...............................................76
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.......................76
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES...............................76
PART IV
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ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES...........................77
SIGNATURES....................................................................78
EXHIBIT INDEX.................................................................79
PART I
ITEM 1. BUSINESS.
Unless the context indicates otherwise, references to "we," "us," and
"our" refer to the consolidated business operations of Conn's, Inc. and all of
its direct and indirect subsidiaries, limited liability companies and limited
partnerships.
Overview
We are a specialty retailer of home appliances and consumer electronics.
We sell major home appliances including refrigerators, freezers, washers, dryers
and ranges, and a variety of consumer electronics including projection, plasma
and LCD televisions, camcorders, DVD players and home theater products. We also
sell home office equipment, lawn and garden equipment, mattresses and furniture
and we continue to introduce additional product categories for the home and for
consumer entertainment, such as MP3's, to help increase same store sales and to
respond to our customers' product needs. We offer over 1,100 product items, or
SKUs, at good-better-best price points representing such national brands as
General Electric, Whirlpool, Frigidaire, Maytag, LG, Mitsubishi, Samsung, Sony,
Toshiba, Serta, Hewlett Packard and Compaq. Based on revenue in 2004, we were
the 12th largest retailer of home appliances in the United States. Additionally,
historically we are the second or third leading retailer of home appliances in
terms of market share in the majority of our established markets. Likewise, in
the home entertainment product categories in which we compete, we rank third or
fourth in market share in the majority of our established markets.
We began as a small plumbing and heating business in 1890. We began
selling home appliances to the retail market in 1937 through one store located
in Beaumont, Texas. We opened our second store in 1959 and have since grown to
56 stores.
We have been known for providing excellent customer service for over 115
years. We believe that our customer-focused business strategies make us an
attractive alternative to appliance and electronics superstores, department
stores and other national, regional and local retailers. We strive to provide
our customers with:
o a high level of customer service;
o highly trained and knowledgeable sales personnel;
o a broad range of competitively priced, customer-driven, brand name
products;
o flexible financing alternatives through our proprietary credit
programs;
o same day and next day delivery capabilities; and
o outstanding product repair service.
We believe that these strategies drive repeat purchases and enable us to
generate substantial brand name recognition and customer loyalty. During fiscal
2006, approximately 62% of our credit customers, based on the number of invoices
written, were repeat customers.
In 1994, we realigned and added to our management team, enhanced our
infrastructure and refined our operating strategy to position ourselves for
future growth. From fiscal 1994 to fiscal 1999, we selectively grew our store
base from 21 to 26 stores while improving operating margins from 5.2% to 8.7%.
Since fiscal 1999, we have generated significant growth in our number of stores,
revenue and profitability. Specifically:
o we have grown from 26 stores to 56 stores, an increase of over 115%,
with several more stores currently under development;
o total revenues have grown by 200% at a compounded annual rate of
17.0% from $234.5 million in fiscal 1999, to $702.4 million in
fiscal 2006;
1
o net income from continuing operations has grown by 360% at a
compounded annual rate of 24.7% from $8.8 million in fiscal 1999 to
$41.2 million in fiscal 2006; and
o our same store sales growth from fiscal 1999 through fiscal 2006 has
averaged 9.2%; it was 16.9% for fiscal 2006. See additional
discussion about same store sales under Managements Discussion and
Analysis of Financial Condition and Results of Operations.
Our principal executives offices are located at 3295 College Street,
Beaumont, Texas 77701. Our telephone number is (409) 832-1696, and our corporate
website is www.conns.com. We do not intend for information contained on our
website to be part of this Form 10-K.
Corporate Reorganization
We were formed as a Delaware corporation in January 2003 with an initial
capitalization of $1,000 to become the holding company of Conn Appliances, Inc.,
a Texas corporation. Prior to the completion of our initial public offering (the
"IPO") in November 2003, we had no operations. As a result of the IPO, Conn
Appliances, Inc. became our wholly-owned subsidiary and the common and preferred
stockholders of Conn Appliances, Inc. exchanged their common and preferred stock
on a one-for-one basis for the common and preferred stock of Conn's, Inc.
Immediately after the IPO, all preferred stock and accumulated dividends were
redeemed, either through the payment of cash or through the conversion of
preferred stock to common stock.
Industry Overview
The home appliance and consumer electronics industry includes major home
appliances, small appliances, home office equipment and software, projection,
plasma and LCD televisions, and audio, video and portable electronics. Sellers
of home appliances and consumer electronics include large appliance and
electronics superstores, national chains, small regional chains, single-store
operators, appliance and consumer electronics departments of selected department
and discount stores and home improvement centers.
Based on data published in Twice, This Week in Consumer Electronics, a
weekly magazine dedicated to the home appliances and consumer electronics
industry in the United States, the top 100 major appliance retailers reported
sales of approximately $22.1 billion in 2004, up approximately 10.0% from
reported sales in 2003 of approximately $20.1 billion. The retail appliance
market is large and concentrated among a few major dealers. Sears has been the
leader in the retail appliance market, with a market share of the top 100
retailers of approximately 39% in 2004, down from approximately 42% in 2003.
Lowe's and Home Depot held the second and third place positions, respectively,
in national market share in 2004.
As measured by Twice, the top 100 consumer electronics retailers in the
United States reported equipment and software sales of $96.7 billion in 2004, a
7.9% increase from the $89.6 billion reported in 2003. According to the Consumer
Electronics Association, or CEA, total industry manufacturer sales of consumer
electronics products in the United States, including imports, are projected to
exceed $109 billion by 2007. The consumer electronics market is highly
fragmented. We estimate, based on data provided in Twice, that the two largest
consumer electronics superstore chains together accounted for less than 28% of
the total electronics sales attributable to the 100 largest retailers in 2004.
New entrants in both the home appliances and consumer electronics industries
have been successful in gaining market share by offering similar product
selections at lower prices.
In the home appliance market, many factors drive growth, including
consumer confidence, household formations and new product introductions. Product
design and innovation is rapidly becoming a key driver of growth in this market.
Products either recently introduced or scheduled to be offered include high
efficiency, front-loading laundry appliances, three door refrigerators, double
ovens, free-standing ranges, cabinet style dishwashers, and dual fuel cooking
appliances.
Technological advancements and the introduction of new products have
largely driven growth in the consumer electronics market. Recently, industry
growth has been fueled primarily by the introduction of products that
incorporate digital technology, such as portable and traditional DVD players,
digital cameras and camcorders, digital stereo receivers, satellite technology,
MP3 products and high definition flat panel and projection televisions. Digital
products offer significant advantages over their analog counterparts, including
better clarity and quality of video and audio, durability of recording and
compatibility with computers. Due to these advantages, we believe that digital
technology will continue to drive industry growth as consumers replace their
analog products with digital products. We believe the following product
advancements will continue to fuel growth in the consumer electronics industry
and that they offer us the potential for significant sales growth:
2
o Digital Television (DTV and High Definition TV). The Federal
Communications Commission has set a hard date of February 17, 2009
for all commercial television stations to transition from
broadcasting analog signals to digital signals. The Yankee Group, a
communications and networking research and consulting firm,
estimates that by the year 2007, HDTV signals will be in nearly 41.6
million, or 40%, of homes in the United States. This represents a
compounded annual growth rate of 17.1% from the estimated 18.9
million homes receiving digital cable at the end of 2002. To view a
digital transmission, consumers will need either a digital
television or a set-top box converter capable of converting the
digital broadcast for viewing on an analog set. According to the
CEA, DTV unit sales are expected to grow from 12.0 million units in
2005 to 15.8 million units in 2006, representing an annual growth
rate of 32.5%. We believe the high clarity digital flat panel
televisions in both liquid crystal display (LCD), and plasma formats
has increased the quality and sophistication of these entertainment
products and will be a key driver of digital television growth as
more digital and high definition content is made available either
through traditional distribution methods or through emerging content
delivery systems. As prices continue to drop on such products, they
become increasingly attractive to larger and more diverse group of
consumers.
o Digital Versatile Disc (DVD). According to the CEA, the DVD player
has become the fastest growing consumer electronics product in
history. First introduced in March 1997, DVD players are currently
in 80% of U.S. homes. We believe newer technology based on the DVD
delivery system, such as high definition DVD, "blu-ray", and
portable players will continue to drive consumer interest in this
entertainment category.
o Portable electronics. Compressed-music portables, represented most
notably by the Apple "iPod", enjoy significant growth, and accounted
for 84.5% of total dollar sales in battery-operated music portables
in 2005 according to the CEA as reported in TWICE magazine. Apple
shipped more than 14 million units of the iPod in the quarter ended
December 31, 2005 as compared to 4.6 million in the prior year
period.
Business Strategy
Our objective is to be the leading specialty retailer of home appliances
and consumer electronics in each of our markets. We strive to achieve this
objective through a continuing focus on superior execution in five key areas:
merchandising, consumer credit, distribution, product service and training.
Successful execution in each area relies on the following strategies:
o Providing a high level of customer service. We endeavor to maintain
a very high level of customer service as a key component of our
culture, which has resulted in average customer satisfaction levels
of approximately 91% over the past three years. We measure customer
satisfaction on the sales floor, in our delivery operation and in
our service department by sending survey cards to all customers to
whom we have delivered or installed a product or made a service
call. Our customer service resolution department attempts to address
all customer complaints within 48 hours of receipt.
o Developing and retaining highly trained and knowledgeable sales
personnel. We require all sales personnel to specialize in home
appliances, consumer electronics or "track" products. Some of our
sales associates qualify in more than one specialty. Track products
include small appliances, computers, camcorders, DVD players,
cameras, MP3 players and telephones that are sold within the
interior of a large colorful track that circles the interior floor
of our stores. This specialized approach allows the sales person to
focus on specific product categories and become an expert in selling
and using products in those categories. New sales personnel must
complete an intensive two-week classroom training program conducted
at our corporate office and an additional week of on-the-job
training riding in a delivery and a service truck to observe how we
serve our customers after the sale is made.
o Offering a broad range of customer-driven, brand name products. We
offer a comprehensive selection of high-quality, brand name
merchandise to our customers at guaranteed low prices. Consistent
with our good-better-best merchandising strategy, we offer a wide
range of product selections from entry-level models through high-end
models. We maintain strong relationships with approximately 50
manufacturers and distributors that enable us to offer over 1,100
SKUs to our customers. Our principal suppliers include General
3
Electric, Whirlpool, Frigidaire, Maytag, LG, Mitsubishi, Samsung,
Sony, Toshiba, Serta, Poulan, Weedeater, American Yard Products,
Hewlett Packard and Compaq. To facilitate our responsiveness to
customer demand, we use our prototype store, located near our
corporate offices in Beaumont, Texas, to test the sales process of
all new products and obtain customers' reactions to new display
formats before introducing these products and display formats to our
other stores.
o Offering flexible financing alternatives through our proprietary
credit programs. In the last three years, we financed, on average,
approximately 57% of our retail sales through our internal credit
programs. We believe our credit programs expand our potential
customer base, increase our sales revenue and enhance customer
loyalty by providing our customers immediate access to financing
alternatives that our competitors typically do not offer. Our credit
department makes all credit decisions internally, entirely
independent of our sales personnel. We provide special consideration
to the customer's credit history with us. Before extending credit,
we match our loss experience by product category with the customer's
credit worthiness to determine down payment amounts and other credit
terms. This facilitates product sales while keeping our credit risk
within an acceptable range. Approximately 58% of customers who have
active credit accounts with us take advantage of our in-store
payment option and come to our stores each month to make their
payments, which we believe results in additional sales to these
customers. Through our predictive dialing program, we contact
customers with past due accounts daily and attempt to work with them
to collect payments in times of financial difficulty or periods of
economic downturn. Our credit decisions and collections process
enabled us to achieve a 2.9% net loss ratio in fiscal 2004, a 2.4%
net loss ratio in fiscal 2005 and a 2.5% net loss ratio in fiscal
2006 on the credit portfolio that we service for a Qualifying
Special Purpose Entity or QSPE.
o Maintaining same day and next day distribution capabilities. We
maintain four regional distribution centers and three other related
facilities that cover all of the major markets in which we operate.
These facilities are part of a sophisticated inventory management
system that also includes a fleet of approximately 130 transfer and
delivery vehicles that service all of our markets. Our distribution
operations enable us to deliver products on the day of, or the day
after, the sale to approximately 95% of our customers.
o Providing outstanding product repair service. We service every
product that we sell, and we service only the products that we sell.
In this way, we can assure our customers that they will receive our
service technicians' exclusive attention to their product repair
needs. All of our service centers are authorized factory service
facilities that provide trained technicians to offer in-home
diagnostic and repair service as well as on-site service and repairs
for products that cannot be repaired in the customer's home.
Store Development and Growth Strategy
In addition to executing our business strategy, we intend to continue to
achieve profitable, controlled growth by increasing same store sales, opening
new stores and updating, expanding or relocating our existing stores.
o Increasing same store sales. We plan to continue to increase our
same store sales by:
o continuing to offer quality products at competitive prices;
o re-merchandising our product offerings in response to changes
in consumer demand;
o adding new merchandise to our existing product lines;
o training our sales personnel to increase sales closing rates;
o updating our stores on a three-year rotating basis;
o continuing to promote sales of computers and smaller
electronics within the interior track area of our stores,
including the expansion of high margin accessory items;
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o continuing to provide a high level of customer service in
sales, delivery and servicing of our products; and
o increasing sales of our merchandise, finance products, service
maintenance agreements and credit insurance through direct
mail and in-store credit promotion programs.
o Opening new stores. We intend to take advantage of our reliable
infrastructure and proven store model to continue the pace of our
new store openings by opening six to eight new stores in fiscal
2007. This infrastructure includes our proprietary management
information systems, training processes, distribution network,
merchandising capabilities, supplier relationships and centralized
credit approval and collection processes. We intend to expand our
store base in existing, adjacent and new markets, as follows:
o Existing and adjacent markets. We intend to increase our
market presence by opening new stores in our existing markets,
in adjacent markets and in new markets as we identify the need
and opportunity. New store openings in these locations will
allow us to maximize opportunity in those markets and leverage
our existing distribution network, advertising presence, brand
name recognition and reputation.
o New markets. In fiscal 2006, we opened another new store in
South Texas in Harlingen and continued to open new stores in
our Dallas/Fort Worth and San Antonio markets. We have
identified several new markets that meet our criteria for site
selection, including East Texas and central Louisiana around
Shreveport, Monroe and Alexandria, southern Oklahoma and
southwest Arkansas. We intend to consider these new markets,
as well as others, over the next several fiscal years. We
intend to first address markets in states in which we
currently operate. We expect that this new store growth will
include major metropolitan markets in both Texas and
Louisiana. We have also identified a number of smaller markets
within Texas and Louisiana in which we expect to explore new
store opportunities. Our long-term growth plans include
markets in other areas of significant population density
within neighboring states.
o Updating, expanding or relocating existing stores. Over the last
three years, we have updated, expanded or relocated most of our
stores. We have implemented our larger prototype store model at all
locations at which the market demands support such store size, and
where available physical space would accommodate the required design
changes. As we continue to add new stores or replace existing
stores, we intend to modify our floor plan to include this new model
as we perceive market support. We continuously evaluate our existing
and potential sites to ensure our stores are in the best possible
locations and relocate stores that are not properly positioned. We
typically lease rather than purchase our stores to retain the
flexibility of subleasing a location if we later decide that the
store is performing below our standards or the market would be
better served by a relocation. After updating, expanding or
relocating a store, we expect to increase same store sales at those
stores.
The addition of new stores has played, and we believe will continue
to play, a significant role in our continued growth and success. We currently
operate 56 retail stores located in Texas and Louisiana. We opened three stores
in fiscal 2004; and we opened six stores in each of fiscal 2005 and fiscal 2006.
We also closed one clearance store in one of our markets in fiscal 2005. We plan
to continue our store development program by opening an additional six to eight
new stores, or an approximately 10% increase, per year and continue to update a
portion of our existing stores each year. We believe that continuing our
strategies of updating existing stores, growing our store base and locating our
stores in desirable geographic markets are essential for our future success.
Customers
We do not have a significant concentration of sales with any
individual customer and, therefore, the loss of any one customer would not have
a material impact on our business. No single customer accounts for more than 10%
of our total revenues; in fact, no single customer accounted for more than
$500,000 (less than 0.1%) of our total revenue of $702.4 million during the year
ended January 31, 2006.
5
Products and Merchandising
Product Categories. Each of our stores sells five major categories of
products: major home appliances, consumer electronics, computers and peripheral
equipment, delivery and installation services and other household products,
including lawn and garden equipment and mattresses. The following table, which
has been adjusted from previous filings to ensure comparability, presents a
summary of net sales by major product category, service maintenance agreement
commissions and service revenues, for the years ended January 31, 2004, 2005,
and 2006:
Years Ended January 31,
------------------------------------------------------------------------------
2004 2005 2006
------------------------ ------------------------ ------------------------
Amount % Amount % Amount %
----------- ---------- ----------- ---------- ----------- ----------
(dollars in thousands)
Major home appliances ........$ 159,401 36.2% $ 168,962 34.2% $ 223,651 36.0%
Consumer electronics ......... 139,417 31.6 154,880 31.3 186,679 30.1
Track ........................ 70,031 15.9 85,644 17.3 100,154 16.1
Delivery ..................... 6,726 1.5 7,605 1.5 9,870 1.6
Lawn and garden .............. 11,505 2.6 13,710 2.8 17,083 2.8
Bedding ...................... 6,441 1.5 10,262 2.1 13,126 2.1
Furniture .................... 5,712 1.3 7,182 1.5 15,313 2.5
Other ........................ 3,346 0.8 3,315 0.7 4,001 0.6
----------- ---------- ----------- ---------- ----------- ----------
Total product sales ....... 402,579 91.3 451,560 91.4 569,877 91.8
Service maintenance agreement
commissions ................ 20,074 4.6 23,950 4.8 30,583 4.9
Service revenues ............. 18,265 4.1 18,725 3.8 20,278 3.3
----------- ---------- ----------- ---------- ----------- ----------
Total net sales ...........$ 440,918 100.0% $ 494,235 100.0% $ 620,738 100.0%
=========== ========== =========== ========== =========== ==========
Within these major product categories (excluding service maintenance
agreements, service revenues and delivery and installation), we offer our
customers over 1,100 SKUs in a wide range of price points. Most of these
products are manufactured by brand name companies, including General Electric,
Whirlpool, Frigidaire, Maytag, LG, Mitsubishi, Samsung, Sony, Hitachi, Toshiba,
Serta, Hewlett Packard and Compaq. As part of our good-better-best merchandising
strategy, our customers are able to choose from products ranging from low-end to
mid- to high-end models in each of our key product categories, as follows:
Category Products Selected Brands
-------- -------- ---------------
Major appliances Refrigerators, freezers, General Electric,
washers, dryers, ranges, Frigidaire, Whirlpool,
dishwashers, air Maytag, LG, KitchenAid,
conditioners and vacuum Sharp, Samsung, Friedrich,
cleaners Roper, Hoover and Eureka
Consumer electronics Projection, plasma, LCD and Mitsubishi, Sony, Toshiba,
DLP televisions, and home Samsung, Sanyo, JVC,
theater systems Hitachi, Yamaha, Apple and
Fujifilm
Track Computers, computer Hewlett Packard, Compaq,
peripherals, VCRs, Sony
camcorders, digital
cameras, DVD players,
audio components, compact
disc players, speakers and
portable electronics (e.g.
iPods)
Other Lawn and garden, furniture Poulan, Husqvarna, Toro,
and mattresses Weedeater, Ashley and
Serta
6
Purchasing. We purchase products from over 100 manufacturers and
distributors. Our agreements with these manufacturers and distributors typically
cover a one or two year time period, are renewable at the option of the parties
and are terminable upon 30 days written notice by either party. Similar to other
specialty retailers, we purchase a significant portion of our total inventory
from a limited number of vendors. During fiscal 2006, 60.6% of our total
inventory purchases were from six vendors, including 17.0%, 12.2% and 11.4% of
our total inventory from Frigidaire, Whirlpool and Sony respectively. The loss
of any one or more of these key vendors or our failure to establish and maintain
relationships with these and other vendors could have a material adverse effect
on our results of operations and financial condition. We have no indication that
any of our suppliers will discontinue selling us merchandise. We have not
experienced significant difficulty in maintaining adequate sources of
merchandise, and we generally expect that adequate sources of merchandise will
continue to exist for the types of products we sell.
Merchandising Strategy. We focus on providing a comprehensive selection of
high-quality merchandise to appeal to a broad range of potential customers.
Consistent with our good-better-best merchandising strategy, we offer a wide
range of product selections from entry-level models through high-end models. We
primarily sell brand name warranted merchandise. Our established relationships
with major appliance and electronic vendors and our affiliation with NATM, a
major buying group, give us purchasing power that allows us to offer
custom-featured appliances and electronics and provides us a competitive selling
advantage over other independent retailers. We use our prototype store, located
near our corporate offices in Beaumont, Texas, to test the sale of all new
products and obtain customers' reactions to new display formats before
introducing these products and display formats to our other stores. As part of
our merchandising strategy, we operate clearance centers, either as stand-alone
units or incorporated within one of our retail stores, in our Houston, San
Antonio and Dallas markets to help sell damaged, used or discontinued
merchandise. We have recently redesigned our approach to the merchandising of
our "track" products to provide consumer-friendly point of sale transactions
that take place within a track area located in the interior of our store. We
believe that this focused approach to creating consumer awareness and ease of
purchase of our track products will help increase same store sales.
Pricing. We emphasize competitive pricing on all of our products and
maintain a low price guarantee that is valid in all markets from 10 to 30 days
after the sale, depending on the product. At most of our stores, to print an
invoice that contains pricing other than the price maintained within our
computer system, sales personnel must call a special "hotline" number at the
corporate office for approval. Personnel staffing this hotline number are
familiar with competitor pricing and are authorized to make price adjustments to
fulfill our low price guarantee when a customer presents acceptable proof of the
competitor's lower price. This centralized function also allows us to maintain
control of pricing and to store and retrieve pricing data of our competitors.
Customer Service
We focus on customer service as a key component of our strategy. We
believe our same day or next day delivery option, which is not offered by most
of our competitors, is one of the keys to our success. Additionally, we attempt
to answer and resolve all customer complaints within 48 hours of receipt. We
track customer complaints by individual salesperson, delivery person and service
technician. We send out over 36,000 customer satisfaction survey cards each
month covering all deliveries and service calls. Based upon a response rate from
our customers of approximately 15%, we consistently report an average customer
satisfaction level of approximately 91%.
7
Store Operations
Stores. At the end of fiscal 2006 we operated 56 retail and clearance
stores located in Texas and Louisiana. The following table illustrates our
markets, the number of freestanding and strip mall stores in each market and the
calendar year in which we opened our first store in each market:
Number of Stores
------------------ First
Market Stand Strip Store
Alone Mall Opened
- -------------------------------------------------------------- --------- -------- ----------
Houston ...................................................... 8 10 1983
San Antonio/Austin ........................................... 6 7 1994
Golden Triangle (Beaumont, Port Arthur and Orange,
Texas and Lake Charles, Louisiana) ....................... 1 4 1937
Baton Rouge/Lafayette ........................................ 1 4 1975
Corpus Christi ............................................... 1 0 2002
Dallas/Fort Worth ............................................ 1 11 2003
South Texas .................................................. 1 1 2004
--------- --------
Total ........................................................ 19 37
========= ========
Our stores have an average selling space of approximately 21,100 square
feet, plus a rear storage area averaging approximately 6,000 square feet for
fast-moving or smaller products that customers prefer to carry out rather than
wait for in-home delivery. Two of our stores are clearance centers for
discontinued product models and damaged merchandise, returns and repossessed
product located in our Houston and Dallas markets and contain 28,800 square feet
of combined selling space. All stores are open from 10:00 a.m. to 9:00 p.m.
Monday through Friday, from 9:00 a.m. to 9:00 p.m. on Saturday, and from 11:00
a.m. to 7:00 p.m. on Sunday. We also offer extended store hours during the
holiday selling season.
Approximately 66% of our stores are located in strip shopping centers and
regional malls, with the balance being stand-alone buildings in "power centers"
of big box consumer retail stores. All of our locations have parking available
immediately adjacent to the store's front entrance. Our storefronts have a
distinctive front that guides the customer to the entrance of the store. Inside
the store, a large colorful tile track circles the interior floor of the store.
One side of the track leads the customer to major appliances, while the other
side of the track leads the customer to a large display of television and
projection television products. The inside of the track contains various home
office and consumer electronic products such as computers, printers, DVD
players, camcorders, digital cameras and MP3 players. We are continually
refining our approach to merchandising of our track products, and in fiscal 2006
expanded our small kitchen appliance assortment, introduced musical products and
expanded our offering of seasonal products. Mattresses, furniture and lawn and
garden equipment displays occupy the rear of the sales floor. To reach the
cashier's desk at the center of the track area, our customers must walk past our
products. We believe this increases sales to customers who have purchased
products from us on credit in the past and who return to our stores to make
their monthly credit payments.
We have updated most of our stores in the last three years. We expect to
continue to update our stores as needed to address each store's specific needs.
All of our updated stores, as well as our new stores, include modern interior
selling spaces featuring attractive signage and display areas specifically
designed for each major product type. Our prototype store for future expansion
has from 25,000 to 30,000 square feet of retail selling space, which is
approximately 20% more than the average size of our existing stores and a rear
storage area of between 5,000 and 7,000 square feet. Our investment to update a
store has averaged approximately $220,000 per store over the past three years,
and as a result of the updating, we expect to increase same store sales at those
stores. Over the last three years, we have invested approximately $7.8 million
updating, refurbishing or relocating our existing stores.
Site Selection. Our stores are typically located adjacent to freeways or
major travel arteries and in the vicinity of major retail shopping areas. We
prefer to locate our stores in areas where our prominent tower storefront will
be the anchor of the shopping center or readily visible from major
thoroughfares. We also attempt to locate our stores in the vicinity of major
home appliance and electronics superstores. We have typically entered major
metropolitan markets where we can potentially support at least 10 to 12 stores.
We believe this number of stores allows us to optimize advertising and
distribution costs. We have and may continue, however, to elect to experiment
with opening lower numbers of new stores in smaller communities where customer
demand for products and services outweighs any extra cost. Other factors we
consider when evaluating potential markets include the distance from our
distribution centers, our existing store locations and store locations of our
competitors and population, demographics and growth potential of the market.
8
Store Economics. We lease 50 of our 56 current store locations, with an
average monthly rent of $18,800. Our average per store investment for the 12 new
stores we have opened in the last two years was approximately $1.5 million,
including leasehold improvements, fixtures and equipment and inventory (net of
accounts payable). For these new stores, the net sales per store have averaged
$0.7 million per month.
Our new stores have typically been profitable on an operating basis within
their first three to six months of operation and, on average have returned our
net cash investment in 20 months or less. We consider a new store to be
successful if it achieves $8 million to $9 million in sales volume and 2% to 5%
in operating margins before other ancillary revenues and allocations of overhead
and advertising in the first full year of operation. We expect successful stores
that have matured, which generally occurs after two to three years of
operations, to generate annual sales of approximately $12 million to $15 million
and 5% to 9% in operating margins before other ancillary revenues and overhead
and allocations. However, depending on the credit and insurance penetration of
an individual store, we believe that a store that does not achieve these levels
of sales can still contribute significantly to our pretax margin.
Personnel and Compensation. We staff a typical store with a store manager,
an assistant manager, an average of 23 sales personnel and other support staff
including cashiers and/or porters based on store size and location. Managers
have an average tenure with us of approximately seven years and typically have
prior sales floor experience. In addition to store managers, we have seven
district managers that generally oversee from six to eight stores in each
market. Our district managers generally have five to fifteen years of sales
experience and report to our vice president of store operations, who has over
twenty years of sales experience.
We compensate our sales associates on a straight commission arrangement,
while we generally compensate store managers on a salary basis plus incentives
and cashiers at an hourly rate. In some instances, store managers receive earned
commissions plus base salary. Our clearance center is staffed with a manager and
six to eight sales personnel who are paid on a straight commission arrangement.
We believe that because our store compensation plans are tied to sales, they
generally provide us an advantage in attracting and retaining highly motivated
employees.
Training. New sales personnel must complete an intensive two week
classroom training program conducted at our corporate office. We then require
them to spend an additional week riding in a delivery and service truck to gain
an understanding of how we serve our customers after the sale is made.
Installation and delivery staff and service personnel receive training through
an on-the-job program in which individuals are assigned to an experienced
installation and delivery or service employee as helpers prior to working alone.
In addition, our employees benefit from on-site training conducted by many of
our vendors.
We attempt to identify store manager candidates early in their careers
with us and place them in a defined program of training. They generally first
attend our in-house training program, which provides guidance and direction for
the development of managerial and supervisory skills. They then attend an
external Dale Carnegie certified management course that helps solidify their
management knowledge and builds upon their internal training. After completion
of these training programs, manager candidates work as assistant managers for
six to twelve months and are then allowed to manage one of our smaller stores,
where they are supervised closely by the store's district manager. We give new
managers an opportunity to operate larger stores as they become more proficient
in their management skills. Each store manager attends mandatory training
sessions on a monthly basis and also attends bi-weekly sales training meetings
where participants receive and discuss new product information.
Marketing
We design our marketing and advertising programs to increase our brand
name recognition, educate consumers about our products and services and generate
customer traffic in order to increase sales. Our programs include periodic
promotions such as three, six, twelve, eighteen, twenty-four or thirty-six
months of no interest financing. We conduct our advertising programs primarily
through local newspapers, local radio and television stations and direct
marketing through direct mail, telephone and our website.
9
Direct marketing has become an effective way for us to present our
products and services to our existing customers and potential new customers. We
use direct mail to target promotional mailings to credit worthy individuals,
including new residents in our market areas from time to time. In addition, we
use direct mail to market increased credit lines to existing customers, to
encourage customers using third party credit to convert to our credit programs
and for customer appreciation mailings. We also conduct a mail program to
reestablish contact with customers who applied for credit recently at one of our
stores but did not purchase a product. We also call customers who recently
applied for credit at one of our retail locations but did not purchase a
product; this often redirects potential purchasers back into the original store
location.
Our website, www.conns.com, offers information about our selection of
products and provides useful information to the consumer on pricing, features
and benefits for each product and required corporate governance information. Our
website also allows the customers residing in the markets in which we operate
retail locations to apply and be considered for credit, to see our special
on-line promotional items and to make purchases on-line through the use of
approved credit cards. The website currently averages approximately 5,040 visits
per day from potential and existing customers and during fiscal 2006, was the
source of approximately 80,400 credit applications. The website is linked to a
call center, allowing us to better assist customers with their credit and
product needs.
Distribution and Inventory Management
We typically locate our stores in close proximity of our five regional
distribution centers located in Houston, San Antonio, Dallas and Beaumont, Texas
and Lafayette, Louisiana and smaller cross-dock facilities in Austin and
Harlingen, Texas. This enables us to deliver products to our customers quickly,
reduces inventory requirements at the individual stores and facilitates
regionalized inventory and accounting controls.
In our retail stores, we maintain an inventory of fast-moving items and
products that the customer is likely to carry out of the store. Our
sophisticated Distribution Inventory Sales computer system and the recent
introduction of scanning technology in our distribution centers allow us to
determine on a real-time basis the exact location of any product we sell. If we
do not have a product at the desired retail store at the time of sale, we can
provide it through our distribution system on a next day basis.
We maintain a fleet of tractors and trailers that allow us to move
products from market to market and from distribution centers to stores. Our
fleet of home delivery vehicles enables our highly-trained delivery and
installation specialists to quickly complete the sales process, enhancing
customer service. We receive a delivery fee based on their choice of same day or
next day delivery. Additionally, we are able to complete deliveries to our
customers on the same day as, or the day after the sale for approximately 95% of
our customers who have requested delivery.
10
Finance Operations
General. We sell our products for cash or for payment through major credit
cards, which we treat as cash sales. We also offer our customers several
financing alternatives through our proprietary credit programs. In the last
three fiscal years, we financed, on average, approximately 57% of our retail
sales through one of our two credit programs. We offer our customers a choice of
installment payment plans and revolving credit plans through our primary credit
portfolio. We also offer an installment program through our secondary credit
portfolio to a limited number of customers who do not qualify for credit under
our primary credit portfolio. The following table shows our product sales and
gross service maintenance agreements sales, excluding returns and allowances and
service revenues, by method of payment for the periods indicated.
Years Ended January 31,
-----------------------------------------------------------------------
2004 2005 2006
---------------------- ---------------------- -----------------------
Amount % Amount % Amount %
---------- ---------- ---------- ---------- ---------- -----------
(dollars in thousands)
Cash and other credit cards ..$ 198,765 47.0% $ 193,753 40.8% $ 254,047 42.3%
Primary credit portfolio:
Installment ............... 182,802 43.3 225,369 47.4 263,667 43.9
Revolving ................. 16,627 3.9 20,663 4.3 30,697 5.1
Secondary credit portfolio ... 24,459 5.8 35,725 7.5 52,049 8.7
---------- ---------- ---------- ---------- ---------- -----------
Total .....................$ 422,653 100.0% $ 475,510 100.0% $ 600,460 100.0%
========== ========== ========== ========== ========== ===========
Credit Approval. Our credit programs are operated by our centralized
credit department staff, completely independent of sales personnel. As part of
our centralized credit approval process, we have developed a proprietary
standardized scoring model that provides preliminary credit decisions, including
down payment amounts and credit terms, based on both customer and product risk.
We developed this model with data analysis by Equifax(R) to correlate the
product category of a customer purchase with the default probability. Although
we rely on this program to approve automatically some credit applications from
customers for whom we have previous credit experience, over 92.8% of our credit
decisions are based on evaluation of the customer's creditworthiness by a
qualified credit grader. As of January 31, 2006, we employed approximately 400
full-time and part-time employees who focus on credit approval and collections.
These employees are highly trained to follow our strict methodology in approving
credit, collecting our accounts, and charging off any uncollectible accounts
based on pre-determined aging criteria.
A significant part of our ability to control delinquency and charge-off
rates is tied to the relatively high level of down payments that we require and
the purchase money security interest that we obtain in the product financed,
which reduce our credit risk and increase our customers' willingness to meet
their future obligations. We require the customer to provide proof of credit
property insurance coverage to offset potential losses relating to theft or
damage of the product financed.
Installment accounts are paid over a specified period of time with set
monthly payments. Revolving accounts provide customers with a specified amount
which the customer may borrow, repay and re-borrow so long as the credit limit
is not exceeded. Most of our installment accounts provide for payment over 12 to
36 months, and for those accounts paid in full during fiscal 2006, the average
account was outstanding for approximately 13 to 15 months. Our revolving
accounts were outstanding approximately 12 to 17 months for those accounts paid
in full during fiscal 2006. During fiscal 2006, approximately 7.2% of the
applications approved under the primary program were handled automatically
through our computer system based on previous credit history with us. We
automatically send the application of any new credit customer or any customer
seeking additional credit where there has been a past delinquency or performance
problem to an experienced, in-house credit grader.
We created our secondary credit portfolio program to meet the needs of
those customers who do not qualify for credit under our primary program. If we
cannot approve a customer's application for credit under our primary portfolio,
we automatically send the application to the credit staff of our secondary
portfolio for further consideration. We offer only the installment program to
these customers, and we grant credit to these consumers under stricter
underwriting criteria, including higher down payments. An experienced, in-house
credit grader administers the credit approval process. Most of the installment
accounts approved under this program provide for repayment over 12 to 36 months,
and for those accounts paid in full during fiscal 2006, the average account was
outstanding for approximately 13 to 15 months.
11
The following two tables present, for comparison purposes, information
regarding our two credit portfolios.
Primary Portfolio (1)
------------------------------------
Years Ended January 31,
------------------------------------
2004 2005 2006
---------- ---------- ----------
(total outstanding balance in thousands)
Total outstanding balance (period end) ....$ 293,909 $ 358,252 $ 421,649
Average outstanding customer balance ......$ 1,189 $ 1,268 $ 1,284
Number of active accounts (period end) .... 247,151 282,533 328,402
Total applications processed (2) .......... 499,755 567,352 684,674
Percent of retail sales financed .......... 47.2% 51.7% 49.0%
Total applications approved ............... 59.3% 56.4% 52.8%
Average down payment ...................... 8.6% 7.4% 7.6%
Average interest spread (3) ............... 12.2% 12.7% 12.0%
Secondary Portfolio
------------------------------------
Years Ended January 31,
------------------------------------
2004 2005 2006
---------- ---------- ----------
(total outstanding balance in thousands)
Total outstanding balance (period end) ....$ 55,561 $ 70,448 $ 98,072
Average outstanding customer balance ......$ 1,057 $ 1,040 $ 1,128
Number of active accounts (period end) .... 52,566 67,718 86,936
Total applications processed (2) .......... 192,228 238,605 314,698
Percent of retail sales financed .......... 5.8% 7.5% 8.7%
Total applications approved ............... 26.9% 33.3% 34.1%
Average down payment ...................... 27.7% 27.2% 26.4%
Average interest spread (3) ............... 13.0% 14.0% 14.1%
- -----------------
(1) The Primary Portfolio consists of owned and sold receivables.
(2) Unapproved credit applications in the primary portfolio are automatically
referred to the secondary portfolio.
(3) Difference between the average interest rate yield on the portfolio and
the average cost of funds under the program plus the allocated interest
related to funds required to finance the credit enhancement portion of the
portfolio. Also reflects the loss of interest income resulting from
interest free promotional programs.
Credit Quality. We enter into securitization transactions to sell our
retail receivables to a qualifying special purpose entity or QSPE, which we
formed for this purpose. After the sale, we continue to service these
receivables under a contract with the QSPE. We closely monitor these credit
portfolios to identify delinquent accounts early and dedicate resources to
contacting customers concerning past due accounts. We believe that our local
presence, ability to work with customers and flexible financing alternatives
contribute to the historically low charge-off rates on these portfolios. In
addition, our customers have the opportunity to make their monthly payments in
our stores, and approximately 58% of our active credit accounts did so at some
time during the last 12 months. We believe that these factors help us maintain a
relationship with the customer that keeps losses low while encouraging repeat
purchases.
Our follow-up collection activities involve a combination of centralized
efforts that take place in our corporate office and outside collection efforts
that involve a visit by one of our credit counselors to the customer's home. We
maintain a sophisticated predictive dialer system and letter campaign that helps
us contact between 20,000 and 25,000 delinquent customers daily. We also
maintain a very experienced skip-trace department that utilizes current
technology to locate customers who have moved and left no forwarding address.
Our outside collectors provide an on-site contact with the customer to assist in
the collection process or, if needed, to actually repossess the product in the
event of non-payment. Repossessions are made when it is clear that the customer
is unwilling to establish a reasonable payment process. Our legal department
represents us in bankruptcy proceedings and filing of delinquency judgment
claims and helps handle any legal issues associated with the collection process.
12
Generally, we deem an account to be uncollectible and charge it off if the
account is 120 days or more past due and has not had a payment in the last seven
months. Over the last 36 months, we have recovered approximately 19% of
charged-off amounts through our collection activities. The income that we
realize from our interest in securitized receivables depends on a number of
factors, including expected credit losses. Therefore, it is to our advantage to
maintain a low delinquency rate and loss ratio on these credit portfolios.
Our accounting and credit staff consistently monitors trends in
charge-offs by examining the various characteristics of the charge-offs,
including store of origination, product type, customer credit information, down
payment amounts and other identifying information. We track our charge-offs both
gross, or before recoveries, and net, or after recoveries. We periodically
adjust our credit granting, collection and charge-off policies based on this
information.
The following table reflects the performance of our two credit portfolios,
net of unearned interest.
Primary Portfolio (1) Secondary Portfolio
------------------------------- ----------------------------
Years Ended January 31, Years Ended January 31,
------------------------------- ----------------------------
2004 2005 2006 2004 2005 2006
--------- --------- --------- -------- -------- --------
(dollars in thousands) (dollars in thousands)
$293,909 $358,252 $421,649 $55,561 $70,448 $98,072
Average total outstanding balance ..........................$271,659 $323,108 $387,464 $54,988 $64,484 $86,461
Account balances over 60 days old (period end) .............$ 13,484 $ 17,503 $ 26,029 $ 4,783 $ 5,640 $ 9,508
Percent of balances over 60 days old to total
outstanding (period end) (2) ............................. 4.6% 4.9% 6.2% 8.6% 8.0% 9.7%
Allowance for doubtful accounts (period end) ...............$ 9,534 $ 10,168 $ 11,464 $ 2,224 $ 2,089 $ 2,348
Percent allowance for doubtful accounts to total
outstanding (period end) ................................. 3.2% 2.8% 2.7% 4.0% 3.0% 2.4%
Bad debt write-offs (net of recoveries) ....................$ 7,905 $ 7,601 $ 10,225 $ 1,499 $ 1,604 $ 1,915
Percent of write-offs (net) to average outstanding (3) ..... 2.9% 2.4% 2.6% 2.7% 2.5% 2.2%
- ------------------------------------------------------
(1) The Primary Portfolio consists of owned and sold receivables.
(2) At January 31, 2006, the percent of balances over 60 days old was elevated
due to the impact of Hurricanes Katrina and Rita. See additional
discussion in Management's Discussion and Analysis of Financial Condition
and Results of Operations.
(3) The fiscal year ended January 31, 2005, includes the benefit of new
information received during the year, which impacted the realization of
sales tax credits on prior year write-offs.
The following table presents information regarding the growth of our
combined credit portfolios, including unearned interest.
Years Ended January 31,
----------------------------------------
2004 2005 2006
----------- ----------- -----------
(dollars in thousands)
Beginning balance ............................$ 362,076 $ 418,702 $ 514,204
New receivables financed ..................... 331,849 423,935 495,553
Revolving finance charges .................... 4,354 3,926 3,858
Returns on account ........................... (6,860) (10,670) (5,397)
Collections on account ....................... (263,313) (312,484) (375,342)
Accounts charged off ......................... (11,934) (11,825) (14,392)
Recoveries of charge-offs .................... 2,530 2,620 2,252
----------- ----------- -----------
Ending balance ............................... 418,702 514,204 620,736
Less unearned interest at end of period ...... (69,232) (85,504) (101,015)
----------- ----------- -----------
Total portfolio, net .........................$ 349,470 $ 428,700 $ 519,721
=========== =========== ===========
Product Support Services
Credit Insurance. Acting as agents for unaffiliated insurance companies,
we sell credit life, credit disability, credit involuntary unemployment and
credit property insurance at all of our stores. These products cover payment of
the customer's credit account in the event of the customer's death, disability
or involuntary unemployment or if the financed property is lost or damaged. We
receive sales commissions from the unaffiliated insurance company at the time we
sell the coverage, and we recognize retrospective commissions, which are
additional commissions paid by the insurance carrier if insurance claims are
lower than projected, as such commissions are actually earned.
13
We require proof of property insurance on all installment credit
purchases, although we do not require that customers purchase this insurance
from us. During fiscal 2006, approximately 75.2% of our credit customers
purchased one or more of the credit insurance products we offer, and
approximately 29.1% purchased all of the insurance products we offer. Commission
revenues from the sale of credit insurance contracts represented approximately
3.3%, 3.2% and 2.6% of total revenues for fiscal years 2004, 2005 and 2006,
respectively.
Warranty Service. We provide warranty service for all of the products we
sell and only for the products we sell. Customers purchased service maintenance
agreements on products representing approximately 48.8% of our total retail
sales for fiscal 2006. These agreements broaden and extend the period of covered
manufacturer warranty service for up to five years from the date of purchase,
depending on the product, and cover certain items during the manufacturer's
warranty period. These agreements are sold at the time the product is purchased.
Customers may finance the cost of the agreements along with the purchase price
of the associated product. We contact the customer prior to the expiration of
the service maintenance period to provide them the opportunity to renew the
period of warranty coverage.
We have contracts with unaffiliated third party insurers that issue the
service maintenance agreements to cover the costs of repairs performed by our
service department under these agreements. The initial service contract is
between the customer and the independent insurance company, but we are the
insurance company's first choice to provide service when it is needed. We
receive a commission on the sale of the contract, and we bill the insurance
company for the cost of the service work that we perform. Commissions on these
third party contracts are recognized in revenues, net of the payment to the
third party obligor. Renewal contracts are between the customer and our in-house
service department. Under renewal contracts we recognize revenues received, and
direct selling expenses incurred, over the life of the contracts, and expense
the cost of the service work performed as products are repaired.
Of the 15,000 to 20,000 repairs that we perform each month, approximately
35.4% are covered under these service maintenance agreements, approximately
50.5% are covered by manufacturer warranties and the remainder are "walk-in"
repairs from our customers. Revenues from the sale of service contracts
represented approximately 4.6%, 4.8%, and 4.9% of net sales during fiscal years
2004, 2005 and 2006, respectively.
Management Information Systems
We have a fully integrated management information system that tracks on a
real-time basis point-of-sale information, inventory receipt and distribution,
merchandise movement and financial information. The management information
system also includes a local area network that connects all corporate users to
e-mail, scheduling and various servers. All of our facilities are linked by a
wide-area network that provides communication for in-house credit authorization
and real time polling of sales and merchandise movement at the store level. In
our distribution centers, we use radio frequency terminals to assist in
receiving, stock put-away, stock movement, order filling, cycle counting and
inventory management. At our stores, we currently use desktop terminals to
assist in receiving, transferring and maintaining perpetual inventories.
Our integrated management information system also includes extensive
functionality for management of the complete credit portfolio life cycle as well
as functionality for the management of product service. The credit system
continues from our in-house credit authorization through account set up and
tracking, credit portfolio condition, collections, credit employee productivity
metrics, skip-tracing, bankruptcy and fraud and legal account management. The
service system provides for service order processing, warranty claims
processing, parts inventory management, technician scheduling and dispatch,
technician performance metrics and customer satisfaction measurement. All of
these systems share a common customer and product sold database.
Our point of sale system uses an IBM Series i5 hardware system that runs
on the i5OS operating system. This system enables us to use a variety of readily
available applications in conjunction with software that supports the system.
All of our current business application software, except our accounting and
human resources systems, has been developed in-house by our management
information system employees. We believe our management information systems
efficiently support our current operations and provide a foundation for future
growth.
14
We employ a Nortel telephone switch and state of the art Avaya (formerly
Mosaix) predictive dialer, as well as a redundant data network and cable plant,
to improve the efficiency of our collection and overall corporate communication
efforts.
As part of our ongoing system availability protection and disaster
recovery planning, we have implemented a secondary IBM Series i5 system. We
installed and implemented a back-up IBM Series i5 system in our corporate
offices to provide the ability to switch production processing from the primary
system to the secondary system within fifteen to thirty minutes should the
primary system become disabled or unreachable. The two machines are kept
synchronized utilizing third party software. This backup system provides "high
availability" of the production processing environment. The primary IBM Series
i5 system is geographically removed from our corporate office for purposes of
disaster recovery and security. These systems worked as designed during our
recent evacuation from our corporate headquarters in Beaumont, Texas, due to
Hurricane Rita. While we were displaced, our store, distribution and service
operations that were not impacted by the hurricane continued to have normal
system availability and functionality.
Competition
According to Twice, total industry manufacturer sales of home appliances
and consumer electronics products in the United States, including imports, to
the top 100 dealers were estimated to be $21.3 billion and $96.4 billion,
respectively, in 2004. The retail home appliance market is large and
concentrated among a few major suppliers. Sears has historically been the leader
in the retail home appliance market, with a market share among the top 100
retailers of approximately 39% in 2004, down from 42% in 2003. The consumer
electronics market is highly fragmented. We estimate that the two largest
consumer electronics superstore chains accounted for less than 35% of the total
electronics sales attributable to the 100 largest retailers in 2003. However,
new entrants in both industries have been successful in gaining market share by
offering similar product selections at lower prices.
As reported by Twice, based upon revenue in 2004, we were the 12th largest
retailer of home appliances. Our competitors include national mass merchants
such as Sears and Wal-Mart, specialized national retailers such as Circuit City
and Best Buy, home improvement stores such as Lowe's and Home Depot, and
locally-owned regional or independent retail specialty stores. The availability
and convenience of the Internet and other direct-to-consumer alternatives are
increasing as a competitive factor in our industry, especially for distribution
of computer and entertainment software.
We compete primarily based on enhanced customer service through our unique
sales force training and product knowledge, same day or next day delivery
capabilities, proprietary in-house credit program, guaranteed low prices and
product repair service.
Regulation
The extension of credit to consumers is a highly regulated area of our
business. Numerous federal and state laws impose disclosure and other
requirements on the origination, servicing and enforcement of credit accounts.
These laws include, but are not limited to, the Federal Truth in Lending Act,
Equal Credit Opportunity Act and Federal Trade Commission Act. State laws impose
limitations on the maximum amount of finance charges that we can charge and also
impose other restrictions on consumer creditors, such as us, including
restrictions on collection and enforcement. We routinely review our contracts
and procedures to ensure compliance with applicable consumer credit laws.
Failure on our part to comply with applicable laws could expose us to
substantial penalties and claims for damages and, in certain circumstances, may
require us to refund finance charges already paid and to forego finance charges
not yet paid under non-complying contracts. We believe that we are in
substantial compliance with all applicable federal and state consumer credit and
collection laws.
Our sale of credit life, credit disability, credit involuntary
unemployment and credit property insurance products is also highly regulated.
State laws currently impose disclosure obligations with respect to our sales of
credit and other insurance products similar to those required by the Federal
Truth in Lending Act, impose restrictions on the amount of premiums that we may
charge and require licensing of certain of our employees and operating entities.
We believe we are in substantial compliance with all applicable laws and
regulations relating to our credit insurance business.
15
Employees
As of January 31, 2006, we had approximately 2,600 full-time employees and
200 part-time employees, of which approximately 1,200 were sales personnel. We
provide a comprehensive benefits package including health, life, long term
disability, and dental insurance coverage as well as a 401(k) plan, employee
stock purchase plan, paid vacation, sick pay and holiday pay. None of our
employees are covered by collective bargaining agreements and we believe our
employee relations are good.
Tradenames and Trademarks
We have registered the trademarks "Conn's" and our logos.
Available Information
We are subject to reporting requirements of the Securities Exchange Act of
1934, or the Exchange Act, and its rules and regulations. The Exchange Act
requires us to file reports, proxy and other information statements and other
information with the Securities and Exchange Commission ("SEC"). Copies of these
reports, proxy statements and other information can be inspected and copied at
the SEC Public Reference Room, 450 Fifth Street, N.W., Washington, D.C. 20549.
You may obtain information on the operation of the Public Reference Room by
calling the SEC at 1-800-SEC-0330. You may also obtain these materials
electronically by accessing the SEC's home page on the internet at www.sec.gov.
In addition, we make available, free of charge on our internet website,
our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports
on Form 8-K, and amendments to these reports filed or furnished pursuant to
Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable
after we electronically file this material with, or furnish it to, the SEC. You
may review these documents, under the heading "Conn's Investor Relations," by
accessing our website at www.conns.com. Also, reports and other information
concerning us are available for inspection and copying at NASDAQ Capital
Markets.
16
ITEM 1A. RISK FACTORS.
An investment in our common stock involves risks and uncertainties. You
should consider carefully the following information about these risks and
uncertainties before buying shares of our common stock. The occurrence of any of
the risks described below could adversely affect our business, financial
condition or results of operations. In that case, the trading price of our stock
could decline, and you could lose all or part of the value of your investment.
Our success depends substantially on our ability to open and operate profitably
new stores in existing, adjacent and new geographic markets.
We plan to continue our expansion by opening an additional six to eight
new stores in fiscal 2007. We anticipate these new stores to include additional
stores in the Dallas/Fort Worth Metroplex, South Texas, where we currently have
two stores, and possibly others in areas where we have not operated previously.
We have not yet selected sites for all of the stores that we plan to open within
the next fiscal year. We may not be able to open all of these stores, and any
new stores that we open may not be profitable or meet our goals. Any of these
circumstances could have a material adverse effect on our financial results.
There are a number of factors that could affect our ability to open and
operate new stores consistent with our business plan, including:
o competition in existing, adjacent and new markets;
o competitive conditions, consumer tastes and discretionary spending
patterns in adjacent and new markets that are different from those
in our existing markets;
o a lack of consumer demand for our products at levels that can
support new store growth;
o limitations created by covenants and conditions under our credit
facilities and our asset-backed securitization program;
o the availability of additional financial resources;
o the substantial outlay of financial resources required to open new
stores and the possibility that we may recognize little or no
related benefit;
o an inability or unwillingness of vendors to supply product on a
timely basis at competitive prices;
o the failure to open enough stores in new markets to achieve a
sufficient market presence;
o the inability to identify suitable sites and to negotiate
acceptable leases for these sites;
o unfamiliarity with local real estate markets and demographics in
adjacent and new markets;
o problems in adapting our distribution and other operational and
management systems to an expanded network of stores;
o difficulties associated with the hiring, training and retention of
additional skilled personnel, including store managers; and
o higher costs for print, radio and television advertising.
These factors may also affect the ability of any newly opened stores to
achieve sales and profitability levels comparable with our existing stores or to
become profitable at all.
17
If we are unable to manage our growing business, our revenues may not increase
as anticipated, our cost of operations may rise and our profitability may
decline.
We face many business risks associated with growing companies, including
the risk that our management, financial controls and information systems will be
inadequate to support our planned expansion. Our growth plans will require
management to expend significant time and effort and additional resources to
ensure the continuing adequacy of our financial controls, operating procedures,
information systems, product purchasing, warehousing and distribution systems
and employee training programs. We cannot predict whether we will be able to
manage effectively these increased demands or respond on a timely basis to the
changing demands that our planned expansion will impose on our management,
financial controls and information systems. If we fail to manage successfully
the challenges our growth poses, do not continue to improve these systems and
controls or encounter unexpected difficulties during our expansion, our
business, financial condition, operating results or cash flows could be
materially adversely affected.
The inability to obtain funding for our credit operations through securitization
facilities or other sources may adversely affect our business and expansion
plans.
We finance most of our customer receivables through asset-backed
securitization facilities. The trust arrangement governing these facilities
currently provides for two separate series of asset-backed notes that allow us
to finance up to $450 million in customer receivables. Under each note series,
we transfer customer receivables to a qualifying special purpose entity we
formed for this purpose in exchange for cash, subordinated securities and the
right to receive cash flows equal to the interest rate spread between the
transferred receivables and the notes issued to third parties ("interest only
strip"). This qualifying special purpose entity, in turn, issues notes that are
collateralized by these receivables and entitle the holders of the notes to
participate in certain cash flows from these receivables. The Series A program
is a $250 million variable funding note held by Three Pillars Funding
Corporation, of which $185.0 million was drawn as of January 31, 2006. The
Series B program consists of $200 million in private bond placements that will
require scheduled principal payments beginning in October 2006.
Our ability to raise additional capital through further securitization
transactions, and to do so on economically favorable terms, depends in large
part on factors that are beyond our control.
These factors include:
o conditions in the securities and finance markets generally;
o conditions in the markets for securitized instruments;
o the credit quality and performance of our customer receivables;
o our ability to obtain financial support for required credit
enhancement;
o our ability to service adequately our financial instruments;
o the absence of any material downgrading or withdrawal of ratings
given to our securities previously issued in securitizations; and
o prevailing interest rates.
Our ability to finance customer receivables under our current
asset-backed securitization facilities depends on our compliance with covenants
relating to our business and our customer receivables. If these programs reach
their capacity or otherwise become unavailable, and we are unable to arrange
substitute securitization facilities or other sources of financing, we may have
to limit the amount of credit that we make available through our customer
finance programs. This may adversely affect revenues and results of operations.
Further, our inability to obtain funding through securitization facilities or
other sources may adversely affect the profitability of outstanding accounts
under our credit programs if existing customers fail to repay outstanding credit
due to our refusal to grant additional credit. Since our cost of funds under our
bank credit facility is expected to be greater in future years than our cost of
funds under our current securitization facility, increased reliance on our bank
credit facility may adversely affect our net income.
18
An increase in interest rates may adversely affect our profitability.
The interest rates on our bank credit facility and the Series A program
under our asset-backed securitization facility fluctuate up or down based upon
the LIBO/LIBOR rate, the prime rate of our administrative agent or the federal
funds rate in the case of the bank credit facility and the commercial paper rate
in the case of the Series A program. To the extent that such rates increase, the
fair value of the interest only strip will decline and our interest expense
could increase which may result in a decrease in our profitability.
We have significant future capital needs which we may be unable to fund, and we
may need additional funding sooner than currently anticipated.
We will need substantial capital to finance our expansion plans,
including funds for capital expenditures, pre-opening costs and initial
operating losses related to new store openings. We may not be able to obtain
additional financing on acceptable terms. If adequate funds are not available,
we will have to curtail projected growth, which could materially adversely
affect our business, financial condition, operating results or cash flows.
We estimate that capital expenditures during fiscal 2007 will be
approximately $25 million to $30 million and that capital expenditures during
future years may exceed this amount. We expect that cash provided by operating
activities, available borrowings under our credit facility, and access to the
unfunded portion of our asset-backed securitization program will be sufficient
to fund our operations, store expansion and updating activities and capital
expenditure programs through at least January 31, 2007. However, this may not be
the case. We may be required to seek additional capital earlier than anticipated
if future cash flows from operations fail to meet our expectations and costs or
capital expenditures related to new store openings exceed anticipated amounts.
A decrease in our credit sales could lead to a decrease in our product sales and
profitability.
In the last three years, we financed, on average, approximately 57% of
our retail sales through our internal credit programs. Our ability to provide
credit as a financing alternative for our customers depends on many factors,
including the quality of our accounts receivable portfolio. Payments on some of
our credit accounts become delinquent from time to time, and some accounts end
up in default, due to several factors, including general and local economic
conditions. As we expand into new markets, we will obtain new credit accounts
that may present a higher risk than our existing credit accounts since new
credit customers do not have an established credit history with us. A general
decline in the quality of our accounts receivable portfolio could lead to a
reduction of available credit provided through our finance operations. As a
result, we might sell fewer products, which could adversely affect our earnings.
Further, because approximately 58% of our credit customers make their credit
account payments in our stores, any decrease in credit sales could reduce
traffic in our stores and lower our revenues. A decline in the credit quality of
our credit accounts could also cause an increase in our credit losses, which
could result in a decrease in our securitization income or increase the
provision for bad debts on our statement of operations and result in an adverse
effect on our earnings. A decline in credit quality could also lead to stricter
underwriting criteria which might have a negative impact on sales.
A downturn in the economy may affect consumer purchases of discretionary items,
which could reduce our net sales.
A large portion of our sales represent discretionary spending by our
customers. Many factors affect discretionary spending, including world events,
war, conditions in financial markets, general business conditions, interest
rates, inflation, energy and gasoline prices, consumer debt levels, the
availability of consumer credit, taxation, unemployment trends and other matters
that influence consumer confidence and spending. Our customers' purchases of
discretionary items, including our products, could decline during periods when
disposable income is lower or periods of actual or perceived unfavorable
economic conditions. If this occurs, our net sales and profitability could
decline.
19
We face significant competition from national, regional and local retailers of
major home appliances and consumer electronics.
The retail market for major home appliances and consumer electronics is
highly fragmented and intensely competitive. We currently compete against a
diverse group of retailers, including national mass merchants such as Sears,
Wal-Mart, Target, Sam's Club and Costco, specialized national retailers such as
Circuit City and Best Buy, home improvement stores such as Lowe's and Home
Depot, and locally-owned regional or independent retail specialty stores that
sell major home appliances and consumer electronics similar, and often
identical, to those we sell. We also compete with retailers that market products
through store catalogs and the Internet. In addition, there are few barriers to
entry into our current and contemplated markets, and new competitors may enter
our current or future markets at any time.
We may not be able to compete successfully against existing and future
competitors. Some of our competitors have financial resources that are
substantially greater than ours and may be able to purchase inventory at lower
costs and better sustain economic downturns. Our competitors may respond more
quickly to new or emerging technologies and may have greater resources to devote
to promotion and sale of products and services. If two or more competitors
consolidate their businesses or enter into strategic partnerships, they may be
able to compete more effectively against us.
Our existing competitors or new entrants into our industry may use a
number of different strategies to compete against us, including:
o expansion by our existing competitors or entry by new competitors
into markets where we currently operate;
o lower pricing;
o aggressive advertising and marketing;
o extension of credit to customers on terms more favorable than we
offer;
o larger store size, which may result in greater operational
efficiencies, or innovative store formats; and
o adoption of improved retail sales methods.
Competition from any of these sources could cause us to lose market
share, revenues and customers, increase expenditures or reduce prices, any of
which could have a material adverse effect on our results of operations.
If new products are not introduced or consumers do not accept new products, our
sales may decline.
Our ability to maintain and increase revenues depends to a large extent
on the periodic introduction and availability of new products and technologies.
We believe that the introduction and continued growth in consumer acceptance of
new products, such as digital video recorders and digital, high-definition
televisions, will have a significant impact on our ability to increase revenues.
These products are subject to significant technological changes and pricing
limitations and are subject to the actions and cooperation of third parties,
such as movie distributors and television and radio broadcasters, all of which
could affect the success of these and other new consumer electronics
technologies. It is possible that new products will never achieve widespread
consumer acceptance.
If we fail to anticipate changes in consumer preferences, our sales may decline.
Our products must appeal to a broad range of consumers whose preferences
cannot be predicted with certainty and are subject to change. Our success
depends upon our ability to anticipate and respond in a timely manner to trends
in consumer preferences relating to major household appliances and consumer
electronics. If we fail to identify and respond to these changes, our sales of
these products may decline. In addition, we often make commitments to purchase
products from our vendors up to six months in advance of proposed delivery
dates. Significant deviation from the projected demand for products that we sell
may have a material adverse effect on our results of operations and financial
condition, either from lost sales or lower margins due to the need to reduce
prices to dispose of excess inventory.
20
A disruption in our relationships with, or in the operations of, any of our key
suppliers could cause our sales to decline.
The success of our business and growth strategies depends to a
significant degree on our relationships with our suppliers, particularly our
brand name suppliers such as General Electric, Whirlpool, Frigidaire, Maytag,
LG, Mitsubishi, Sony, Hitachi, Samsung, Toshiba, Serta, Hewlett Packard and
Compaq. We do not have long term supply agreements or exclusive arrangements
with the majority of our vendors. We typically order our inventory through the
issuance of individual purchase orders to vendors. We also rely on our suppliers
for cooperative advertising support. We may be subject to rationing by suppliers
with respect to a number of limited distribution items. In addition, we rely
heavily on a relatively small number of suppliers. Our top six suppliers
represented 60.6% of our purchases for fiscal 2006, and the top two suppliers
represented approximately 29.2% of our total purchases. The loss of any one or
more of these key vendors or our failure to establish and maintain relationships
with these and other vendors could have a material adverse effect on our results
of operations and financial condition.
Our ability to enter new markets successfully depends, to a significant
extent, on the willingness and ability of our vendors to supply merchandise to
additional warehouses or stores. If vendors are unwilling or unable to supply
some or all of their products to us at acceptable prices in one or more markets,
our results of operations and financial condition could be materially adversely
affected.
Furthermore, we rely on credit from vendors to purchase our products. As
of January 31, 2006, we had $40.9 million in accounts payable and $74.0 million
in merchandise inventories. A substantial change in credit terms from vendors or
vendors' willingness to extend credit to us would reduce our ability to obtain
the merchandise that we sell, which could have a material adverse effect on our
sales and results of operations.
You should not rely on our comparable store sales as an indication of our future
results of operations because they fluctuate significantly.
Our historical same store sales growth figures have fluctuated
significantly from quarter to quarter. For example, same store sales growth for
each of the quarters of fiscal 2006 were 7.3%, 12.1%, 23.3%, and 22.6%,
respectively. Even though we achieved double-digit same store sales growth
during fiscal 2006, we may not be able to increase same store sales at this pace
in the future. A number of factors have historically affected, and will continue
to affect, our comparable store sales results, including:
o changes in competition;
o general economic conditions;
o new product introductions;
o consumer trends;
o changes in our merchandise mix;
o changes in the relative sales price points of our major product
categories;
o the impact of our new stores on our existing stores, including
potential decreases in existing stores' sales as a result of
opening new stores;
o weather conditions in our markets;
o timing of promotional events;
o timing and location of major sporting events; and
o our ability to execute our business strategy effectively.
21
Changes in our quarterly and annual comparable store sales results could
cause the price of our common stock to fluctuate significantly.
Because we experience seasonal fluctuations in our sales, our quarterly results
will fluctuate, which could adversely affect our common stock price.
We experience seasonal fluctuations in our net sales and operating
results. In fiscal 2006, we generated 29.4% of our net sales and 31.4% of our
net income in the fiscal quarter ended January 31 (which included the holiday
selling season). We also incur significant additional expenses during this
fiscal quarter due to higher purchase volumes and increased staffing. If we
miscalculate the demand for our products generally or for our product mix during
the fiscal quarter ending January 31, our net sales could decline, resulting in
excess inventory, which could harm our financial performance. A shortfall in
expected net sales, combined with our significant additional expenses during
this fiscal quarter, could cause a significant decline in our operating results.
This could adversely affect our common stock price.
Our business could be adversely affected by changes in consumer protection laws
and regulations.
Federal and state consumer protection laws and regulations, such as the
Fair Credit Reporting Act, limit the manner in which we may offer and extend
credit. Since we finance a substantial portion of our sales, any adverse change
in the regulation of consumer credit could adversely affect our total revenues
and gross margins. For example, new laws or regulations could limit the amount
of interest or fees that may be charged on consumer loan accounts or restrict
our ability to collect on account balances, which would have a material adverse
effect on our earnings. Compliance with existing and future laws or regulations
could require us to make material expenditures, in particular personnel training
costs, or otherwise adversely affect our business or financial results. Failure
to comply with these laws or regulations, even if inadvertent, could result in
negative publicity, fines or additional licensing expenses, any of which could
have an adverse effect on our results of operations and stock price.
Pending litigation relating to the sale of credit insurance and the sale of
service maintenance agreements in the retail industry, including one lawsuit in
which we were the defendant, could adversely affect our business.
We understand that states' attorneys general and private plaintiffs have
filed lawsuits against other retailers relating to improper practices conducted
in connection with the sale of credit insurance in several jurisdictions around
the country. We offer credit insurance in all of our stores and require the
purchase of property credit insurance products from us or from third party
providers in connection with sales of merchandise on installment credit;
therefore, similar litigation could be brought against us. We were previously
named as a defendant in a purported class action lawsuit alleging breach of
contract and violations of state and federal consumer protection laws arising
from the terms of our service maintenance agreements. A final judgment was
entered dismissing that lawsuit. While we believe we are in full compliance with
applicable laws and regulations, if we are found liable in any future lawsuit
regarding credit insurance or service maintenance agreements, we could be
required to pay substantial damages or incur substantial costs as part of an
out-of-court settlement, either of which could have a material adverse effect on
our results of operations and stock price. An adverse judgment or any negative
publicity associated with our service maintenance agreements or any potential
credit insurance litigation could also affect our reputation, which could have a
negative impact on sales.
If we lose key management or are unable to attract and retain the highly
qualified sales personnel required for our business, our operating results could
suffer.
Our future success depends to a significant degree on the skills,
experience and continued service of Thomas J. Frank, Sr., our Chairman of the
Board and Chief Executive Officer, William C. Nylin, Jr., our President and
Chief Operating Officer, David L. Rogers, our Chief Financial Officer, David R.
Atnip, our Senior Vice President and Treasurer, Sydney K. Boone, our Secretary
and General Counsel, and other key personnel. If we lose the services of any of
these individuals, or if one or more of them or other key personnel decide to
join a competitor or otherwise compete directly or indirectly with us, our
business and operations could be harmed, and we could have difficulty in
22
implementing our strategy In addition, as our business grows, we will need to
locate, hire and retain additional qualified sales personnel in a timely manner
and develop, train and manage an increasing number of management level sales
associates and other employees. Competition for qualified employees could
require us to pay higher wages to attract a sufficient number of employees, and
increases in the federal minimum wage or other employee benefits costs could
increase our operating expenses. If we are unable to attract and retain
personnel as needed in the future, our net sales growth and operating results
could suffer.
Because our stores are located in Texas and Louisiana, we are subject to
regional risks.
Our 56 stores are located exclusively in Texas and Louisiana. This
subjects us to regional risks, such as the economy, weather conditions,
hurricanes and other natural disasters. If the region suffered an economic
downturn or other adverse regional event, there could be an adverse impact on
our net sales and profitability and our ability to implement our planned
expansion program. Several of our competitors operate stores across the United
States and thus are not as vulnerable to the risks of operating in one region.
Our information technology infrastructure is vulnerable to damage that could
harm our business.
Our ability to operate our business from day to day, in particular our
ability to manage our credit operations and inventory levels, largely depends on
the efficient operation of our computer hardware and software systems. We use
management information systems to track inventory information at the store
level, communicate customer information, aggregate daily sales information and
manage our credit portfolio. These systems and our operations are vulnerable to
damage or interruption from:
o power loss, computer systems failures and Internet,
telecommunications or data network failures;
o operator negligence or improper operation by, or supervision of,
employees;
o physical and electronic loss of data or security breaches,
misappropriation and similar events;
o computer viruses;
o intentional acts of vandalism and similar events; and
o hurricanes, fires, floods and other natural disasters.
The software that we have developed to use in granting credit may contain
undetected errors that could cause our network to fail or our expenses to
increase. Any failure due to any of these causes, if it is not supported by our
disaster recovery plan, could cause an interruption in our operations and result
in reduced net sales and profitability.
If we are unable to maintain our current insurance coverage for our service
maintenance agreements, our customers could incur additional costs and our
repair expenses could increase, which could adversely affect our financial
condition and results of operations.
There are a limited number of insurance carriers that provide coverage
for our service maintenance agreements. If insurance becomes unavailable from
our current carriers for any reason, we may be unable to provide replacement
coverage on the same terms, if at all. Even if we are able to obtain replacement
coverage, higher premiums could have an adverse impact on our profitability if
we are unable to pass along the increased cost of such coverage to our
customers. Inability to obtain insurance coverage for our service maintenance
agreements could cause fluctuations in our repair expenses and greater
volatility of earnings.
23
If we are unable to maintain group credit insurance policies from insurance
carriers, which allow us to offer their credit insurance products to our
customers purchasing on credit, our revenues could be reduced and bad debts
might increase.
There are a limited number of insurance carriers that provide credit
insurance coverage for sale to our customers. If credit insurance becomes
unavailable for any reason we may be unable to offer replacement coverage on the
same terms, if at all. Even if we are able to obtain replacement coverage, it
may be at higher rates or reduced coverage, which could affect the customer
acceptance of these products, reduce our revenues or increase our credit losses.
Changes in trade regulations, currency fluctuations and other factors beyond our
control could affect our business.
A significant portion of our inventory is manufactured overseas and in
Mexico. Changes in trade regulations, currency fluctuations or other factors
beyond our control may increase the cost of items we purchase or create
shortages of these items, which in turn could have a material adverse effect on
our results of operations and financial condition. Conversely, significant
reductions in the cost of these items in U.S. dollars may cause a significant
reduction in the retail prices of those products, resulting in a material
adverse effect on our sales, margins or competitive position. In addition,
commissions earned on both our credit insurance and service maintenance
agreement products could be adversely affected by changes in statutory premium
rates, commission rates, adverse claims experience and other factors.
We may be unable to protect our intellectual property rights, which could impair
our name and reputation.
We believe that our success and ability to compete depends in part on
consumer identification of the name "Conn's." We have registered the trademarks
"Conn's" and our logo. We intend to protect vigorously our trademark against
infringement or misappropriation by others. A third party, however, could
attempt to misappropriate our intellectual property in the future. The
enforcement of our proprietary rights through litigation could result in
substantial costs to us that could have a material adverse effect on our
financial condition or results of operations.
Any changes in the tax laws of the states of Texas and Louisiana could affect
our state tax liabilities.
From time to time, legislation has been introduced in the Texas
legislature that would, among other things, remove the current exemption from
franchise tax liability that limited partnerships enjoy. Currently, the Texas
Legislature is not in session and its next regular session is scheduled to begin
in January 2007; however, the Texas Governor has announced he will call a
special session of the Texas Legislature beginning April 17, 2006 to address
school finance reform mandated by the Texas Supreme Court. Legislation could be
introduced that, among other things, could change the way that limited
partnerships are taxed in the state of Texas; however, the outcome of any
particular proposal cannot be predicted with any certainty.
A further rise in oil and gasoline prices could affect our customers'
determination to drive to our stores, and cause us to raise our delivery
charges.
A further significant increase in oil and gasoline prices could adversely
affect our customers' shopping decisions and patterns. We rely heavily on our
internal distribution system and our same or next day delivery policy to satisfy
our customers' needs and desires, and any such significant increases could
result in increased distribution charges. Such increases may not significantly
affect our competitors.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
24
ITEM 2. PROPERTIES.
The following summarizes the geographic location of our stores, warehouse
and distribution centers and corporate facilities by major market area:
Leases
With
Options
Total Warehouse Expiring
No. of Leased Square Square Beyond
Geographic Location Locations Facilities Feet Feet 10 Years
- ---------------------------- ---------- ----------- ----------- ----------- ---------
Golden Triangle District (1) 5 5 153,568 32,169 5
Louisiana District .......... 5 5 129,890 27,200 5
Houston District ............ 18 14 394,240 90,070 13
San Antonio/Austin District . 13 13 379,330 83,982 12
Corpus Christi .............. 1 1 51,670 14,300 1
South Texas ................. 2 2 55,660 8,435 2
Dallas District ............. 12 10 351,243 79,245 10
---------- ----------- ---------- ---------- ---------
Store Totals ............. 56 50 1,515,601 335,401 48
Warehouse/Distribution
Centers .................... 6 3 703,453 703,453 1
Service Centers ............. 5 3 191,932 133,636 1
Corporate Offices ........... 1 1 106,783 25,000 1
---------- ----------- ---------- ---------- ---------
Total .................... 68 57 2,517,769 1,197,490 51
========== =========== ========== ========== =========
- -----------------
(1) Includes one store in Lake Charles, Louisiana.
ITEM 3. LEGAL PROCEEDINGS.
We are involved in routine litigation incidental to our business from
time to time. We do not expect the outcome of any of this routine litigation to
have a material effect on our financial condition or results of operation.
However, the results of their 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.
There were no matters submitted to a vote of security holders during the
fourth quarter of fiscal 2006.
25
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, AND RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES.
What is the principal market for our common stock?
The principal market for our common stock is the NASDAQ National Market.
Our common stock is listed on the NASDAQ National Market under the symbol
"CONN." Information regarding the high and low sales prices for our common stock
for each quarterly period since our initial public offering as reported on
NASDAQ is summarized as follows:
High Low
--------- ---------
Quarter ended April 30, 2004 .................... $ 18.08 $ 14.50
Quarter ended July 31, 2004 ..................... $ 19.18 $ 15.35
Quarter ended October 31, 2004 .................. $ 16.82 $ 13.79
Quarter ending January 31, 2005 ................. $ 18.33 $ 14.37
Quarter ended April 30, 2005 .................... $ 19.70 $ 15.29
Quarter ended July 31, 2005 ..................... $ 27.51 $ 16.69
Quarter ended October 31, 2005 .................. $ 29.80 $ 23.20
Quarter ended January 31, 2006 .................. $ 44.93 $ 28.68
How many common stockholders do we have?
As of March 27, 2006, we had approximately 57 common stockholders of
record and an estimated 6,400 beneficial owners of our common stock.
Did we declare any cash dividends in fiscal 2005 or fiscal 2006?
No cash dividends were paid in fiscal 2005 or 2006. We do not anticipate
paying dividends in the foreseeable future. Any future payment of dividends will
be at the discretion of the Board of Directors and will depend upon our results
of operations, financial condition, cash requirements and other factors deemed
relevant by the Board of Directors, including the terms of our indebtedness.
Provisions in agreements governing our long-term indebtedness restrict the
amount of dividends that we may pay to our stockholders. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources."
Has the Company had any sales of unregistered securities during the last year?
The Company has had no sales of unregistered securities during fiscal
2006.
26
ITEM 6. SELECTED FINANCIAL DATA
Twelve
Year Six Months Months
Ended Ended Ended Years Ended January 31,
July 31, January 31, January 31, ---------------------------------------------
2001 2002 2002 2003 2004 2005 2006
--------- --------- --------- --------- --------- --------- ---------
(unaudited)
Statement of Operations (1): (dollars and shares in thousands, except per share amounts)
Total revenues ................................$327,257 $206,896 $378,525 $445,973 $499,310 $567,092 $702,422
Operating expense:
Cost of goods sold, including ware-
housing and occupancy cost .................... 201,963 127,543 233,226 276,956 317,712 359,710 453,374
Selling, general and
administrative expense ........................ 92,194 58,630 106,949 125,712 135,174 152,900 181,631
Provision for bad debts .................... 1,734 1,286 2,406 4,125 4,657 5,637 3,769
--------- --------- --------- --------- --------- --------- ---------
Total operating expense ....................... 295,891 187,459 342,581 406,793 457,543 518,247 638,774
--------- --------- --------- --------- --------- --------- ---------
Operating income .............................. 31,366 19,437 35,944 39,180 41,767 48,845 63,648
Interest expense, net and minority interest ... 3,754 2,940 4,855 7,237 4,577 2,477 400
--------- --------- --------- --------- --------- --------- ---------
Earnings before income taxes .................. 27,612 16,497 31,089 31,943 37,190 46,368 63,248
Provision for income taxes .................... 9,879 5,944 11,130 11,342 12,850 16,243 22,067
--------- --------- --------- --------- --------- --------- ---------
Net income from continuing operations ......... 17,733 10,553 19,959 20,601 24,340 30,125 41,181
Discontinued operations, net of tax ........... (546) - (389) - - - -
--------- --------- --------- --------- --------- --------- ---------
Net income .................................... 17,187 10,553 19,570 20,601 24,340 30,125 41,181
Less preferred stock dividends (2) ............ (2,173) (1,025) (1,939) (2,133) (1,954) - -
--------- --------- --------- --------- --------- --------- ---------
Net income available for
common stockholders ......................$ 15,014 $ 9,528 $ 17,631 $ 18,468 $ 22,386 $ 30,125 $ 41,181
========= ========= ========= ========= ========= ========= =========
Earnings per common share:
Basic ..................................$ 0.87 $ 0.56 $ 1.03 $ 1.10 $ 1.26 $ 1.30 $ 1.76
Diluted ................................$ 0.87 $ 0.55 $ 1.01 $ 1.10 $ 1.22 $ 1.27 $ 1.70
Average common shares outstanding:
Basic .................................. 17,169 17,025 17,060 16,724 17,726 23,192 23,412
Diluted ................................ 17,194 17,327 17,383 16,724 18,335 23,754 24,192
Other Financial Data:
Stores open at end of period .................. 32 36 36 42 45 50 56
Same store sales growth (3) ................... 10.3% 16.7% 15.6% 1.3% 2.6% 3.6% 16.9%
Inventory turns (4) ........................... 5.9 7.5 6.8 6.6 6.5 6.0 6.6
Gross margin percentage (5) ................... 38.3% 38.4% 38.4% 37.9% 36.4% 36.6% 35.5%
Operating margin (6) .......................... 9.6% 9.4% 9.5% 8.8% 8.4% 8.6% 9.1%
Return on average equity (7) .................. 36.7% 35.9% 34.9% 28.3% 19.5% 16.4% 18.5%
Capital expenditures ..........................$ 14,833 $ 10,551 $ 15,547 $ 15,070 $ 9,401 $ 19,619 $ 18,490
Balance Sheet Data:
Working capital ...............................$ 40,752 $ 45,546 $ 45,546 $ 69,984 $115,366 $148,074 $179,496
Total assets .................................. 134,425 145,644 145,644 181,798 234,760 268,792 341,995
Total debt .................................... 31,445 38,750 38,750 51,992 14,512 10,532 136
Preferred stock ............................... 15,400 15,226 15,226 15,226 - - -
Total stockholders' equity .................... 54,879 62,860 62,860 82,669 166,590 200,802 245,284
- --------------------------------------------------
(1) Information excludes the operations of the rent-to-own division that was
sold in February, 2001.
(2) Dividends were not actually declared or paid until 2004, but are
presented for purposes of earnings per share calculations.
(3) Same store sales growth is calculated by comparing the reported sales by
store for all stores that were open throughout a period to reported sales
by store for all stores that were open throughout the prior period. Sales
from closed stores have been removed from each period. Sales from
relocated stores have been included in each period because each such
store was relocated within the same general geographic market. Sales from
expanded stores have been included in each period.
(4) Inventory turns are defined as the cost of goods sold, excluding
warehousing and occupancy cost, divided by the average of the beginning
and ending product inventory, excluding consigned goods; information for
the six months ended January 31, 2002 has been annualized for comparison
purposes.
(5) Gross margin percentage is defined as total revenues less cost of goods
and parts sold, including warehousing and occupancy cost, divided by
total revenues.
(6) Operating margin is defined as operating income divided by total
revenues.
(7) Return on average equity is calculated as current period net income from
continuing operations divided by the average of the beginning and ending
equity; information for the six months ended January 31, 2002 has been
annualized for comparison purposes.
27
ITEM 7. 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
South Texas;
o our intention 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 borrowings or
reduce securitization income;
o technological and market developments, growth trends and projected
sales in the home appliance and consumer electronics industry,
including with respect to digital products like DVD players, HDTV,
digital radio, home networking devices and other new products, and
our ability to capitalize on such growth;
o the potential for price erosion or lower unit sales points that
could result in declines in revenues;
o increasing oil and gas prices that could adversely affect our
customers' shopping decisions and patterns;
o both short-term and long-term impact of adverse weather conditions
(e.g. hurricanes) that could result in volatility in our revenues
and increased expenses and casualty losses;
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.
28
Additional important factors that could cause our actual results to
differ materially from our expectations are discussed under "Risk Factors" in
this Form 10-K. In light of these risks, uncertainties and assumptions, the
forward-looking events and circumstances discussed in this report might not
happen.
The forward-looking statements in this report reflect our views and
assumptions only as of the date of this report. We undertake no obligation to
update publicly or revise any forward-looking statements, whether as a result of
new information, future events or otherwise, except as required by law.
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
We intend the following discussion and analysis to provide you with a
better 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.
Through our 56 retail stores, we provide products and services to our
customers in six primary market areas, including Houston, San Antonio/Austin,
Dallas/Fort Worth, southern Louisiana, Southeast Texas, and South Texas.
Products and services offered through retail sales outlets include major home
appliances, consumer electronics, home office equipment, lawn and garden
products, mattresses, furniture, service maintenance agreements, customer credit
programs, including installment and revolving credit account services, and
various credit insurance products. These activities are supported through our
extensive service, warehouse and distribution system. Our stores bear the
"Conn's" name, after our founder's family, and deliver the same products and
services to our customers. All of our stores follow the same procedures and
methods in managing their operations. The Company's management evaluates
performance and allocates resources based on the operating results of the retail
stores and considers the credit programs, service contracts and distribution
system to be an integral part of the Company's retail operations.
Presented below is a diagram setting forth our five cornerstones which
represent, in our view, the five components of our sales goal - strong
merchandising systems, state of the art credit options for our customers, an
extensive warehousing and distribution system, a service system to support our
customers needs beyond the product warranty periods, and our uniquely,
well-trained employees in each area. Each of these systems combine to create a
"nuts and bolts" support system for our customers needs and desires. Each of
these systems is discussed at length in the Business section of this report.
BUSINESS
CORNERSTONES:
- --------------- => DRIVE => SALES
Merchandising
Credit
Distribution
Service
Training
We, of course, derive a large part of our revenue from our product sales.
However, unlike many of our competitors, we provide in-house credit options for
our customers' product purchases. In the last three years, we have financed, on
average, approximately 57% of our retail sales through these programs. In turn,
we finance (convert to cash) substantially all of our customer receivables from
these credit options through an asset-backed securitization facility. See
29
"Business - Finance Operations" for a detailed discussion of our in-house credit
programs. 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 to fund such purchases. We transfer our
receivables, consisting of retail installment contracts and revolving accounts
extended to our customers, to the issuer in exchange for cash and subordinated
securities.
While our warehouse and distribution system does not directly generate
revenues, other than the fees paid by our customers for delivery and
installation of the products to their homes, it is our extra, "value-added"
program that our existing customers have come to rely on, and our new customers
are hopefully sufficiently impressed with to become repeat customers. We derive
revenues from our repair services on the products we sell. Additionally, acting
as an agent for unaffiliated companies, we sell credit insurance to protect our
customers from credit losses due to death, disability, involuntary unemployment
and damage to the products they have purchased; to the extent they do not
already have it.
Executive Overview
This overview is intended to provide an executive level overview of our
operations for our fiscal year ended January 31, 2006. A detailed explanation of
the changes in our operations for the fiscal year ended January 31, 2006 as
compared to the prior year is included beginning on page 36. Following are
significant financial items in managements view:
o Our revenues for the fiscal year ended January 31, 2006 increased
by 23.9 percent, or $135.3 million, from fiscal year 2005 to
$702.4 million due to sales growth, primarily from existing
stores, and increased securitization income. Our same store sales
product growth rate for the fiscal year ended January 31, 2006 was
16.9%, versus 3.6% for fiscal 2005. The improvement in same store
sales growth was due primarily to improved execution at the store
level and effective sales promotions. (Also see "Operational
Changes and Outlook.")
o During the last half of fiscal year 2006, two hurricanes, Katrina
and Rita, hit the Gulf Coast. These storms significantly impacted
our operations by:
o temporary closing of our Louisiana, South East Texas,
Corpus Christi and Houston stores and related distribution
operations for limited periods of time,
o positively impacting Net sales as customers in the affected
areas replaced appliances and other household products
damaged as a result of the storms,
o disrupting credit collection efforts while we were
displaced from our corporate headquarters as a result of
Hurricane Rita, causing a short-term increase in the credit
portfolio's delinquency statistics and resulting in a
reduction of Finance charges and other and an increase in
Bad debt expense, and
o causing us to incur expenses related to the relocation of
our corporate office functions and losses related to
damaged merchandise and facilities, net of insurance
proceeds.
o Same store sales benefited from the effects of the hurricanes.
Appliance sales accounted for the majority of the increase in
total same stores sales during the period due in part to our
customers' need to replace items damaged by the storms. We believe
same store sales, adjusted for our estimate of the impact of the
hurricanes, grew approximately 12% for the year ended January 31,
2006.
o Our entry into the Dallas/Fort Worth and the South Texas markets
had a positive impact on our revenues. Approximately $75.9 million
of our product sales for the year ended January 31, 2006, came
from the opening of twelve 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 2007 as we
focus on opportunities in markets in which we have existing
infrastructure.
o While deferred interest and "same as cash" plans continue to be an
important part of our sales promotion plans, our improved
execution and effective use of a variety of sales promotions,
enabled us to reduce the level of deferred interest and "same as
cash" plans that extend beyond one year, relative to gross product
sales volume. For the fiscal years ended January 31, 2005 and
2006, $29.0 million and $33.9 million, respectively, in gross
product sales were financed by extended deferred interest and
"same as cash" plans. These extended term promotional programs
were not offered broadly until April, 2004. We expect to continue
to offer this type of extended term promotional credit in the
future.
30
o During the year ended January 31, 2006, pretax income was reduced
by $1.0 million to reflect our estimate of expected losses due to
increased delinquencies from Hurricane Rita and a temporary
increase in bankruptcy filings. The increase in bankruptcy filings
is as a result of the new bankruptcy law that took effect October
17, 2005, prompting consumers to file for bankruptcy protection
before the new law went into effect. The $1.0 million charge to
earnings reduced Finance charges and other by $895,000 and
increased Bad debt expense by $105,000.
o Our gross product margin was 35.5% for fiscal year 2006, a
decrease from 36.6% in fiscal 2005, primarily as a result of a
change in our revenue mix as Product sales grew faster than
Service revenues and Finance charges and other. Also, reduced
insurance sales penetration negatively impacted our gross margin.
o Our operating margin increased to 9.1% from 8.6% in fiscal 2005.
In fiscal year 2006, we decreased SG&A expense as a percent of
revenues to 25.8% from 27.0% 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 increased general liability
insurance expense and expenses incurred due to Hurricane Rita of
approximately $907,000, net of estimated insurance proceeds.
Additionally, our operating margin benefited from a decrease in
the Provision for bad debts as a percent of revenues from 1.0% to
0.5%.
o Operating cash flows were $64.3 million for fiscal 2006. Our
operating cash flows increased as a result of increased net
income, improved funding under our asset-backed securitization and
vendor and federal employment and income tax payment deferrals
granted because of the hurricanes. Most of the payments deferred
will be paid during the three month period ended April 30, 2006.
o Our pretax income for fiscal 2006 increased by 36.4% or
approximately $16.8 million, from fiscal 2005 to $63.2 million.
The increase was driven largely by the increase in sales with
additional benefit from improved expense leverage, as Selling,
general and administrative expenses did not grow as fast as
revenues.
Operational Changes and Outlook
We have implemented, continued increased focus on or modified several
initiatives in fiscal 2006 that we believe will positively impact our future
operating results, including:
o A reorganization of our retail management team, including
strengthening the district management team in the Dallas/Fort
Worth market;
o Successfully increasing the sales force by adding approximately
13% more sales associates per store, resulting in incremental
sales volume;
o Implementation of call centers in the stores, emphasizing regular,
consistent contact with our customers;
o Increased emphasis on the sales of furniture, and additional
product lines added to this category; and
o Promoting flat panel technology in our stores as the price point
becomes more affordable for our customers.
31
Our sales during the last five months of fiscal 2006 benefited from the
impact of Hurricanes Katrina and Rita. This impact could affect future same
store sales due to:
o The acceleration of the sale of essential appliances in the affected
markets disrupting the normal replacement o cycle for these items;
and
o The same store sales reported for the impacted markets being
elevated to a level that might not be duplicated. o
While our credit portfolio delinquency statistics were still negatively
impacted by the effects of the hurricanes at January 31, 2006, we anticipate the
portfolio performance returning to historical levels as we continue to work with
the customers impacted by these events.
During the year, we opened four new stores in the Dallas/Fort Worth
market, one in Harlingen, Texas and one in San Antonio, Texas. We continue to be
satisfied with the results in the Dallas/Fort Worth market and will continue to
expand the number of stores in that market. We added additional distribution
capability during the year by opening our 140,000 square foot distribution
center in Dallas, and increased our service center capabilities in Dallas by
converting our previous distribution center to a full-time service center. Our
new Harlingen store now joins a store in McAllen, Texas, opened in early
September 2004, forming our South Texas market, We believe that this market is
substantially underserved and provides great growth potential for our company.
We have several other locations in Texas and Louisiana that we believe are
promising and, along with new stores in existing markets, are in various stages
of development for opening in fiscal year 2007. We also continue to look at
other markets, including neighboring states for opportunities.
The consumer electronics industry depends on new products to drive same
store sales increases. Typically, these new products, such as digital
televisions, DVD players, digital cameras and MP3 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 drive 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 volume 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 January 31, 2006.
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 Statement of Financial
Accounting Standards ("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 cash flows
resulting entirely from the interest on the security. The gain or loss
recognized on these transactions is based on our best estimates of key
assumptions, including forecasted credit losses, payment rates, forward yield
curves, costs of servicing the accounts and appropriate discount rates. The use
32
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), our interest in securitized assets
would have been reduced by $4.7 million as of January 31, 2006, which may have
an adverse effect on earnings. We recognize income from our interest in these
transferred accounts based on the difference between the interest earned on
customer accounts and the costs associated with financing and servicing the
transferred accounts, less a provision for bad debts associated with the
transferred assets. This income is recorded as "Finance charges and other" in
our consolidated statement of operations. If we had assumed a 10% increase in
the assumption used for developing the reserve for doubtful accounts on the
books of the QSPE, the impact to recorded "Finance charges and other" would have
been a reduction in revenues and pretax income of $1.2 million.
Deferred Tax Assets. We have significant net deferred tax assets
(approximately $5.5 million as of January 31, 2006), which are subject to
periodic recoverability assessments. Realization of our net deferred tax assets
may be dependent upon whether we achieve projected future taxable income. Our
estimates regarding future profitability may change due to future market
conditions, our ability to continue to execute at historical levels and our
ability to continue our growth plans. These changes, if any, may require
material adjustments to these deferred tax asset balances. For example, if we
had assumed that the future tax rate at which these deferred items would reverse
was 34.1% rather than 35.1%, we would have reduced the net deferred tax asset
and net income by approximately $94,000.
Intangible Assets. We have significant intangible assets related primarily
to goodwill. The determination of related estimated useful lives and whether or
not these assets are impaired involves significant judgments. Effective with the
implementation of SFAS 142, we ceased amortizing goodwill and began testing
potential impairment of this asset annually based on judgments regarding ongoing
profitability and cash flow of the underlying assets. 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 January 31, 2005 and 2006 was $9.6 million
Property, Plant and Equipment. Our accounting policies regarding land,
buildings, and equipment include judgments regarding the estimated useful lives
of such assets, the estimated residual values to which the assets are
depreciated, and the determination as to what constitutes increasing the life of
existing assets. These judgments and estimates may produce materially different
amounts of depreciation and amortization expense than 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 if the
anticipated cash flows associated with the assets are not 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. We sell service
maintenance agreements and credit insurance contracts on behalf of unrelated
third parties. For contracts where the third parties are the obligor on the
contract, commissions are recognized in revenues at the time of sale, and in the
case of retrospective commissions, based on claims experience, at the time that
they are earned. When we sell service maintenance 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 direct obligor 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 and 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 amounts of service
maintenance agreement revenue deferred at January 31, 2005 and 2006 were $3.9
million and $3.6 million, respectively, and are included in "Deferred revenue"
in the accompanying balance sheets. The amounts of service maintenance agreement
revenue recognized for the fiscal years ended January 31, 2004, 2005 and 2006
were $4.5 million, $5.0 million and $5.0 million, respectively.
33
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.
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 required to implement the provisions of this statement
effective February 1, 2006, and intend to elect to retrospectively adjust prior
year results for comparison purposes. 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.
Accounting for Leases. The accounting for leases is governed primarily by
SFAS No. 13, Accounting for Leases. As required by the standard, we analyze each
lease, at its inception, to determine whether it should be accounted for as an
operating lease or a capital lease. Additionally, monthly lease expense for each
operating lease is calculated as the average of all payments required under the
minimum lease term, including rent escalations. The minimum lease term begins
with the date we take possession of the property and ends on the last day of the
minimum lease term, and includes all rent holidays, but excludes renewal terms
that are at our option. Any tenant improvement allowances received are deferred
and amortized into income as a reduction of lease expense on a straight line
basis over the minimum lease term. The amortization of leasehold improvements is
computed on a straight line basis over the shorter of the remaining lease term
or the estimated useful life of the improvements.
34
Results of Operations
The following table sets forth certain statement of operations information
as a percentage of total revenues for the periods indicated.
Years ended January 31,
----------------------------
2004 2005 2006
-------- -------- --------
Revenues:
Product sales .................................. 80.6% 79.6% 81.1%
Service maintenance agreement
commissions (net) ............................ 4.0 4.2 4.4
Service revenues ............................... 3.7 3.3 2.9
-------- -------- --------
Total net sales ................................ 88.3 87.1 88.4
Finance charges and other ...................... 11.7 12.9 11.6
-------- -------- --------
Total revenues ................................. 100.0 100.0 100.0
Cost and expenses:
Cost of goods sold, including
warehousing and occupancy costs .............. 62.8 62.6 63.8
Cost of parts sold, including
warehousing and occupancy costs .............. 0.8 0.8 0.8
Selling, general and administrative expense .... 27.1 27.0 25.8
Provision for bad debts ........................ 0.9 1.0 0.5
-------- -------- --------
Total costs and expenses ................... 91.6 91.4 90.9
-------- -------- --------
Operating income ............................... 8.4 8.6 9.1
Interest expense (including minority interest) . 0.9 0.4 0.1
-------- -------- --------
Earnings before income taxes ................... 7.5 8.2 9.0
Provision for income taxes
Current .................................... 2.6 2.9 3.3
Deferred ................................... - - (0.2)
-------- -------- --------
Total provision for income taxes ............... 2.6 2.9 3.1
-------- -------- --------
Net income ..................................... 4.9% 5.3% 5.9%
======== ======== ========
In reviewing the percentages reflected in the above table, we noted that
the following trends in our operations developed within the last twelve months.
o The increase in cost of goods sold as a percentage of total
revenues reflects the shift in revenue mix as product sales
grew faster than service revenues and finance charges and
other. Cost of products sold was 78.7% of net product sales in
the 2005 period and 78.6% in the 2006 period.
o The decline in selling, general and administrative 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 increased general liability insurance
expense and higher expenses incurred due to Hurricane Rita.
o The declining trend in interest expense as a percentage of
total revenues is a function of continuing to generate
positive cash flow, the pay-off of debt with our IPO proceeds
in fiscal year 2004 and the impact of expiring interest rate
swap agreements.
The presentation of our 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 of
merchandising our products, including amounts related to purchasing the product
and a portion of our advertising cost, in selling, general and administrative
expense. It is our understanding that other retailers may include such costs as
part of cost of goods sold.
35
The following table presents certain operations information in dollars and
percentage changes from year to year:
Analysis of Consolidated Statements of Operations
(in thousands except percentages) 2005 vs. 2004 2006 vs. 2005
Years Ended January 31, Incr/(Decr) Incr/(Decr)
------------------------------- ----------------- -------------------
2004 2005 2006 Amount Pct Amount Pct
--------- --------- --------- -------- ------- --------- --------
Revenues
Product sales ....................$402,579 $451,560 $569,877 $48,981 12.2% $118,317 26.2%
Service maintenance agreement
commissions (net) ................ 20,074 23,950 30,583 3,876 19.3 6,633 27.7
Service revenues ................. 18,265 18,725 20,278 460 2.5 1,553 8.3
--------- --------- --------- -------- ------- --------- --------
Total net sales .................. 440,918 494,235 620,738 53,317 12.1 126,503 25.6
Finance charges and other ........ 58,392 72,857 81,684 14,465 24.8 8,827 12.1
--------- --------- --------- -------- ------- --------- --------
Total revenues ................... 499,310 567,092 702,422 67,782 13.6 135,330 23.9
Cost of goods and parts sold ..... 317,712 359,710 453,374 41,998 13.2 93,664 26.0
--------- --------- --------- -------- ------- --------- --------
Gross Profit ..................... 181,598 207,382 249,048 25,784 14.2 41,666 20.1
Gross Margin ..................... 36.4% 36.6% 35.5%
Selling, general and
administrative expense .......... 135,174 152,900 181,631 17,726 13.1 28,731 18.8
Provision for bad debts .......... 4,657 5,637 3,769 980 21.0 (1,868) (33.1)
--------- --------- --------- -------- ------- --------- --------
Operating income ................. 41,767 48,845 63,648 7,078 16.9 14,803 30.3
Operating Margin ................. 8.4% 8.6% 9.1%
Interest expense ................. 4,577 2,359 400 (2,218) (48.5) (1,959) (83.0)
Minority interest in limited
partnership ..................... - 118 - 118 (118)
--------- --------- --------- -------- ------- --------- --------
Pretax Income .................... 37,190 46,368 63,248 9,178 24.7 16,880 36.4
Income taxes ..................... 12,850 16,243 22,067 3,393 26.4 5,824 35.9
--------- --------- --------- -------- ------- --------- --------
Net Income ....................... 24,340 30,125 41,181 5,785 23.8 11,056 36.7
Less preferred dividends ......... 1,954 - - (1,954) (100.0) - -
--------- --------- --------- -------- ------- --------- --------
Net income available
for common stockholders ..........$ 22,386 $ 30,125 41,181 $ 7,739 34.6% $ 11,056 36.7%
========= ========= ========= ======== ======= ========= ========
Refer to the above Analysis of Consolidated Statements of Operations in
condensed form while reading the operations review on a year by year basis.
Year Ended January 31, 2005 Compared to the Year Ended January 31, 2006
Revenues. Total revenues increased by $135.3 million, or 23.9%, from
$567.1 million for the year ended January 31, 2005 to $702.4 million for the
year ended January 31, 2006. The increase was attributable to increases in net
sales of $126.5 million, or 25.6%, and $8.8 million, or 12.1%, in finance
charges and other revenue.
The $126.5 million increase in net sales was made up of the following:
o a $75.8 million increase resulted from a same store sales increase
of 16.9%. Appliance sales accounted for the majority of the increase
and were significantly impacted by our customers' need to replace
items damaged as a result of Hurricanes Katrina and Rita. After
adjusting for our estimate of the impact of the storms, we believe
same store sales increased approximately 12%, with appliance,
electronics, track and furniture sales being the biggest
contributors. As a result of changes in the commission structure on
our third-party service maintenance agreement (SMA) contracts,
beginning July 2005, we began realizing the benefit of increased
front-end commissions on SMA sales, which increased net sales $1.4
million, (offsetting this increase is a decrease in retrospective
commissions which is reflected in Finance charges and other),
o a $49.8 million increase generated by twelve retail locations that
were not open for twelve consecutive months in each period, net of
reductions related to the closing of one location,
o a $644,000 decrease resulted from an increase in discounts on
promotional credit sales, and
o a $1.6 million increase resulted from an increase in service
revenues.
36
The components of the $126.5 million increase in net sales were a $118.3
million increase in product sales and an $8.2 million net increase in service
maintenance agreement commissions and service revenues. The $118.3 million
increase in product sales resulted from the following:
o approximately $82.6 million was attributable to increases in unit
sales, due to increased appliances, track, furniture, and consumer
electronics sales, and
o approximately $35.7 million was attributable to increases in unit
price points. The price point impact was driven primarily by:
o consumers selecting higher priced consumer electronics products,
as the new technology becomes more affordable;
o consumers selecting higher priced appliance products, including
high-efficiency washers and dryers and stainless kitchen
o appliances, and higher prices on appliances in general.
The following table presents the makeup of net sales by product category in
each period, including service maintenance agreement commissions and service
revenues, expressed both in dollar amounts and as a percent of total net sales.
Classification of sales has been adjusted from previous filings to ensure
comparability between the categories.
Years Ended January 31,
-----------------------------------------------------
2005 2006
----------------------- --------------------------- Percent
Category Amount Percent Amount Percent Increase
----------- --------- ----------- ------------- -----------
(dollars in thoursands)
Major home appliances ...........$ 168,962 34.2% $ 223,651 36.0% 32.4% (1)
Consumer electronics ............ 154,880 31.3 186,679 30.1 20.5 (2)
Track ........................... 85,644 17.3 100,154 16.1 16.9 (2)
Delivery ........................ 7,605 1.5 9,870 1.6 29.8 (2)
Lawn and garden ................. 13,710 2.8 17,083 2.8 24.6 (2)
Bedding ......................... 10,262 2.1 13,126 2.1 27.9 (2)
Furniture ....................... 7,182 1.5 15,313 2.5 113.2 (3)
Other ........................... 3,315 0.7 4,001 0.6 20.7 (2)
----------- --------- ----------- -------------
Total product sales ........ 451,560 91.4 569,877 91.8 26.2
Service maintenance agreement
commissions .................. 23,950 4.8 30,583 4.9 27.7 (2)
Service revenues ................ 18,725 3.8 20,278 3.3 8.3
----------- --------- ----------- -------------
Total net sales ............$ 494,235 100.0% $ 620,738 100.0% 25.6%
=========== ========= =========== =============
(1) In addition to strong overall sales growth, appliance sales benefited
from our customers' needs after the hurricanes.
(2) These increases are consistent with overall increase in product sales
and improved unit prices.
(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 $8.8
million, or 12.1%, from $72.9 million for the year ended January 31. 2005 to
$81.7 million for the year ended January 31, 2006. This increase in revenue
resulted primarily from increases in securitization income of $9.6 million, a
$1.0 million decrease in service maintenance agreement retrospective commissions
and a net increase in insurance commissions and other revenues of $210,000. The
increase in securitization income is 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. Partially offsetting the
securitization income increases was a reduction of $895,000 for estimated losses
resulting from increased bankruptcy filings by our customers prior to October
17, 2005, the effective date of the new bankruptcy law and our estimate of
expected additional loan losses due to the impact of Hurricane Rita.
37
Cost of Goods Sold. Cost of goods sold, including warehousing and occupancy
cost, increased by $92.9 million, or 26.2%, from $355.2 million for the year
ended January 31, 2005 to $448.1 million for the year ended January 31, 2006.
This increase was consistent with the 26.2% increase in net product sales during
the year ended January 31, 2006. Cost of products sold was 78.7% of net product
sales in the 2005 period and 78.6% in the 2006 period.
Cost of Service Parts Sold. Cost of service parts sold, including
warehousing and occupancy cost, increased approximately $758,000, or 16.7%, for
the year ended January 31, 2006 as compared to the year ended January 31, 2005,
due to increases in parts sales.
Selling, General and Administrative Expense. While Selling, general and
administrative expense increased by $28.7 million, or 18.8%, from $152.9 million
for the year ended January 31, 2005 to $181.6 million for the year ended January
31, 2006, it decreased as a percentage of total revenue from 27.0% to 25.8%. 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 increased general liability
insurance expense and higher expenses incurred due to Hurricane Rita of
approximately $907,000, net of estimated insurance proceeds, including expenses
related to relocation of the corporate office functions and losses related to
damaged merchandise and facility damage.
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 $1.9 million, or 33.1%, during the year ended
January 31, 2006 as compared to the year ended January 31, 2005, 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. Partially offsetting the
bad debt expense decrease was a charge of $105,000 for estimated losses
resulting from increased bankruptcy filings by our customers prior to October
17, 2005, the effective date of the new bankruptcy law and expected additional
loan losses due to the impact of Hurricane Rita on our customers. See Note 2 to
the financial statements for information regarding the performance of the credit
portfolio.
Interest Expense, net. Net interest expense decreased by $2.0 million, or
83.0%, from $2.4 million for the year ended January 31, 2005 to $400,000 for the
year ended January 31, 2006. 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 $856,000; and
o the deconsolidation of SRDS (previously consolidated as a VIE
according to FIN 46) resulted in a decrease of interest expense of
$759,000,
The remaining decrease in interest expense of $385,000 resulted from lower
average outstanding debt balances and higher interest income from invested
funds.
Minority Interest. As a result of FIN 46, for the year ended January 31,
2005, 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
$5.9 million, or 36.0%, from $16.2 million for the year ended January 31, 2005
to $22.1 million for the year ended January 31, 2006, consistent with the
increase in pretax income of 36.1%.
Net Income. As a result of the above factors, Net income increased $11.1
million, or 36.7%, from $30.1 million for the year ended January 31, 2005 to
$41.2 million for the year ended January 31, 2006.
Year Ended January 31, 2004 Compared to the Year Ended January 31, 2005
Revenues. Total revenues increased by $67.8 million, or 13.6%, from $499.3
million for the year ended January 31, 2004 to $567.1 million for the year ended
January 31, 2005. The increase was attributable to increases in net sales of
$53.3 million, or 12.1%, and $14.5 million, or 24.8%, in finance charges and
other revenue.
38
The $53.3 million increase in net sales was made up of the following:
o a $14.8 million increase resulted from a same store sales increase of
3.6%.
o a $40.5 million increase generated by nine retail locations that were
not open for twelve consecutive months in each period.
o a $2.4 million decrease resulted from an increase in discounts on
promotional credit sales, and
o a $460,000 increase resulted from an increase in service revenues.
The components of the $53.3 million increase in net sales were a $49.0
million increase in product sales and a $4.3 million net increase in service
maintenance agreement commissions and service revenues. The $49.0 million
increase in product sales resulted from the following:
o approximately $18.0 million was attributable to increases in unit
sales, due to increased appliances, mattresses and track sales, and
o approximately $31.0 million was attributable to increases in unit
price points. The price point impact was driven primarily by consumers
selecting higher priced products as new technology prices fall and
become more affordable.
The following table presents the makeup of net sales by product category in
each period, including service maintenance agreement commissions and service
revenues, expressed both in dollar amounts and as a percent of total net sales.
Classification of sales has been adjusted from previous filings to ensure
comparability between the categories.
Years Ended January 31,
-----------------------------------------------------
2004 2005
----------------------- --------------------------- Percent
Category Amount Percent Amount Percent Increase
----------- --------- ----------- ------------- -----------
(dollars in thousands)
Major home appliances ...........$ 159,401 36.1% $ 168,962 34.2% 6.0%
Consumer electronics ............ 139,417 31.6 154,880 31.3 11.1
Track ........................... 70,031 15.9 85,644 17.3 22.3 (1)
Delivery ........................ 6,726 1.5 7,605 1.5 13.1
Lawn and garden ................. 11,505 2.6 13,710 2.8 19.2 (2)
Bedding ......................... 6,441 1.5 10,262 2.1 59.3 (2)
Furniture ....................... 5,712 1.3 7,182 1.5 25.7 (3)
Other ........................... 3,346 0.8 3,315 0.7 (0.9)
----------- --------- ----------- -------------
Total product sales ........ 402,579 91.3 451,560 91.4 12.2
Service maintenance agreement
commissions .................. 20,074 4.6 23,950 4.8 19.3
Service revenues ................ 18,265 4.1 18,725 3.8 2.5
----------- --------- ----------- -------------
Total net sales ............$ 440,918 100.0% $ 494,235 100.0% 12.1%
=========== ========= =========== =============
(1) Emphasis continues to be given to promotion of sales in the "track"
area of computers, computer peripherals, portable electronics and
small appliances.
(2) The increases in lawn and garden and mattresses result from our
increased emphasis placed on these relatively new product categories
and the introduction of the Serta brand mattresses to our product
line.
(3) There has been significant growth in the sales of furniture, primarily
recliners and other seating products. More square footage is being
devoted to furniture in certain store locations as we continue to
"test the market" for this product category.
Revenue from Finance charges and other increased by approximately $14.5
million, or 24.8%, from $58.4 million for the year ended January 31. 2004 to
$72.9 million for the year ended January 31, 2005. This increase in revenue
resulted primarily from increases in securitization income of $11.7 million, and
increases in insurance commissions and other revenues of $2.8 million. The
increase in securitization income is 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.
39
Cost of Goods Sold. Cost of goods sold, including warehousing and occupancy
cost, increased by $41.5 million, or 13.2%, from $313.6 million for the year
ended January 31, 2004 to $355.1 million for the year ended January 31, 2005.
This increase primarily resulted from the 12.2% increase in net product sales as
well as an increase in cost of products sold. Cost of products sold was 77.9% of
net product sales in the 2004 period and 78.7% in the 2005 period. The overall
increase in cost of goods sold as a percentage of product sales was primarily
caused by the continued deterioration of retail price points and sales of
relatively lower margin computer products growing at a more rapid rate than
sales of higher margin products.
Cost of Service Parts Sold. Cost of service parts sold, including
warehousing and occupancy cost, increased approximately $500,000, or 11.7%, for
the year ended January 31, 2005 as compared to the year ended January 31, 2004,
due to increases in parts sales.
Selling, General and Administrative Expense. While Selling, general and
administrative expense increased by $17.7 million, or 13.1%, from $135.2 million
for the year ended January 31, 2004 to $152.9 million for the year ended January
31, 2005, it decreased as a percentage of total revenue from 27.1% to 27.0%. The
increase in total expense was primarily the result of increased sales salaries
and commissions (and other payroll-related expense), delivery, occupancy and
depreciation expense due to the addition of new stores and all in line with the
12.1% increase in net sales. Professional services was up 41.2% which partially
reflects the effect of complying with Sarbanes/Oxley Section 404 by expending
approximately $600,000 on direct implementation, including our independent
accounting firms cost incurred in testing and preparation necessary to issue its
initial report, but not including our employee man hours. General liability,
property and health insurance costs were up 24.3% due to additional stores,
additional employees (primarily sales) and the higher exposure of being a
publicly-traded company. These cost increases were partially offset by decreases
in telephone, amortization, advertising and equipment lease expense.
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 increased by $1.0 million, or 21.1%, during the year ended
January 31, 2005 as compared to the year ended January 31, 2004, primarily due
to the 21.2% increase in our average outstanding balance of our credit
portfolio.
Interest Expense, net. Net interest expense decreased by $2.2 million, or
48.5%, from $4.6 million for the year ended January 31, 2004 to $2.4 million for
the year ended January 31, 2005. The net decrease in interest expense was
attributable to the following factors:
o the expiration of $30.0 million of our interest rate hedges in April
2003 and the expiration of $50.0 million of our interest rate hedges
in November 2003 and the discontinuation of hedge accounting for
derivatives resulted in a net decrease of $1.4 million in interest
expense from the prior period; and
o the decrease in our average outstanding debt from $39.9 million to
$2.6 million (when ignoring the impact of FIN 46 consolidation of
$14.8 million, see below) as a result of our public offering and
payoff of substantially all of our outstanding debt with the proceeds
resulted in a decrease in interest expense of approximately $1.9
million;
these decreases were offset by the following:
o the increase in interest rates in our continuing revolving debt
facilities and related commitment fees of $361,000; and
o the implementation of FIN 46 resulted in reclassification of $759,000
in expenses previously reflected as occupancy cost in Selling, general
and administrative expense to Interest expense; these
reclassifications should not be necessary in the future since we are
no longer subject to the provisions of FIN 46.
Minority Interest. As a result of FIN 46, beginning February 1, 2004, we
eliminate the pretax operating profit contributed from the consolidation of SRDS
through the minority interest line item in our consolidated statement of
operations.
40
Provision for Income Taxes. The provision for income taxes increased by
$3.4 million, or 26.4%, from $12.8 million for the year ended January 31, 2004
to $16.2 million for the year ended January 31, 2005. The increase in the tax
provision was directly related to the increase in pretax profits of $9.2
million, or 24.7%. The effective tax rate attributable to continuing operations
for the year ended January 31, 2005 was 35.0%, compared with 34.6% for the prior
year. Taxes were comprised of federal and state rates totaling 35.5% in both
periods offset by cash refunds due to return amounts being lower than estimates
and adjustments of previous tax provisions in both periods.
Net Income. As a result of the above factors, Net income increased $5.8
million, or 23.8%, from $24.3 million for the year ended January 31, 2004 to
$30.1 million for the year ended January 31, 2005.
Impact of Inflation
We do not believe that inflation has a material effect on our net sales or
results of operations. However, a continuing significant increase in oil and
gasoline prices could adversely affect our customers' shopping decisions and
patterns. We rely heavily on our internal distribution system and our same or
next day delivery policy to satisfy our customers' needs and desires, and any
such significant increases could result in increased distribution charges. Such
increases may not affect our competitors in the same manner as it affects us.
Seasonality and Quarterly Results of Operations
Our business is somewhat seasonal, with a higher portion of sales and
operating profit realized during the quarter that ends January 31. The fiscal
quarter ending January 31 reflects the holiday selling season, the major
collegiate bowl season, the National Football League playoffs and the Super
Bowl. Over the four quarters of fiscal 2006, gross margins were 35.4%, 36.2%,
35.7% and 34.6%. During the same period, operating margins were 9.7%, 8.8%, 8.2%
and 9.5%. A portion of the fluctuation in gross margins and operating margins is
due to planned infrastructure cost additions, such as increased warehouse space
and larger stores, additional personnel and systems required to absorb the
significant increase in revenues that we have experienced over the last several
years.
Additionally, quarterly results may fluctuate materially depending on
factors such as the following:
o timing of new product introductions, new store openings and store
relocations;
o sales contributed by new stores;
o increases or decreases in comparable store sales;
o adverse weather conditions;
o shifts in the timing of certain holidays or promotions; and
o changes in our merchandise mix.
Results for any quarter are not necessarily indicative of the results that
may be achieved for a full year.
41
The following table sets forth certain unaudited quarterly statement of
operations information for the eight quarters ended January 31, 2006. The
unaudited quarterly information has been prepared on a consistent basis and
includes all normal recurring adjustments that management considers necessary
for a fair presentation of the information shown.
2005 2006
--------------------------------------------- ---------------------------------------------
Quarter Ended Quarter Ended
--------------------------------------------- ---------------------------------------------
Apr. 30 Jul. 31 Oct. 31 Jan. 31 Apr. 30 Jul. 31 Oct. 31 Jan. 31
--------- --------- --------- --------- --------- --------- --------- ---------
(dollars and shares in thousands, except per share amounts)
Total revenues .............$134,877 $136,601 $132,910 $162,704 $158,163 $164,375 $173,305 $206,579
Percent of total revenues .. 23.8% 24.1% 23.4% 28.7% 22.5% 23.4% 24.7% 29.4%
Gross profit ...............$ 48,999 $ 49,805 $ 49,228 $ 59,350 $ 56,021 $ 59,560 $ 61,947 $ 71,520
Gross profit
as a % of total revenues ... 36.3% 36.5% 37.0% 36.5% 35.4% 36.2% 35.7% 34.6%
Operating profit ...........$ 12,715 $ 11,057 $ 10,117 $ 14,956 $ 15,387 $ 14,417 $ 14,137 $ 19,707
Operating profit
as a % total revenues ...... 9.4% 8.1% 7.6% 9.2% 9.7% 8.8% 8.2% 9.5%
Net income available
for common stockholder .....$ 7,773 $ 6,790 $ 6,315 $ 9,247 $ 9,802 $ 9,324 $ 9,131 $ 12,924
Net income available
for common stockholder
as a % of revenue .......... 5.8% 5.0% 4.8% 5.7% 6.2% 5.7% 5.3% 6.3%
Outstanding shares:
Basic ................ 23,145 23,179 23,206 23,230 23,307 23,366 23,458 23,523
Diluted .............. 23,749 23,801 23,681 23,764 23,856 24,114 24,286 24,512
Earnings per share:
Basic ................$ 0.34 $ 0.29 $ 0.27 $ 0.40 $ 0.42 $ 0.40 $ 0.39 $ 0.55
Diluted ..............$ 0.32 $ 0.29 $ 0.27 $ 0.39 $ 0.41 $ 0.39 $ 0.38 $ 0.53
Liquidity and Capital Resources
We require capital to finance our growth as we add new stores and markets
to our operations, which in turn requires additional working capital for
increased receivables and inventory. We have historically 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. At January 31, 2006, we had a revolving line of credit facility with
a group of lenders in the amount of $50 million, under which we had no
borrowings outstanding but utilized $3.0 million of availability to issue
letters of credit. We expect that our cash requirements for the foreseeable
future, including those for our capital expenditure requirements, will be met
with our available line of credit and our existing $45.2 million in cash and
cash equivalents at January 31, 2006, together with cash generated from
operations. Our current plans are to grow our store base by approximately 10% a
year. We expect we will invest in real estate and customer receivables to
support the additional stores and same store sales growth. Depending on market
conditions we may, at times, enter into sale-leaseback transactions to finance
our real estate or seek alternative financing sources for new store expansions
and customer receivables growth.
The following is a comparison of our statement of cash flows for our
fiscal years 2005 and 2006:
The increase in cash flow from operating activities for fiscal year 2006
from fiscal year 2005 of $64.1 million, resulted primarily from increased net
income, a smaller increase in the retained interest in the asset backed
securitization program and the timing of payments of accounts payable and
federal income and employment taxes. Operating cash flows have been positively
impacted in the amount of approximately $18.9 million by federal income and
employment tax payment deadlines being deferred until February 28, 2006 after
Hurricane Rita.
Our promotional credit programs offered to certain customers provide for
"same as cash" interest free periods of varying terms, generally three, six,
twelve, eighteen, twenty-four or thirty-six months. These promotional accounts
are eligible for securitization up to 30.0% of eligible securitized receivables.
The percentage of eligible securitized receivables represented by promotional
receivables was 15.0%, 23.5% and 19.4% as January 31, 2004, 2005 and 2006,
respectively. To the extent we exceed the 30.0% limit, or to the extent we have
such promotional credit receivables that do not qualify for inclusion in the
42
programs, we are required to use our other capital resources to fund the unpaid
balance of the receivables for the promotional period. The weighted average
promotional period was 12.5 and 11.8 months for promotional receivables
outstanding as of January 31, 2005 and January 31, 2006, respectively. The
weighted average remaining term on those same promotional receivables was 9.0
and 7.3 months, respectively. While overall these promotional receivables have a
much shorter average weighted life 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 the receivables. As a result, the existence of the
interest free extended payment terms negatively impacts the gains or losses as
compared to the other receivables, and results in a decrease in our available
cash.
Net cash used in investing activities was $18.5 million for both fiscal
year 2005 and fiscal year 2006. Offsetting the $1.1 million decline in purchases
of property and equipment was a $1.1 million decline in proceeds from sales of
property and equipment. Included in fiscal 2005 purchase of property and
equipment was $1.7 million of purchases by SRDS, which was consolidated in our
fiscal 2005 Statement of Cash Flows. 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. We estimate that
capital expenditures for the 2007 fiscal year will approximate $25 million to
$30 million.
We lease 50 of our 56 stores, and our plans for future store locations
include primarily leases, but does not exclude store ownership. Our capital
expenditures for future store projects should primarily be for our tenant
improvements to the property leased (including any new distribution centers and
warehouses), the cost of which is approximately $1.5 million per store, and for
our existing store remodels, in the range of $220,000 per store remodel,
depending on store size. In the event we purchase existing properties, our
capital expenditures will depend on the particular property and whether it is
improved when purchased. We are continuously reviewing new relationship and
funding sources and alternatives for new stores, which may include
"sale-leaseback" or direct "purchase-lease" programs, as well as other funding
sources for our purchase and construction of those projects. If we are
successful in these relationship developments, our direct cash needs should
include only our capital expenditures for tenant improvements to leased
properties and our remodel programs for existing stores, but could include full
ownership if it meets our cash investment strategy.
Net cash from financing activities decreased $19.6 million from $11.9
million for the year ended January 31, 2005, to a use of cash of $7.7 million
for the year ended January 31, 2006. This change resulted primarily from
increases in payments on various debt instruments of $10.5 million, as opposed
to borrowings in the prior year of $10.4 million. Partially offsetting the use
of cash was increased proceeds from stock issued under employee benefit plans.
We do not expect to incur significant net borrowing or repayments under our bank
credit facilities in fiscal 2007.
On October 31, 2005, we entered into a new, expanded bank credit facility
with the same group of banks that had provided the previous credit arrangement.
The new agreement expands the line of credit to $50 million, from $35 million,
provides an accordion feature to allow further expansion of the facility to $90
million, under certain conditions, and extends the maturity date to November 1,
2010. Additionally, the facility provides sublimits of $8 million for a
swingline line of credit for faster advances on borrowing requests, and $5
million for standby letters of credit. Loans under our revolving credit facility
may, at our option, bear interest at either the alternate base rate, which is
the greater of the administrative agent's prime rate or the federal funds rate,
or the adjusted LIBO/LIBOR rate for the applicable interest period, in each case
plus an applicable interest margin. The interest margin is between 0.00% and
0.50% for base rate loans and between 0.75% and 1.75% for LIBO/LIBOR alternative
rate loans. The interest margin will vary depending on our debt coverage ratio.
We additionally pay commitment fees for the undrawn portion of our revolving
credit facility. At January 31, 2006 the interest rate on the revolving facility
was 7.25%.
43
A summary of the significant financial covenants that govern our bank
credit facility compared to our actual compliance status at January 31, 2006, is
presented below:
Required
Minimum/
Actual Maximum
---------------- ----------------
Debt service coverage ratio must exceed required minimum ................ 4.44 to 1.00 2.00 to 1.00
Total adjusted leverage ratio must be lower than required maximum ....... 1.53 to 1.00 3.00 to 1.00
Adjusted consolidated net worth must exceed required minimum ............ $ 237,280,000 $ 143,240,000
Charge-off ratio must be lower than required maximum .................... 0.02 to 1.00 0.06 to 1.00
Extension ratio must be lower than required maximum ..................... 0.03 to 1.00 0.05 to 1.00
30-day delinquency ratio must be lower than required maximum ............ 0.09 to 1.00 0.13 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.
Events of default under the credit facility include, subject to grace
periods and notice provisions in certain circumstances, non-payment of
principal, interest or fees; violation of covenants; material inaccuracy of any
representation or warranty; default under or acceleration of certain other
indebtedness; bankruptcy and insolvency events; certain judgments and other
liabilities; certain environmental claims; and a change of control. If an event
of default occurs, the lenders under the credit facility are entitled to take
various actions, including accelerating amounts due under the credit facility
and requiring that all such amounts be immediately paid in full. Our obligations
under the credit facility are secured by all of our and our subsidiaries'
assets, excluding customer receivables owned by the QSPE and certain inventory
subject to vendor floor plan arrangements.
The following table reflects outstanding commitments for borrowings and
letters of credit, and the amounts utilized under those commitments, as of
January 31, 2006:
Balance Available
Commitment Expires in Fiscal Year Ending January 31, at at
------------------------------------------------------------ January 31, January 31,
2007 2008 2009 2010 2011 Thereafter Total 2006 2006
---- ---- ---- ---- ---- ---------- ----- ---- ----
(in thousands)
Revolving Bank Facility (1) ...$ - $ 50,000 $ 50,000 $ 3,015 $ 46,985
Unsecured Line of Credit ...... 8,000 8,000 - 8,000
Inventory Financing (2) ....... 30,000 30,000 12,626 17,374
Letters of Credit ............. 1,500 1,500 - 1,500
------------------------------------------------------------------------------------
Total .............$ 39,500 $ - $ - $ 50,000 $ - $ - $ 89,500 $ 15,641 $ 73,859
====================================================================================
(1) Includes letter of credit sublimit. There was $3.0 million of letters of
credit issued at January 31, 2006.
(2) Included in accounts payable on the consolidated balance sheet as of
January 31, 2006.
Since we extend credit in connection with a large portion of our retail,
service maintenance and credit insurance sales, we created a QSPE in 2002 to
purchase customer receivables from us and to issue asset-backed and variable
funding notes to third parties to finance its purchase of these receivables. We
transfer receivables, consisting of retail installment contracts and revolving
accounts extended to our customers, to the issuer in exchange for cash,
subordinated securities and the right to receive the interest spread between the
assets held by the QSPE and the notes issued to third parties and our servicing
fees. The subordinated securities issued to us accrue interest based on prime
rates and are subordinate to these third party notes
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 asset-backed securitization program can be adversely
affected if we exceed certain predetermined levels of re-aging receivables,
write-offs, bankruptcies or other ineligible receivable amounts. If the funding
under the asset-backed securitization program were reduced or terminated, we
would have to draw down our bank credit facility more quickly than we have
estimated.
44
A summary of the total receivables managed under the credit portfolio,
including quantitative information about delinquencies, net credit losses and
components of securitized assets, is presented in note 2 to our consolidated
financial statements.
Based on current operating plans, we believe that cash provided by
operating activities, available borrowings under our credit facility, access to
the unfunded portion of the variable funding portion of our asset- backed
securitization program and our current cash and cash equivalents will be
sufficient to fund our operations, store expansion and updating activities and
capital expenditure programs through at least January 31, 2007. 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 o 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 o asset-backed
securitization programs or a requirement that we retain a higher
percentage of the credit portfolio under such programs;
o increases in the program costs (interest and administrative fees
relative to our receivables portfolio) associated with the funding
of our receivables;
o increases in personnel costs required for us to stay competitive in
our markets; and
o our inability to obtain a relationship to provide the purchase of
and financing of our capital expenditures for our new stores.
If cash provided by operating activities during this period is less than
we expect or if we need additional financing for future growth, we may need to
increase our revolving credit facility or undertake additional equity or debt
offerings. We may not be able to obtain such financing on favorable terms, if at
all.
Off-Balance Sheet Financing Arrangements
At January 31, 2006, the issuer has issued two series of notes: a Series A
variable funding note with a capacity of $250.0 million purchased by Three
Pillars Funding Corporation and three classes of Series B notes in the aggregate
amount of $200.0 million. The commercial paper underlying the Series A variable
funding note is rated A1/P1 by Standard and Poors and Moody's, respectively.
These ratings represent the highest rating ("highest quality") of each rating
agency's three short-term investment grade ratings, except that Standard and
Poors could add a "+" which would convert the "highest quality" rating to an
"extremely strong" rating. The Series B notes consist of: Class A notes in the
amount $120.0 million, rated Aaa by Moody's representing the highest rating
("highest quality") of the four long term investment grade ratings provided by
this organization; Class B notes in the amount $57.8 million, rated A2 by
Moody's representing the middle of the third rating ("upper medium quality") of
the four long term investment grade ratings provided by this organization; and
45
Class C notes in the amount of $22.2 million, rated Baa2/BBB by Moody's and
Fitch, respectively. These ratings represent the lowest of the four investment
grades ("medium quality") provided by these organizations. The ratings disclosed
are not recommendations to buy, sell or hold securities. These ratings may be
changed or withdrawn at any time without notice, and each of the ratings should
be evaluated independently of any other rating. We are not aware of a rating by
any other rating organization and are not aware of any changes in these ratings.
Private institutional investors, primarily insurance companies, purchased the
Series B notes. The issuer used the proceeds of these issuances, along with
funds provided by us in fiscal 2003 from borrowings under our bank credit
facility, to initially purchase eligible accounts receivable from us and to fund
a required $8.0 million restricted cash account for credit enhancement of the
Series B notes.
We are entitled to a monthly servicing fee, so long as we act as servicer,
in an amount equal to .25% multiplied by the average aggregate principal amount
of receivables 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
to either Three Pillars Funding Corporation or the Series B note holders, and
the servicing fee. SunTrust Capital Markets, Inc. serves as an administrative
agent for Three Pillars Funding Corporation in connection with the Series A
variable funding note.
The Series A variable funding note permits the issuer to borrow funds up
to $250.0 million to purchase receivables from us, thereby functioning as a
credit facility to accumulate receivables. When borrowings under the Series A
variable funding note approach $250.0 million, the issuer intends to refinance
the receivables by issuing a new series of notes and use the proceeds to pay
down the outstanding balance of the Series A variable funding note, so that the
credit facility will once again become available to accumulate new receivables.
As of January 31, 2006, borrowings under the Series A variable funding note were
$185.0 million.
The Series A variable funding note matures on September 1, 2007. The
issuer will repay the Series A variable funding note and any refinancing note
with amounts received from customers pursuant to receivables that we transferred
to the issuer. Beginning on October 20, 2006, the issuer will begin to make
scheduled principal payments on the Series B notes with amounts received from
customers pursuant to receivables that we transferred to the issuer. To the
extent that the issuer has not otherwise repaid the Series B notes, they mature
on September 1, 2010. We are currently in negotiations to increase the amount
and extend the term of the Series A variable funding note and issue a new series
of fixed-rate notes to provide funding for additional purchases of receivables
and the paydown of the Series B notes.
The Series A variable funding note bears interest at the commercial paper
rate plus an applicable margin, in most instances of 0.8%, and the Series B
notes have fixed rates of 4.469%, 5.769% and 8.180% for the Class A, B and C
notes, respectively. In addition, there is an annual administrative fee and a
non-use fee associated with the unused portion of the committed facility.
We are not directly liable to the lenders under the asset-backed
securitization facility. If the issuer is unable to repay the Series A and
Series B notes 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 lenders
could claim the balance in the 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 notes, including covenants that restrict, subject to
specified exceptions: the incurrence of additional 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 covenants 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.
Events of default under the Series A variable funding note and the Series
B notes, 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 events
pertaining to us. The issuer's obligations under the program are secured by the
receivables and proceeds.
46
[GRAPHIC OMITTED]
[SEE SUPPLEMENTAL PDF OF SECURITIZATION FACILITIES CHART]
Certain Transactions
Since 1996, we have leased a retail store location of approximately 19,150
square feet in Houston, Texas from Thomas J. Frank, Sr., our Chairman of the
Board and Chief Executive Officer. The lease provides for base monthly rental
payments of $17,235 plus escrows for taxes, insurance and common area
maintenance expenses of increasing monthly amounts based on expenditures by the
management company operating the shopping center of which this store is a part
through January 31, 2011. We also have an option to renew the lease for two
additional five-year terms. Mr. Frank received total payments under this lease
of $281,000 in fiscal 2004, 2005 and 2006, respectively. Based on market lease
rates for comparable retail space in the area, we believe that the terms of this
lease are no less favorable to us than we could have obtained in an arms' length
transaction at the date of the lease commencement.
We leased six store locations from Specialized Realty Development
Services, LP ("SRDS"), a real estate development company that was created prior
to our becoming publicly held and was owned by various members of management and
individual investors of Stephens Group, Inc., a significant shareholder of the
company. Based on independent appraisals that were performed on each project
that was completed, we believe that the terms of the leases were at least
comparable to those that could be obtained in an arms' length transaction. As
part of the ongoing operation of SRDS, we received management fees associated
with the administrative functions that were provided to SRDS of $5,000, $100,000
and $6,500 for the years ended January 31, 2004, 2005 and 2006, respectively. As
of January 31, 2005, we no longer leased any properties from SRDS since it
divested itself of the leased properties. As part of the divestiture, SRDS
reimbursed us $75,000 for costs related to lease modifications.
We engage the services of Direct Marketing Solutions, Inc., or DMS, for a
substantial portion of its direct mail advertising. Direct Marketing Solutions,
Inc. is partially owned (less than 50%) by the Stephens Group Inc., members of
the Stephens family, Jon Jacoby, and Doug Martin. The Stephens Group Inc. and
the members of the Stephens family are significant shareholders of the Company,
and Jon Jacoby and Doug Martin are members of our Board of Directors. The fees
we paid to DMS during fiscal years ended 2005 and 2006 amounted to approximately
$1.8 million and $4.3 million, respectively. Thomas J. Frank, the Chief
Executive Officer and Chairman of the Board of Directors owned a small
percentage (0.7%) at the end of fiscal year 2005, but divested his interest
during the first half of fiscal year 2006.
47
Contractual Obligations
The following table presents a summary of our known contractual
obligations as of January 31, 2005, with respect to the specified categories,
classified by payments due per period.
Payments due by period
--------------------------------------
Less More
Than 1-3 3-5 Than 5
Total 1 Year Years Years Years
--------- -------- -------- -------- --------
(in thousands)
Long term debt .........................$ 136 $ 136 $ - $ - $ -
Operating leases:
Real estate ............................ 112,262 14,348 27,448 24,933 45,533
Equipment .............................. 3,795 1,217 1,439 831 308
Purchase obligations (1) ............... 2,789 1,664 1,125 - -
--------- -------- -------- -------- --------
Total contractual cash obligations .....$ 118,982 $ 17,365 $ 30,012 $ 25,764 $ 45,841
========= ======== ======== ======== ========
---------------------
(1) Includes contracts for long-term communication services. Does not
include outstanding purchase orders for merchandise, services or supplies
which are ordered in the normal course of operations and which generally
are received and recorded within 30 days.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Interest rates under our bank credit facility 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 0.50%, or LIBO/LIBOR plus the LIBO/LIBOR margin, which ranges from
0.75% to 1.75%. Accordingly, changes in the prime rate, the federal funds rate
or LIBO/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. See footnote 2 to the audited financial statements for
disclosures related to the sensitivity of the current fair value of the interest
only strip and the subordinated securities to 10% and 20% adverse changes in the
factors that affect these assets, including interest rates.
We held interest rate swaps and collars with notional amounts totaling
$20.0 million as of January 31, 2004, with terms extending through April 2005.
Those instruments were held for the purpose of hedging variable interest rate
risk, primarily related to cash flows from our interest-only strip as well as
our variable rate debt. In fiscal 2004, hedge accounting was discontinued for
the remaining $20.0 million. At the time the cash flow hedge designation was
discontinued, we began to recognize changes in the fair value of the swaps as
interest expense and to amortize the accumulated other comprehensive loss
related to those derivates as interest expense over the period that the
forecasted transactions effected the statement of operations. During fiscal
2004, we reclassified $0.2 million of losses previously recorded in accumulated
other comprehensive losses into the statement of operations and recorded $1.7
million of income into the statement of operations because of the change in fair
value of the swaps. During fiscal 2005, we reclassified $1.1 million of losses
previously recorded in accumulated other comprehensive losses into the statement
of operations and recorded $1.1 million of income into the statement of
operations because of the change in fair value of the swaps. During fiscal 2006,
we reclassified $0.2 million of losses previously recorded in accumulated other
comprehensive losses into the statement of operations and recorded $0.2 million
of income into the statement of operations because of the change in fair value
of the swaps.
Prior to discontinuing these hedges, each period we recorded hedge
ineffectiveness, which arose from differences between the interest rate stated
in the derivative instrument and the interest rate upon which the underlying
hedged transaction is based. Ineffectiveness totaled $0.4 million, for the year
ended January 31, 2004, and is reflected in "Interest Expense" in our
consolidated statement of operations. Since all hedge accounting has ceased, no
ineffectiveness was recognized in fiscal 2005 or 2006.
48
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Management's Report on Internal Control Over Financial Reporting..............50
Report of Independent Registered Public Accounting Firm
on Internal Control Over Financial Reporting................................51
Report of Independent Auditors................................................52
Consolidated Balance Sheets...................................................53
Consolidated Statements of Operations.........................................54
Consolidated Statements of Stockholders' Equity...............................55
Consolidated Statements of Cash Flows.........................................56
Notes to Consolidated Financial Statements....................................57
49
Management's Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rule 13a-15(f) or Rule
15(d)-15(f) under the Exchange Act. Our internal control over financial
reporting is designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Therefore, even those systems
determined to be effective can provide only reasonable assurance with respect to
financial statement preparation and presentation.
Our management (with the participation of our principal executive officer and
our principal financial officer) assessed the effectiveness of our internal
control over financial reporting as of January 31, 2006. In making this
assessment, management used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control -
Integrated Framework. Based on our assessment and those criteria, management
believes that, as of January 31, 2006, our internal control over financial
reporting is effective.
Management's assessment of the effectiveness of our internal control over
financial reporting as of January 31, 2006 has been audited by Ernst & Young
LLP, an independent registered public accounting firm, as stated in their report
which is included elsewhere herein.
Conn's, Inc.
Beaumont, Texas
March 30, 2006
/s/ David L. Rogers
-----------------------
David L. Rogers
Chief Financial Officer
/s/ Thomas J. Frank
-----------------------
Thomas J. Frank
Chief Executive Officer
50
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of Conn's, Inc.
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control Over Financial Reporting, that Conn's,
Inc. maintained effective internal control over financial reporting as of
January 31, 2006, based on criteria established in Internal Control--Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (the COSO criteria). Conn's, Inc.'s management is responsible for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting.
Our responsibility is to express an opinion on management's assessment and an
opinion on the effectiveness of the company's internal control over financial
reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that Conn's, Inc. maintained effective
internal control over financial reporting as of January 31, 2006, is fairly
stated, in all material respects, based on the COSO criteria. Also, in our
opinion, Conn's, Inc. maintained, in all material respects, effective internal
control over financial reporting as of January 31, 2006, based on the COSO
criteria.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
Conn's, Inc. as of January 31, 2006 and 2005, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended January 31, 2006 of Conn's, Inc. and our report
dated March 29, 2006 expressed an unqualified opinion thereon.
Ernst & Young LLP
Houston, Texas
March 29, 2006
51
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of Conn's, Inc.
We have audited the accompanying consolidated balance sheets of Conn's, Inc. as
of January 31, 2006 and 2005, and the related consolidated statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended January 31, 2006. Our audits also included the financial
statement schedule listed in the Index at Item 15(a). These financial statements
and schedules are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Conn's, Inc. at
January 31, 2006 and 2005, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended January 31, 2006,
in conformity with U.S. generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
As discussed in Note 1 to the consolidated financial statements, effective
January 31, 2005 the Company adopted Financial Standards Board Interpretation
No. 46, "Consolidation of Variable Interest Entities".
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of January 31, 2006, based on
criteria established in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated March 29, 2006 expressed an unqualified opinion thereon.
Ernst & Young LLP
Houston, Texas
March 29, 2006
52
Conn's, Inc.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
January 31,
---------------------
Assets 2005 2006
--------- ---------
Current Assets
Cash and cash equivalents ...............................$ 7,027 $ 45,176
Accounts receivable, net of allowance for
doubtful accounts of $2,211 and $914, respectively .... 26,728 23,542
Interest in securitized assets .......................... 105,159 123,449
Inventories ............................................. 62,346 73,987
Deferred income taxes ................................... 4,901 4,670
Prepaid expenses and other assets ....................... 3,552 4,004
--------- ---------
Total current assets .................................... 209,713 274,828
Non-current deferred income tax asset 1,523 2,464
Property and equipment
Land .................................................... 2,919 6,671
Buildings ............................................... 8,068 7,084
Equipment and fixtures .................................. 10,036 9,612
Transportation equipment ................................ 4,419 3,284
Leasehold improvements .................................. 56,926 65,507
--------- ---------
Subtotal ................................................ 82,368 92,158
Less accumulated depreciation ........................... (34,658) (37,332)
--------- ---------
Total property and equipment, net ....................... 47,710 54,826
Goodwill, net ........................................... 9,617 9,617
Other assets, net ....................................... 229 260
--------- ---------
Total assets ............................................$268,792 $341,995
========= =========
Liabilities and Stockholders' Equity
Current Liabilities
Notes payable ...........................................$ 5,500 $ -
Current portion of long-term debt ....................... 29 136
Accounts payable ........................................ 27,108 40,920
Accrued compensation and related expenses ............... 8,548 18,847
Accrued expenses ........................................ 11,928 17,380
Income taxes payable .................................... - 8,794
Deferred income taxes ................................... 966 757
Deferred revenues and allowances ........................ 7,383 8,498
Fair value of derivatives ............................... 177 -
--------- ---------
Total current liabilities ............................... 61,639 95,332
Long-term debt .......................................... 5,003 -
Non-current deferred tax liability ...................... 704 903
Deferred gain on sale of property ....................... 644 476
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 23,571,564
shares issued and outstanding
at January 31, 2005 and 2006, respectively) ....... 233 236
Accumulated other comprehensive income .................. 7,516 8,004
Additional paid in capital .............................. 84,257 87,067
Retained earnings ....................................... 108,796 149,977
--------- ---------
Total stockholders' equity .............................. 200,802 245,284
--------- ---------
Total liabilities and stockholders' equity ..............$268,792 $341,995
========= =========
See notes to consolidated financial statements.
53
Conn's, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except earnings per share)
Years Ended January 31,
---------------------------------
2004 2005 2006
--------- --------- ---------
Revenues
Product sales .....................................$402,579 $451,560 $569,877
Service maintenance agreement
commissions (net) ............................... 20,074 23,950 30,583
Service revenues .................................. 18,265 18,725 20,278
--------- --------- ---------
Total net sales ................................. 440,918 494,235 620,738
Finance charges and other ......................... 58,392 72,857 81,684
--------- --------- ---------
Total revenues .................................... 499,310 567,092 702,422
Cost and expenses
Cost of goods sold, including
warehousing and occupancy costs ................. 313,637 355,159 448,064
Cost of service parts sold, including
warehousing and occupancy cost .................. 4,075 4,551 5,310
Selling, general and administrative expense ....... 135,174 152,900 181,631
Provision for bad debts ........................... 4,657 5,637 3,769
--------- --------- ---------
Total cost and expenses ....................... 457,543 518,247 638,774
--------- --------- ---------
Operating income .................................. 41,767 48,845 63,648
Interest expense .................................. 4,577 2,359 400
--------- --------- ---------
Income before minority interest and income taxes .. 37,190 46,486 63,248
Minority interest in limited partnership .......... - 118 -
--------- --------- ---------
Income before income taxes ........................ 37,190 46,368 63,248
Provision for income taxes
Current ......................................... 12,980 16,147 23,048
Deferred ........................................ (130) 96 (981)
--------- --------- ---------
Total provision for income taxes ................ 12,850 16,243 22,067
--------- --------- ---------
Net Income ........................................ 24,340 30,125 41,181
Less preferred dividends .......................... 1,954 - -
--------- --------- ---------
Net income available for common stockholders ......$ 22,386 $ 30,125 $ 41,181
========= ========= =========
Earnings per share
Basic ...........................................$ 1.26 $ 1.30 $ 1.76
Diluted .........................................$ 1.22 $ 1.27 $ 1.70
Average common shares outstanding
Basic ........................................... 17,726 23,192 23,412
Diluted ......................................... 18,335 23,754 24,192
See notes to consolidated financial statements.
54
Conn's, Inc.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except per share amounts)
Accum.
Other
Preferred Stock Common Stock Compre- Treasury Stock
---------------- --------------- hensive Paid in Retained ----------------
Shares Amount Shares Amount Income Capital Earnings Shares Amount Total
------ -------- ------- ------ ------- -------- --------- ------ -------- ---------
Balance January 31, 2003 ............. 175 15,226 17,175 $ 172 $2,751 $ - $68,131 $ 455 $(3,611) $ 82,669
-
Preferred dividends declared ......... 10,194 (10,194)
Preferred stock redeemed:
For cash .......................... (10) (1,454) (1,454)
For common stock .................. (165) (23,966) 1,712 17 23,949 -
Additional common
stock issued at IPO ................ 4,623 46 58,311 58,357
Exercise of options .................. 47 1 396 397
Cancellation of treasury stock ....... (455) (5) (3,606) (455) 3,611 -
Net income 24,340 24,340
Unrealized gain on derivative
instruments (net of tax of $794),
net of reclassification
adjustments of $158
(net of tax of $ 89) ............... 1,411 1,411
Adjustment of fair value of securitized
assets (net of tax of $489),
net of reclassification adjustments
of $ 239 (net of tax of $ 134) ..... 870 870
---------
Total comprehensive income ........... 26,621
------ -------- ------- ------ ------- -------- --------- ------ -------- ---------
Balance January 31, 2004 ............. - - 23,102 231 5,032 82,656 78,671 - - 166,590
Exercise of options,
including tax benefit .............. 162 2 1,492 1,494
Issuance of common stock under
Employee Stock Purchase Plan ....... 9 109 109
Forfeiture of 5,181 restricted shares (5) -
Net income ........................... 30,125 30,125
Reclassification adjustments
on derivative instruments
(net of tax of $ 399) ............. 732 732
Adjustment of fair value of
securitized assets (net of
tax of $955), net of reclass-
ification adjustments of
$9,643 (net of tax of $5,249) ..... 1,752 1,752
---------
Total comprehensive income ........... 32,609
------ -------- ------- ------ ------- -------- --------- ------ -------- ---------
Balance January 31, 2005 ............. - - 23,268 233 7,516 84,257 108,796 - - 200,802
Exercise of options,
including tax benefit ................ 293 3 2,618 2,621
Issuance of common stock under
Employee Stock Purchase Plan ......... 11 192 192
Net income ........................... 41,181 41,181
Reclassification adjustments
on derivative instruments
(net of tax of $ 86) .............. 160 160
Adjustment of fair value of
securitized assets (net of
tax of $164), net of reclass-
ification adjustments of
$9,175 (net of tax of $4,963) ..... 328 328
---------
Total comprehensive income ........... 41,669
------ -------- ------- ------ ------- -------- --------- ------ -------- ---------
Balance January 31, 2006 ............. - $ - 23,572 $ 236 $8,004 $87,067 $149,977 - $ - $245,284
====== ======== ======= ====== ======= ======== ========= ====== ======== =========
See notes to consolidated financial statements.
55
Conn's, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years Ended January 31,
---------------------------------
2004 2005 2006
--------- --------- ---------
Cash flows from operating activities
Net income ..........................................................$ 24,340 $ 30,125 $ 41,181
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation ...................................................... 6,654 8,777 11,271
Amortization ...................................................... 592 18 (318)
Provision for bad debts ........................................... 4,657 5,637 3,769
Accretion from interests in securitized assets .................... (12,529) (14,892) (14,138)
Provision for deferred income taxes ............................... (130) 96 (981)
Loss (gain) from sale of property and equipment.................... 64 126 69
Discounts on promotional credit, net .............................. - 1,571 691
Losses (gains) from derivatives ................................... (1,010) (15) 69
Change in operating assets and liabilities:
Accounts receivable ............................................... (11,412) (29,339) (4,889)
Inventory ......................................................... (7,624) (8,604) (11,641)
Prepaid expenses and other assets ................................. 900 (515) (452)
Accounts payable .................................................. 1,910 696 13,812
Accrued expenses .................................................. 4,200 7,697 15,751
Income taxes payable .............................................. 2,429 (2,430) 8,794
Deferred revenues and allowances .................................. (648) 1,222 1,330
--------- --------- ---------
Net cash provided by operating activities ........................... 12,393 170 64,318
--------- --------- ---------
Cash flows from investing activities
Purchase of property and equipment ................................ (9,401) (19,619) (18,490)
Proceeds from sales of property ................................... 1,291 1,131 34
--------- --------- ---------
Net cash used in investing activities ............................... (8,110) (18,488) (18,456)
--------- --------- ---------
Cash flows from financing activities
Net proceeds from the sale of common stock ........................ 58,357 - -
Net proceeds from stock issued under employee benefit plans,
including tax benefit ......................................... 397 1,603 2,813
Redemption of preferred stock ..................................... (1,454) - -
Net borrowings (payments) under line of credit .................... (31,999) 10,500 (10,500)
Payments on term note ............................................. (15,000) - -
Increase in debt issuance costs ................................... (213) (118) (130)
Borrowings on promissory notes .................................... - - 136
Payment of promissory notes ....................................... (4,901) (60) (32)
--------- --------- ---------
Net cash provided by (used in) financing activities ................. 5,187 11,925 (7,713)
--------- --------- ---------
Impact on cash of consolidation of SRDS ............................. 1,024 478 -
--------- --------- ---------
Net change in cash .................................................. 10,494 (5,915) 38,149
Cash and cash equivalents
Beginning of the year ............................................. 2,448 12,942 7,027
--------- --------- ---------
End of the year ...................................................$ 12,942 $ 7,027 $ 45,176
========= ========= =========
Supplemental disclosure of cash flow information
Cash interest paid ................................................$ 5,718 $ 2,387 $ 635
Cash income taxes paid, net of refunds ............................ 10,162 19,372 13,179
Cash interest received from interests in securitized assets ....... 12,801 19,630 26,996
Cash proceeds from new securitizations ............................ 213,741 256,139 285,529
Cash flows from servicing fees .................................... 11,963 14,496 17,542
Supplemental disclosure of non-cash activity
Customer receivables exchanged for interests in securitized assets 41,123 58,342 58,835
Amounts reinvested in interests in securitized assets ............. (56,478) (81,652) (76,133)
See notes to consolidated financial statements.
56
CONN'S , INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
January 31, 2006
1. Summary of Significant Accounting Policies
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 Company enters into securitization transactions to sell its retail
installment and revolving customer receivables. These securitization
transactions are accounted for as sales in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishment of Liabilities because the
Company has relinquished control of the receivables. Additionally, the Company
has transferred such receivables to a qualifying special purpose entity
("QSPE"). Accordingly, neither the transferred receivables nor the accounts of
the QSPE are included in the consolidated financial statements of the Company.
See Note 2 for further discussion.
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 year ended
January 31, 2005 was to reduce "Selling, general and administrative expense" by
$0.9 million, increase "Interest expense" by $0.8 million and reduce "Income
before income taxes" by $0.1 million for "Minority interest in limited
partnership". The Company had no exposure to losses incurred by SRDS.
Business Activities. The Company, through its retail stores, provides
products and services to its customer base in six primary market areas,
including southern Louisiana, southeast Texas, Houston, South Texas, San
Antonio/Austin, and Dallas, Texas. Products and services offered through retail
sales outlets include major home appliances, consumer electronics, home office
equipment, lawn and garden products, mattresses, furniture, service maintenance
agreements, installment and revolving credit account services, and various
credit insurance products. These activities are supported through an extensive
service, warehouse and distribution system. For the reasons discussed below, the
aggregation of operating companies represent one reportable segment under SFAS
No. 131, Disclosures About Segments of an Enterprise and Related Information.
Accordingly, the accompanying consolidated financial statements reflect the
operating results of the Company's single reportable segment. The Company's
retail stores bear the "Conn's" name, and deliver the same products and services
to a common customer group. The Company's customers generally are individuals
rather than commercial accounts. All of the retail stores follow the same
procedures and methods in managing their operations. The Company's management
evaluates performance and allocates resources based on the operating results of
the retail stores and considers the credit programs, service contracts and
distribution system to be an integral part of the Company's retail operations.
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.
57
Vendor Programs. The Company receives funds from vendors for price
protection, product and volume rebates, marketing, training and promotional
programs which are recorded on as the amounts are earned as a reduction to the
related product cost or advertising expense, according to the nature of the
program. The Company accrues 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, which would include price protection, product and volume rebates, the
allowances, credits, or payments are recorded as a reduction of product cost and
are reflected in cost of goods sold when the related product is sold. If the
programs relate to marketing, training and promotions that are not for
reimbursement of specific incremental costs, the allowances, credits or payments
are reflected as a reduction of cost of goods sold. If the programs are related
to promotion or marketing of the product, the allowances, credits, or payments
for reimbursement of specific, incremental, identifiable, advertising-related
costs incurred in selling the vendors' products are recorded as a reduction of
advertising expense and are reflected in selling, general and administrative
expenses in the period in which the expense is incurred. The credits/payments
received from vendors that were netted against advertising expense for the years
ended January 31, 2004, 2005 and 2006 were $2.8 million, $4.8 million and $5.8
million, respectively.
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 (shares in thousands):
Year Ended January 31,
----------------------------
2004 2005 2006
-------- -------- --------
Common stock outstanding, beginning of period .............. 17,175 23,102 23,268
Weighted average common stock issued in initial
public offering .......................................... 719 -
Weighted average common stock issued in preferred
stock redemption ......................................... 285 -
Weighted average common stock issued in stock
option exercises ......................................... 2 89 142
Weighted average common stock issued to employee
stock purchase plan ...................................... - 3 2
Weighted average number of restricted shares forfeited ..... - (2)
Less: Weighted average treasury shares purchased and
weighted average shares purchased and cancelled .......... (455) -
-------- -------- --------
Shares used in computing basic earnings per share .......... 17,726 23,192 23,412
Dilutive effect of stock options, net of assumed repurchase
of treasury stock ........................................ 609 562 780
-------- -------- --------
Shares used in computing diluted earnings per share ........ 18,335 23,754 24,192
======== ======== ========
During the periods presented, options with an exercise price in excess of
the average market price of the Company's common stock are excluded from the
calculation of the dilutive effect of stock options for diluted earnings per
share calculations. The weighted average number of options not included in the
calculation of the dilutive effect of stock options was 0.1 million for each of
the years ended January 31, 2005 and 2006, and none for the year ended January
31, 2004.
Cash and Cash Equivalents. The Company considers all highly liquid debt
instruments purchased with a maturity of three months or less to be cash
equivalents.
Inventories. Inventories consist of finished goods or parts and are valued
at the lower of cost (moving weighted average method) or market.
58
Property and Equipment. Property and equipment are recorded at cost. Costs
associated with major additions and betterments that increase the value or
extend the lives of assets are capitalized and depreciated. Normal repairs and
maintenance that do not materially improve or extend the lives of the respective
assets are charged to operating expenses as incurred. Depreciation is computed
on the straight-line method over the estimated useful lives of the assets, or in
the case or leasehold improvements, over the shorter of the estimated useful
lives or the remaining terms of the respective leases. The estimated lives used
to compute depreciation expense are summarized as follows:
Buildings ............................. 30 years
Equipment and fixtures ................ 3 - 5 years
Transportation equipment .............. 3 years
Leasehold improvements ................ 5 - 10 years
Property and equipment are evaluated for impairment at the retail store
level. The Company performs a periodic assessment of assets for impairment in
the absence of such information or indicators. Additionally, an impairment
evaluation is performed whenever events or changes in circumstances indicate
that the carrying amount of the assets might not be recoverable. The most likely
condition that would necessitate an assessment would be an adverse change in
historical and estimated future results of a retail store's performance. For
property and equipment to be held and used, the Company recognizes an impairment
loss if its carrying amount is not recoverable through its undiscounted cash
flows and measures the impairment loss based on the difference between the
carrying amount and fair value.
All gains and losses on sale of assets are included in "Selling, general
and administrative expense" in the consolidated statements of operations.
Years Ended January 31,
------------------------------
(in thousands of dollars) 2004 2005 2006
- ---------------------------------- --------- --------- ----------
Gain (loss) on sale of assets .......... (64) (126) (69)
Receivable Sales and Interests in Securitized Receivables. The Company
enters into securitization transactions to sell customer retail installment and
revolving receivable accounts. In these transactions, the Company retains
interest-only strips and subordinated securities, all of which are retained
interests in the securitized receivables. Gain or loss on the sales of the
receivables depends in part on the previous carrying amount of the financial
assets involved in the transfer, allocated between the assets sold and the
retained interests, based on their relative fair value at the date of transfer.
Retained interests are carried at fair value on the Company's balance sheet as
available-for-sale securities in accordance with SFAS No. 115, Accounting for
Certain Investments in Debt and Equity Securities. Impairment and interest
income are recognized in accordance with Emerging Issues Task Force ("EITF") No.
99-20, Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets. Servicing fees are
recognized monthly as they are earned. Gains on sales of receivables, impairment
on retained interests, interest income from retained interests and servicing
fees are included in "Finance charges and other" in the consolidated statement
of operations.
The Company estimates fair value of its retained interest in both the
initial securitization and thereafter based on the present value of future
expected cash flows using management's best estimates of the key
assumptions--credit losses, prepayment rates, forward yield curves, and discount
rates commensurate with the risks involved. The Company's retained interest in
the transferred receivables are valued on a revolving pool basis.
Receivables Not Sold. Certain receivables are not eligible for inclusion
in the securitization transactions and are therefore carried on the Company's
balance sheet in "Accounts receivable". Such receivables are recorded net of an
allowance for doubtful accounts, which is calculated based on historical losses.
Generally, a receivable is considered delinquent if a payment has not been
received on the scheduled due date. Generally, an account that is delinquent
more than 120 days and for which no payment has been received in the past seven
months will be charged-off against the allowance and interest accrued subsequent
to the last payment will be reversed. The Company has a secured interest in the
merchandise financed by these receivables and therefore has the opportunity to
recover a portion of the charged-off value. (See also Note 2.)
59
Goodwill. Goodwill represents the excess of purchase price over the fair
market value of net assets acquired. The Company assesses the potential future
impairment of goodwill on an annual basis, or at any other time when impairment
indicators exist. In fiscal 2004, 2005 and 2006, the Company concluded that
goodwill was not impaired based on its annual impairment testing.
Income Taxes. The Company follows the liability method of accounting for
income taxes. Under this method, deferred tax assets and liabilities are
determined based on differences between financial reporting and tax bases of
assets and liabilities and are measured using the tax rates and laws that are
expected be in effect when the differences are expected to reverse.
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. The Company
sells service maintenance agreements and credit insurance contracts on behalf of
unrelated third parties. For contracts where the third parties are the obligor
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. The
Company records a receivable for earned but unremitted retrospective commissions
and reserves for future cancellations of service maintenance agreements and
credit insurance contracts estimated based on historical experience. Where the
Company sells service maintenance agreements in which it is 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
Company-obligor service maintenance agreements are renewal contracts which
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 EITF No. 00-21, Revenue Arrangements with
Multiple Deliverables and are valued based on the agreed upon retail selling
price. The amounts of service maintenance agreement revenue deferred at January
31, 2005 and 2006 were $3.9 million and $3.6 million, respectively, and are
included in "Deferred revenue and allowances" in the accompanying balance
sheets. Under the renewal contracts, the Company defers and amortizes its direct
selling expenses over the contract term and records the cost of the service work
performed as products are repaired.
The classification of the amounts included as "Finance charges and other"
is summarized as follows (in thousands):
Years Ended January 31,
-----------------------------------
2004 2005 2006
--------- --------- ---------
Securitization income:
Servicing fees received ....................... $11,963 $14,496 $17,542
Accretion of gains on sale of receivables ..... 12,529 14,892 14,138
Interest earned on retained interests ......... 12,801 19,630 26,996
--------- --------- ---------
Total securitization income ................. 37,293 49,018 58,676
Interest Income from receivables not sold ....... 888 1,224 1,181
Insurance commissions ........................... 16,498 17,992 18,305
Other ........................................... 3,713 4,623 3,522
--------- --------- ---------
Finance charges and other ................... $58,392 $72,857 $81,684
========= ========= =========
Gains on sale of receivables .................... $13,510 $17,604 $14,692
========= ========= =========
60
Securitization income includes accretion of gains on sales of receivables,
impairment of retained interests, interest income from retained interests and
servicing fees. No significant impairments related to the interest only strip of
retained interests have been recorded in the years ended January 31, 2004, 2005,
or 2006. Gains on sale of receivables will be recognized as securitization
income as accretion over the lives of the related receivables. See "Receivable
Sales and Interest in Securitized Receivables" for revenue recognition policies
related to these components.
The Company offers interest free promotional programs for three- to
24-month contracts and has recorded interest income only on those contracts that
are not expected to make payments within the time period specified to satisfy
the promotional requirements. The Company also offers 24- and 36-month
no-interest contracts on which no interest is owed for the term of the contract,
unless the terms of the contract related to periodic payments are not met, in
which case interest accrues at the normal contract rate from that point forward.
Other than these promotional programs, the Company does not extend credit at
interest rates other than market rates.
The following table sets forth the sales made under the interest free
programs (in thousands):
Years Ended January 31,
----------------------------------
2004 2005 2006
---------- ---------- ------------
Sales under interest-free programs .. $66,986 $126,575 $159,767
These sales are recognized at the time the product is delivered to the
customer, which is consistent with the above stated policy. Considering the
short-term nature of interest free programs for terms less than one year, sales
are recorded at full value and are not discounted. Sales financed by longer-term
(18-, 24- and 36-month) interest free programs are recorded at their net present
value (see "Application of APB 21 to Cash Option Programs that Exceed One Year
in Duration" below). Receivables arising out of the Company's interest-free
programs are securitized with other qualifying customer receivables.
The Company classifies amounts billed to customers relating to shipping
and handling as revenues. Costs of $15.1 million, $16.7 million and $21.0
million associated with shipping and handling revenues are included in "Selling,
general and administrative expense" for the years ended January 31, 2004, 2005
and 2006, respectively.
Fair Value of Financial Instruments. The fair value of cash and cash
equivalents, receivables, and notes and accounts payable approximate their
carrying amounts because of the short maturity of these instruments. The fair
value of the Company's interests in securitized receivables is determined by
estimating the present value of future expected cash flows using management's
best estimates of the key assumptions, including credit losses, prepayment
rates, forward yield curves and discount rates commensurate with the risks
involved. See Note 2. The carrying value of the Company's long-term debt
approximates fair value due to either the time to maturity or the existence of
variable interest rates that approximate current market rate.
The fair value of interest rate swap agreements are recorded in current
liabilities based on the settlement value obtained from the counter-party in the
transaction. The Company does not use derivative financial instruments for
trading purposes. The Company uses derivatives to hedge a portion of the
variable interest rate risk related to the cash flows from its interest only
strip and its variable rate debt.
We held interest rate swaps and collars with notional amounts totaling
$20 million at both January 31, 2004 and 2005, with terms extending through
April 2005. Those instruments were held for the purpose of hedging a portion of
the variable interest rate risk, primarily related to cash flows from our
interest-only strip as well as our variable rate debt. Hedge accounting was
discontinued for the rate swaps in fiscal 2004. At the time the cash flow hedge
designation was discontinued, we began to recognize changes in the fair value of
the swaps as interest expense and amortize the accumulated other comprehensive
loss related to those derivates as interest expense over the period that the
forecasted transactions effected the statement of operations. During fiscal
2004, we reclassified $0.2 million of losses previously recorded in accumulated
other comprehensive losses into the statement of operations and recorded $1.7
million of income into the statement of operations because of the change in fair
value of the swaps. During fiscal 2005, we reclassified $1.1 million of losses
previously recorded in accumulated other comprehensive losses into the statement
of operations and recorded $1.1 million of income into the statement of
operations because of the change in fair value of the swaps. During fiscal 2006,
we reclassified $0.2 million of losses previously recorded in accumulated other
comprehensive losses into the statement of operations and recorded $0.2 million
of income into the statement of operations because of the change in fair value
of the swaps.
61
Prior to discontinuing these hedges, each period we recorded hedge
ineffectiveness, which arose from differences between the interest rate stated
in the derivative instrument and the interest rate upon which the underlying
hedged transaction is based. Ineffectiveness totaled $0.4 million for the year
ended January 31, 2004, and is reflected in "Interest Expense" in our
consolidated statement of operations. Since all hedge accounting has ceased, no
ineffectiveness was recognized in fiscal 2005 or 2006.
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 Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations. Since all options have been issued at or
above fair value, no compensation expense has been recognized under the
Company's stock option plan for any of the periods presented. Additionally, no
compensation expense is recorded for shares issued pursuant to the employee
stock purchase plan as it is a qualified plan.
If compensation expense for the Company's stock option plan and employee
stock purchase plan had been recognized using the fair value method of
accounting under SFAS 123, net income and earnings per share would have
decreased by the percentages reflected in the tables below. The straight-line
attribution method was used to allocate compensation expense over the vesting
period for the stock option plan. The fair value of the options issued was
estimated on the date of grant, with the weighted average assumptions used for
grants as reflected in the table. For post-IPO 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 presents the impact to earnings per share
if the Company had adopted the fair value recognition provisions of SFAS 123
(dollars in thousands except per share data):
Years Ended January 31,
----------------------------------
2004 2005 2006
---------- ---------- ----------
Net income available for common stockholders as
reported ..............................................$ 22,386 $ 30,125 $ 41,181
Stock-based compensation, net of tax, that would have
been reported under SFAS 123 ......................... (530) (1,017) (1,313)
---------- ---------- ----------
Pro forma net income ...................................$ 21,856 $ 29,108 $ 39,868
========== ========== ==========
Earnings per share-as reported:
Basic ................................................$ 1.26 $ 1.30 $ 1.76
Diluted ..............................................$ 1.22 $ 1.27 $ 1.70
Pro forma earnings per share:
Basic ................................................$ 1.23 $ 1.26 $ 1.70
Diluted ..............................................$ 1.20 $ 1.23 $ 1.66
Percent change:
Net income ........................................... (2.4)% (3.4)% (3.2)%
Assumptions used in pricing model:
Weighted average risk free interest rates ............ 0.9% 1.8% 3.9%
Weighted average expected lives in years ............. 4.3 4.4 4.6
Weighted average volatility .......................... 37.5% 30.0% 32.0%
Expected dividends ................................... - - -
62
Self insurance. The Company is self-insured for certain losses relating to
group health, workers' compensation, automobile, general and product liability
claims. The Company has stop loss coverage to limit the exposure arising from
these claims. Self-insurance losses for claims filed and claims incurred, but
not reported, are accrued based upon the Company's estimates of the aggregate
liability for uninsured claims incurred using development factors based on
historical experience.
Expense Classifications. The Company records "Cost of goods sold" as the
direct cost of products sold, any related in-bound freight costs, and receiving
costs, inspection costs, internal transfer costs, and other costs associated
with the operations of its distribution system. Also included in "Cost of goods
sold" is an allocation of advertising expense computed at approximately 6% of
the product direct cost. The offset for this allocation is in "Selling, general
and administrative expense" and is netted with advertising costs along with
vendor rebates (see "Vendor Programs" above). Advertising expense included in
Selling, general and administrative expense for the years ended January 31,
2004, 2005 and 2006, was:
Years Ended January 31,
------------------------------------
2004 2005 2006
---------- ---------- -----------
(in thousands)
Gross advertising expense ............................$ 24,686 $ 28,564 $ 32,107
Less:
Vendor rebates ....................................... (2,812) (4,752) (5,793)
Allocation to Cost of goods sold ..................... (17,517) (20,635) (26,621)
---------- ---------- ----------
Net advertising expense in
Selling, general and adminstrative expense .......$ 4,357 $ 3,177 $ (307)
========== ========== ==========
In addition, the Company records as "Cost of service parts sold" the
direct cost of parts used in its service operation and the related inbound
freight costs, purchasing and receiving costs, inspection costs, internal
transfer costs, and other costs associated with the warranty and service
distribution operation.
The costs associated with the Company's merchandising function, including
product purchasing, advertising, sales commissions, and all store occupancy
costs are included in "Selling, general and administrative expense."
Application of APB 21 to Cash Option Programs that Exceed One Year in
Duration. In February 2004, the Company began offering promotional credit
payment plans on certain products that extend beyond one year. In accordance
with APB 21, Interest on Receivables and Payables, such sales are discounted to
their fair value resulting in a reduction in sales and receivables and the
amortization of the discount amount over the term of the deferred interest
payment plan. The difference between the gross sale and the discounted amount is
reflected as a reduction of Product sales in the consolidated statements of
operations and the amount of the discount being amortized in the current period
is recorded in Finance charges and other. For the years ended January 31, 2005
and 2006, "Product sales" were reduced by $2.4 million and $3.1 million,
respectively, and "Finance charges and other" was increased by $0.9 million and
$2.4 million, respectively, to effect the adjustment to fair value and to
reflect the appropriate amortization of the discount.
Reclassifications. Certain reclassifications have been made in the prior
years' financial statements to conform to the current year's presentation.
Accumulated Other Comprehensive Income. The balance of accumulated other
comprehensive income (net of tax) at January 31, 2005 was comprised of $7.7
million of unrealized gains on interests in securitized assets less $0.2 million
of unrealized losses on derivatives. The balance of accumulated other
comprehensive income (net of tax) at January 31, 2006 was comprised of $8.0
million of unrealized gains on interests in securitized assets.
63
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.
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
SFAS No. 123. The Company is required to adopt this statement on February 1,
2006, and intends to elect the modified retrospective application and will
adjust the financial statements for prior periods to give effect to the
fair-value-based method of accounting for share-based payments. See Note 1 -
Stock-Based Compensation for the expected impact on prior year "Net income".
In February 2006, SFAS No. 155, Accounting for Certain Hybrid Financial
Instruments, was issued. This statements is an amendment of SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities, and SFAS No. 140,
Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities-a replacement of FASB Statement No. 125. This statement permits
fair value remeasurement for any hybrid financial instrument that contains an
embedded derivative that would otherwise require bifurcation, clarifies which
interest-only strips and principal-only strips are not subject to the
requirements of SFAS No. 133, establishes a requirement to evaluate interests in
securitized financial assets to identify interests that are freestanding
derivatives or that are hybrid financial instruments that contain an embedded
derivative requiring bifurcation, clarifies that concentrations of credit risk
in the form of subordination are not embedded derivatives and amends SFAS No.
140 to eliminate the prohibition on a qualifying special-purpose entity from
holding a derivative financial instrument that pertains to a beneficial interest
other than another derivative financial instrument. This statement is effective
for all financial instruments acquired or issued after the beginning of an
entity's first fiscal year that begins after September 15, 2006. The Company is
currently analyzing the impact this statement will have on its consolidated
results of operations and its financial position.
In March 2006, SFAS No. 156, Accounting for Servicing of Financial Assets
an amendment of FASB Statement No. 140, was issued. This statement requires an
entity to recognize a servicing asset or liability each time it undertakes an
obligation to service a financial asset by entering into a servicing contract,
requires all separately recognized servicing assets and servicing liabilities to
be initially measured at fair value, permits an entity to choose either the
amortization method or fair value measurement method for subsequent measurement
of each class of separately recognized servicing assets, permits, at its initial
adoption, a one-time reclassification of available-for-sale securities to
trading securities by entities with recognized servicing rights and, requires
separate presentation of and additional disclosures for servicing assets and
servicing liabilities subsequently measured at fair value. This statement is
effective for all financial instruments acquired or issued after the beginning
of an entity's first fiscal year that begins after September 15, 2006. The
Company is currently analyzing the impact this statement will have on its
consolidated results of operations and its financial position.
64
2. Interests in Securitized Receivables
The Company has an agreement to sell customer receivables. As part of
this agreement, the Company sells eligible retail installment and revolving
receivable accounts to a QSPE that pledges the transferred accounts to a trustee
for the benefit of investors. The following table summarizes the availability of
funding under the Company's securitization program at January 31, 2006 (in
thousands):
Capacity Utilized Available
---------- ---------- ----------
Series A ........................$ 250,000 $ 185,000 $ 65,000
Series B - Class A .............. 120,000 120,000 --
Series B - Class B .............. 57,778 57,778 --
Series B - Class C .............. 22,222 22,222 --
---------- ---------- ---------
Total .........................$ 450,000 $ 385,000 $ 65,000
========== ========== =========
The Series A program functions as a credit facility to fund the initial
transfer of eligible receivables. When the facility approaches capacity, the
QSPE ("Issuer") intends to seek financing to pay down the outstanding balance in
the Series A variable funding note; at that point, the facility will once again
become available to accumulate the transfer of new receivables or to meet
required principal payments on other series as they become due. This new
financing could be in the form of additional notes, bonds or other instruments
as the market might allow. The Series A program matures September 1, 2007. The
Series B program (which is non-amortizing for the first four years) matures
officially on September 1, 2010, although it is expected that the principal
payments, which are required to begin in October 2006, will retire the bonds
prior to that date.
The agreement contains certain covenants requiring the maintenance of
various financial ratios and receivables performance standards. The Company was
in compliance with the requirements of the agreement as of January 31, 2006. As
part of the new securitization program, the Company and Issuer arranged for the
issuance of a stand-by letter of credit in the amount of $10.0 million to
provide assurance to the trustee on behalf of the bondholders that funds
collected monthly by the Company, as servicer, will be remitted as required
under the base indenture and other related documents. The letter of credit has a
term of one year, and the maximum potential amount of future payments is the
face amount of the letter of credit. The letter of credit is callable, at the
option of trustee, if the Company, as servicer, fails to make the required
monthly payments of the cash collected to the trustee.
Through its retail sales activities, the Company generates customer retail
installment and revolving receivable accounts. The Company enters into
securitization transactions to sell these accounts to the QSPE. In these
securitizations, the Company retains servicing responsibilities and subordinated
interests. The Company receives annual servicing fees and other benefits
approximating 3.9% of the outstanding balance and rights to future cash flows
arising after the investors in the securities issued by or on behalf of the QSPE
have received from the trustee all contractually required principal and interest
amounts. The Company does not record an asset or liability related to any
servicing obligations because the servicing benefits received are determined to
be just adequate to compensate the Company for its servicing responsibilities.
The investors and the securitization trustee have no recourse to the Company's
other assets for failure of the individual customers of the Company and the QSPE
to pay when due. The Company's retained interests are subordinate to the
investors' interests. Their value is subject to credit, prepayment, and interest
rate risks on the transferred financial assets.
65
The fair values of the Company's interest in securitized assets were as
follows (in thousands):
January 31,
-----------------------------
2005 2006
------------- -------------
Interest-only strip ............................$ 16,365 $ 18,853
Subordinated securities ........................ 88,794 104,596
------------- -------------
Total fair value of interests in securitized
assets ........................................$ 105,159 $ 123,449
============= =============
The table below summarizes valuation assumptions used for each period
presented:
Years Ended January 31,
--------------------------------
2004 2005 2006
------------------- ------------
Prepayment rates
Primary installment ................ 1.5% 1.5% 1.5%
Primary revolving .................. 3.0% 3.0% 3.0%
Secondary installment .............. 1.5% 1.5% 1.5%
Net interest spread
Primary installment ................ 12.2% 12.0% 11.1%
Primary revolving .................. 12.2% 12.0% 11.1%
Secondary installment .............. 13.0% 13.6% 13.5%
Expected losses
Primary installment ................ 3.5% 3.4% 3.0%
Primary revolving .................. 3.5% 3.4% 3.0%
Secondary installment .............. 3.5% 3.4% 3.0%
Projected expense
Primary installment ................ 3.9% 3.9% 3.9%
Primary revolving .................. 3.9% 3.9% 3.9%
Secondary installment .............. 3.9% 3.8% 3.9%
Discount rates
Primary installment ................ 10.0% 10.0% 13.0%
Primary revolving .................. 10.0% 10.0% 13.0%
Secondary installment .............. 14.0% 14.0% 17.0%
Delinquency and deferral rates
Primary installment ................ 9.4% 10.1% 9.3%
Primary revolving .................. 11.3% 8.9% 7.3%
Secondary installment .............. 16.5% 15.3% 14.0%
66
At January 31, 2006, key economic assumptions and the sensitivity of the
current fair value of the interests in securitized assets to immediate 10% and
20% adverse changes in those assumptions are as follows (dollars in thousands):
Primary Primary Secondary
Portfolio Portfolio Portfolio
Installment Revolving Installment
------------- -------------- ------------
Fair value of interest in securitized assets ......... $87,491 $9,691 $26,267
Expected weighted average life ....................... 1.2 years 1.4 years 1.6 years
Annual prepayment rate assumption .................... 1.5% 3.0% 1.5%
Impact on fair value of 10% adverse change ......... $ 122 $ 14 $ 108
Impact on fair value of 20% adverse change ......... $ 240 $ 27 $ 210
Net interest spread assumption ....................... 11.1% 11.1% 13.5%
Impact on fair value of 10% adverse change ......... $ 2,845 $ 315 $ 1,545
Impact on fair value of 20% adverse change ......... $ 5,630 $ 624 $ 3,019
Expected losses assumptions .......................... 3.0% 3.0% 3.0%
Impact on fair value of 10% adverse change ......... $ 775 $ 86 $ 349
Impact on fair value of 20% adverse change ......... $ 1,546 $ 171 $ 695
Projected expense assumption ......................... 3.9% 3.9% 3.9%
Impact on fair value of 10% adverse change ......... $ 983 $ 109 $ 421
Impact on fair value of 20% adverse change ......... $ 1,966 $ 217 $ 841
Discount rate assumption ............................. 13.0% 13.0% 17.0%
Impact on fair value of 10% adverse change ......... $ 821 $ 91 $ 482
Impact on fair value of 20% adverse change ......... $ 1,630 $ 181 $ 951
Delinquency and deferral ............................. 9.3% 7.3% 14.0%
Impact on fair value of 10% adverse change (1) ..... $ 73 $ 8 $ 96
Impact on fair value of 20% adverse change (1) ..... $ 146 $ 16 $ 186
- ---------------------------------------------------------------
(1) For purposes of this analysis, an adverse change is assumed to be a decrease
in the delinquency and deferral rate. A decrease results in a faster repayment
of the loans, which reduces the fair value of the interest-only strip a greater
amount than the resulting increase in the fair value of the subordinated
securities. Since it is assumed that none of the other assumptions would change,
an increase in the delinquency and deferral rate results in an increase in the
fair value, (i.e. losses are not assumed to increase as a result).
These sensitivities are hypothetical and should be used with caution. As
the figures indicate, changes in fair value based on a 10% variation in
assumptions generally cannot be extrapolated because the relationship of the
change in assumption to the change in fair value may not be linear. Also, the
effect of the variation in a particular assumption on the fair value of the
interest-only strip is calculated without changing any other assumption; in
reality, changes in one factor may result in changes in another (i.e. increases
in market interest rates may result in lower prepayments and increased credit
losses), which might magnify or counteract the sensitivities.
67
The following illustration presents quantitative information about the
receivables portfolios managed by the Company (in thousands):
Total Principal Amount
of Principal Amount Over
Receivables 60 Days Past Due (1)
January 31, January 31,
----------------------- -----------------------
2005 2006 2005 2006
---------- ----------- ---------- -----------
Primary portfolio:
Installment .......$ 328,042 $ 380,603 $ 16,636 $ 24,934
Revolving ......... 30,210 41,046 867 1,095
---------- ----------- ---------- -----------
Subtotal ..................... 358,252 421,649 17,503 26,029
Secondary portfolio:
Installment ....... 70,448 98,072 5,640 9,508
---------- ----------- ---------- -----------
Total receivables managed .... 428,700 519,721 23,143 35,537
Less receivables sold ........ 419,172 509,681 21,540 33,483
---------- ----------- ---------- -----------
Receivables not sold ......... 9,528 10,040 $ 1,603 $ 2,054
========== ===========
Non-customer receivables ..... 17,200 13,502
---------- -----------
Total accounts
receivable, net ...$ 26,728 $ 23,542
========== ===========
Average Balances Net Credit Losses
January 31, (1) January 31, (2)
----------------------- -----------------------
2005 2006 2005 2006
---------- ----------- --------- ------------
Primary portfolio:
Installment .......$ 297,187 $ 352,315
Revolving ......... 25,921 35,149
---------- -----------
Subtotal ..................... 323,108 387,464 $ 8,829 $ 11,303
Secondary portfolio:
Installment ....... 64,484 83,461 2,394 2,421
---------- ----------- --------- ------------
Total receivables managed .... 387,592 470,925 11,223 13,724
Less receivables sold ........ 378,178 461,215 9,760 13,165
---------- ----------- --------- ------------
Receivables not sold .........$ 9,414 $ 9,710 $ 1,463 $ 559
========== =========== ========= ============
--------------
(1) Amounts are based on end of period balances.
(2) Amounts represent total loan loss provision, net of recoveries, on
total receivables.
3. Notes Payable and Long-Term Debt
At January 31, 2006, the Company had $47.0 million of its $50 million
revolving credit facility available for borrowings. The amounts utilized under
the revolving credit facility reflected $3.0 million related to letters of
credit issued. The letters of credit were issued under a $5.0 million sublimit
provided under the facility for standby letters of credit. Additionally, there
were no amounts outstanding under a short-term revolving bank agreement that
provides up to $8.0 million of availability on an unsecured basis. This
unsecured facility matures in May 2006 and has a floating rate of interest,
based on Prime, which equaled 7.00% at January 31, 2006.
68
Long-term debt consists of the following (in thousands, except repayment
explanations):
January 31,
--------------------
2005 2006
--------- ----------
Revolving credit facility with interest at variable
rates (7.25% at January 31, 2006) ......................$ 5,000 $ -
Promissory notes, due in monthly installments ............ 32 136
--------- ----------
Total long-term debt ..................................... 5,032 136
Less amounts due within one year ......................... (29) (136)
--------- ----------
Amounts classified as long-term ..........................$ 5,003 $ -
========= ==========
The revolving facility is subject to the Company maintaining various
financial and non-financial covenants. In addition, the provisions of the bank
credit facility limit the payment of dividends on the Company's common stock. As
of January 31, 2005 and January 31, 2006, the Company was in compliance with all
financial and non-financial covenants.
The current agreement provides for a revolving facility capacity of $50
million, with a $5 million letter of credit sublimit and an $8.0 million
sublimit for a swingline of credit. Interest rates are variable and are
determined, at the option of the Company, at the Base Rate (the greater of
Agent's prime rate or federal funds rate plus 0.50%) plus the Base Rate Margin
(which ranges from 0.00% to 0.50%) or LIBO/LIBOR Rate plus the LIBO/LIBOR Margin
(which ranges from 0.75% to 1.75%). Both the Base Rate Margin and the LIBO/LIBOR
Margin are determined quarterly based on a debt coverage ratio equal to the
rolling four-quarter relationship of total debt (including lease obligations) to
earnings before interest, taxes, depreciation, amortization and rent. The
Company is obligated to pay a non-use fee on a quarterly basis on the
non-utilized portion of the revolving facility at rates ranging from .20% to
..375%. The revolving facility is secured by the assets of the Company not
otherwise encumbered and a pledge of substantially all of the stock of the
Company's present and future subsidiaries and matures in November 2010.
Interest expense incurred on notes payable and long-term debt totaled
$2.2, $1.1 and $0.2 million for the years ended January 31, 2004, 2005 and 2006,
respectively. Interest expense included interest related to SRDS debt, which
totaled $0.8 million for the year ended January 31, 2005. Aggregate maturities
of long-term debt as of January 31 in the year indicated are as follows (in
thousands):
2007 ................................. $ 136
2008 ................................. -
2009 ................................. -
-----------
Total ................................ $ 136
===========
4. 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
January 31, 2006, the Company had outstanding unsecured letters of credit of
$12.1 million and $13.0 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 January
31, 2006, $3.0 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, as the
servicer, would be remitted as required under the base indenture and
other related documents. The letter of credit has a term of one year
and expires in August 2006.
o The Company obtained a $1.5 million commitment for trade letters of
credit to secure product purchases under an international
arrangement. At January 31, 2006, there were no letters of credit
outstanding under this commitment. The letter of credit commitment
has a term of one year and expires in May 2006.
69
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 $16.5 million as of January 31, 2006.
5. Income Taxes
Deferred income taxes reflect the net effects of temporary timing
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's net deferred tax assets result primarily from
differences between financial and tax methods of accounting for income
recognition on service contracts and residual interests, capitalization of costs
in inventory, and deductions for depreciation and doubtful accounts, and the
fair value of derivatives. The deferred tax assets and liabilities are
summarized as follows (in thousands):
January 31,
--------------------
2005 2006
------- -------
Deferred Tax Assets
Allowance for doubtful accounts
and warranty and insurance cancellations ........$ 763 $ 1,844
Deferred revenue .................................. 2,204 597
Fair value of derivatives ......................... 62 -
Interest in securitized assets .................... 479 982
Property and equipment ............................ 1,297 2,297
Inventories ....................................... 952 772
Accrued vacation and other ........................ 667 1,268
-------- --------
Total deferred tax assets ......................... 6,424 7,760
Deferred Tax Liabilities
Sales tax receivable .............................. (919) (768)
Goodwill .......................................... (672) (903)
Other ............................................. (79) (615)
-------- --------
Total deferred tax liabilities .................... (1,670) (2,286)
-------- --------
Net Deferred Tax Asset ............................$ 4,754 $ 5,474
======== ========
Significant components of income taxes were as follows (in thousands):
Years Ended January 31,
------------------------------------
2004 2005 2006
---------- ---------- ------------
Current:
Federal .....................$ 13,095 $ 16,100 $ 23,023
State ....................... (115) 47 25
---------- ---------- ------------
Total current ............. 12,980 16,147 23,048
Deferred:
Federal ..................... (339) 96 (975)
State ....................... 209 - (6)
---------- ---------- ------------
Total deferred ............ (130) 96 (981)
---------- ---------- ------------
Total tax provision ............$ 12,850 $ 16,243 $ 22,067
========== ========== ============
70
A reconciliation of the statutory tax rate and the effective tax rate for
each of the periods presented in the statements of operations is as follows:
Years Ended January 31,
-----------------------------------
2004 2005 2006
---------- --------- ------------
U.S. Federal statutory rate ................... 35.0% 35.0% 35.0%
State and local income taxes .................. 0.3 0.1 0.1
Non-deductible entertainment,
tax-free interest income and other .......... 0.2 0.4 (0.1)
---------- --------- ------------
Effective tax rate attributable
to continuing operations ..................... 35.5% 35.5% 35.0%
Other ......................................... (0.9) (0.5) (0.1)
---------- --------- ------------
Effective tax rate ............................ 34.6% 35.0% 34.9%
========== ========= ============
6. Leases
The Company leases certain of its facilities and operating equipment from
outside parties and from a stockholder/officer. The real estate leases generally
have initial lease periods of from 5 to 15 years with renewal options at the
discretion of the Company; the equipment leases generally provide for initial
lease terms of three to seven years and provide for a purchase right by the
Company at the end of the lease term at the fair market value of the equipment.
The following is a schedule of future minimum base rental payments
required under the operating leases that have initial non-cancelable lease terms
in excess of one year (in thousands):
Third Related
Years Ended January 31, Party Party Total
---------------------------- ------------- ---------- -----------
2007 ........................ $ 15,358 $ 207 $ 15,565
2008 ........................ 14,764 207 14,971
2009 ........................ 13,709 207 13,916
2010 ........................ 13,077 207 13,284
2011 ........................ 12,273 207 12,480
Thereafter .................. 45,841 - 45,841
------------- ---------- -----------
Total ....................... $ 115,022 $ 1,035 $ 116,057
============= ========== ===========
Total lease expense was approximately $14.0 million, $15.0 million and
$15.7 million for the years ended January 31, 2004, 2005 and 2006, respectively,
including approximately $1.6 million, $0.2 million and $0.2 million paid to
related parties, respectively. During the year ended January 31, 2005, the
Company paid $1.4 million under leases with SRDS. As SRDS was consolidated in
the statement of operations for the year ended January 31, 2005, these payments
were characterized as selling, general and administrative expenses, depreciation
expense, interest expense and minority interest in limited partnership. See Note
1.
Certain of our leases are subject to scheduled minimum rent increases or
escalation provisions, the cost of which is recognized on a straight-line basis
over the minimum lease term. Tenant improvement allowances, when granted by
lessor, are deferred and amortized as contra-lease expense over the term of the
lease.
7. Stock-Based Compensation
The Company approved an Incentive Stock Option Plan that provides for a
pool of up to 3.5 million options to purchase shares of the Company's common
stock. Such options are to be granted to various officers and employees at
prices equal to the market value on the date of the grant. The options vest over
three or five year periods (depending on the grant) and expire ten years after
the date of grant. As part of the completion of the IPO, the Company amended the
Incentive Stock Option Plan to provide for a total available pool of 2,559,767
options, adopted a Non-Employee Director Stock Option Plan that included 300,000
options, and adopted an Employee Stock Purchase Plan that reserved up to
1,267,085 shares of the Company's common stock to be issued. On November 24,
2003, the Company issued six non-employee directors 240,000 total options to
acquire the Company's stock at $14.00 per share. On June 3, 2004, the Company
issued 40,000 options to acquire the Company's stock at $17.34 per share to a
seventh non-employee director. At January 31, 2006, the Company had 20,000
options remaining in the Non-Employee Director Stock Option Plan.
71
The Employee Stock Purchase Plan is available to a majority of the
employees of the Company and its subsidiaries, subject to minimum employment
conditions and maximum compensation limitations. At the end of each calendar
quarter, employee contributions are used to acquire shares of common stock at
85% of the lower of the fair market value of the common stock on the first or
last day of the calendar quarter. During the year ended January 31, 2005 and
2006, the Company issued 8,664 and 10,496 shares of common stock, respectively,
to employees participating in the plan, leaving 1,247,925 shares remaining
reserved for future issuance under the plan as of January 31, 2006.
A summary of the status of the Company's Incentive Stock Option Plan and
the activity during the years ended January 31, 2004, 2005 and 2006 is presented
below (shares in thousands):
Years Ended January 31,
-------------------------------------------------------------
2004 2005 2006
--------------------- ------------------ --------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------- ---------- -------- --------- -------- -----------
Outstanding, beginning of year 1,241 $8.34 1,531 $9.68 1,666 $11.50
Granted 369 14.00 387 17.43 343 33.88
Exercised (47) (8.36) (162) (8.72) (271) (8.34)
Canceled (32) (9.15) (90) (11.07) (112) (17.78)
---------- ---------- -------- --------- -------- -----------
Outstanding, end of year 1,531 $9.68 1,666 $11.50 1,626 $16.31
========== ========== ======== ========= ======== ===========
Weighted average grant date
fair value of options granted
during period $4.77 $4.97 $11.09
========== ========= ===========
Options exercisable at end of
year 551 712 743
Options available for grant 981 684 453
Options Outstanding Options Exercisable
-------------------------------- --------------------
Weighted
Shares Average Weighted Shares Weighted
Outstanding Remaining Average Exercisable Average
January Contractual Exercise January 31, Exercise
31, 2006 Life in Price 2006 Price
Range of Exercise Prices Years
- ------------------------------------------- ----------- -------- ----------- --------
$4.29-$4.29 9 3.9 $4.29 9 $4.29
$8.21-$10.83 696 5.3 8.51 569 8.38
$14.00 -$16.49 306 7.9 14.33 108 14.17
$17.73-$17.73 288 8.9 17.73 57 17.73
$33.88-$33.88 327 9.8 33.88 - -
----------- ----------- -------- ----------- --------
Total 1,626 7.3 $16.31 743 $9.88
=========== =========== ======== =========== ========
72
8. Significant Vendors
As shown in the table below, a significant portion of the Company's
merchandise purchases for years ended January 31, 2004, 2005 and 2006 were made
from six vendors:
Years Ended January 31,
--------------------------------
Vendor 2004 2005 2006
--------------- ---------- ---------- ----------
A 15.5 % 14.2 % 17.0 %
B 11.2 13.8 12.2
C 12.5 13.2 11.4
D 5.7 8.0 7.8
E 4.0 6.7 6.8
F 4.7 5.8 5.4
---------- ---------- ----------
Totals 53.6 % 61.7 % 60.6 %
========== ========== ==========
As part of a program to purchase product inventory from vendors
overseas, the Company was not obligated at January 31, 2006 for under any
stand-by letters of credit.
9. Related Party Transactions
The Company leases one of its stores from its Chief Executive Officer
and Chairman of Board, under the terms of a lease it entered prior to becoming a
publicly held company. It also leased six store locations from Specialized
Realty Development Services, LP ("SRDS"), a real estate development company that
was created prior to the Company's becoming publicly held and was owned by
various members of management and individual investors of Stephens Group, Inc.
The Stephens Group, Inc. is a significant shareholder of the Company. Based on
independent appraisals that were performed on each project that was completed,
the Company believes that the terms of the leases were at least comparable to
those that could be obtained in an arms' length transaction. As part of the
ongoing operation of SRDS, the Company received a management fee associated with
the administrative functions that were provided to SRDS of $5,000, $100,000 and
$6,500 for the years ended January 31, 2004, 2005 and 2006, respectively. As of
January 31, 2005, the Company no longer leased any properties from SRDS since it
divested itself of the leased properties. As part of the divestiture, SRDS
reimbursed the Company $75,000 for costs related to lease modifications. As a
result of the divestiture, the Company's consolidated balance sheet at January
31, 2005 does not include accounts of SRDS that were previously consolidated
with our financial statements at January 31, 2004. However, the consolidated
statements of operations and cash flows for fiscal 2005 include the operations
and cash flows of SRDS through the dates the sales were completed.
The Company engaged the services of Direct Marketing Solutions, Inc., or
DMS, for a substantial portion of its direct mail advertising. Direct Marketing
Solutions, Inc. is partially owned (less than 50%) by the Stephens Group Inc.,
members of the Stephens family, Jon Jacoby, and Doug Martin. The Stephens Group
Inc. and the members of the Stephens family are significant shareholders of the
Company, and Jon Jacoby and Doug Martin are members of the Company's Board of
Directors. The fees the Company paid to DMS during fiscal years ended 2005 and
2006 amounted to approximately $1.8 million and $4.3 million, respectively.
Thomas J. Frank, the Chief Executive Officer and Chairman of the Board of
Directors owned a small percentage (0.7%) at the end of fiscal year 2005, but
divested his interest during the first half of fiscal year 2006.
10. Benefit Plans
The Company has established a defined contribution 401(k) plan for
eligible employees who are at least 21 years old and have completed at least
one-year of service. Employees may contribute up to 20% of their eligible pretax
compensation to the plan. The Company will match 100% of the first 3% of the
employees' contributions and 50% of the next 2% of the employees' contributions.
Employees at least 50 years of age may make supplemental contributions to the
Plan as defined by current regulations. At its option, the Company may also make
supplemental contributions to the Plan, but has not made such contributions in
the past three years. The matching contributions made by the company totaled
$1.2, $1.4 and $1.6 million during the years ended January 31, 2004, 2005 and
2006, respectively.
73
11. Common and Preferred Stock
The Company has outstanding 23,571,564 shares of common stock at
January 31, 2006, of which 7,000 shares are restricted as to various vesting
rights until July 2006.
As part of the Company's recapitalization and reorganization that took
place in 1998, a total of 213,720 shares of preferred stock were issued in
exchange for existing common stock of the Company; such shares were valued as of
the date of the transaction at $87.18 per share and bore a cumulative dividend
of 10% that was not payable until declared by the Company's board of directors.
Such cumulative dividends must be paid before dividends on the common stock can
be distributed. On January 24, 2003, the board of directors declared a preferred
stock dividend as of April 30, 2003 in the amount of $8.8 million ($50.53 per
share) contingent upon the completion of a proposed initial public offering. On
December 1, 2003 when the initial public offering was closed, the Company
redeemed all preferred stock and accumulated dividends for 1,711,832 shares of
common stock and $1.5 million in cash.
The table below reflects the number of preferred shares the Company
redeemed during the periods covered and the total costs of the redemptions
including accumulated dividends (dollars in thousands):
Year ended January 31, Redeemed Costs Dividends
---------------------- ----------- ---------- -------------
2004 174,648 $25,420 $10,194
2005 - - -
2006 - - -
12. Contingencies
Legal Proceedings. The Company is involved in routine litigation
incidental to our 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.
Insurance. Because of its inventory, vehicle fleet and general operations,
the Company has purchased insurance covering a broad variety of potential risks.
The Company purchases insurance polices covering general liability, workers
compensation, real property, inventory and employment practices liability, among
others. Additionally, the Company has umbrella policies with an aggregate limit
of $50.0 million. The Company has retained a portion of the risk under these
policies and its group health insurance program. See additional discussion under
Note 1. The Company has a $3.0 million letter of credit outstanding supporting
its obligations under the property and casualty portion of its insurance
program.
Service Maintenance Agreement Obligations. 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 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
sales and recorded in revenues in the statement of operations over the life of
the agreements. The amounts deferred are reflected on the face of the balance
sheet in "Deferred revenues and allowances," see also Note 1 for additional
discussion.
74
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
In accordance with Rules 13a-15 and 15d-15 under the Securities Exchange
Act of 1934, we have evaluated, under the supervision and with the participation
of management, including our Chief Executive Officer and our Chief Financial
Officer, the effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Exchange Act) as of the end of the period covered by this annual report. Based
on that evaluation, our Chief Executive Officer and our Chief Financial Officer
concluded that, as of the end of the period covered by this annual report, our
disclosure controls and procedures were effective in timely alerting them to
material information relating to our business (including our consolidated
subsidiaries) required to be included in our Exchange Act filings.
Management's Report on Internal Control over Financial Reporting
Please refer to Management's Report on Internal Control over Financial
Reporting on page 49 of this report.
Changes in Internal Controls Over Financial Reporting
There have been no changes in our internal controls over financial
reporting that occurred in the quarter ended January 31, 2006, which have
materially affected, or are reasonably likely to materially affect our internal
controls over financial reporting.
ITEM 9B. OTHER INFORMATION
None
75
PART III
The information required by Items 10 through 14 is included in our
definitive Proxy Statement relating to our 2006 Annual Meeting of Stockholders,
and is incorporated herein by reference.
CROSS REFERENCE TO ITEMS 10-14 LOCATED IN THE PROXY STATEMENT
Caption in the Conn's, Inc.
Item 2006 Proxy Statement
------------------------------------------ -------------------------------------------------------
ITEM 10. DIRECTORS AND EXECUTIVE BOARD OF DIRECTORS, EXECUTIVE OFFICERS
OFFICERS OF THE REGISTRANT
ITEM 11. EXECUTIVE COMPENSATION EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL STOCK OWNERSHIP OF DIRECTORS, EXECUTIVE OFFICERS AND
OWNERS AND MANAGEMENT PRINCIPAL STOCKHOLDERS
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
TRANSACTION
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES INDEPENDENT PUBLIC ACCOUNTANTS
76
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) The following documents are filed as a part of this report:
(1) The financial statements listed in response to Item 8 of this
report are as follows:
Consolidated Balance Sheets as of January 31, 2005 and 2006
Consolidated Statements of Operations for the Years Ended
January 31, 2004, 2005 and 2006
Consolidated Statements of Stockholders' Equity for the Years
Ended January 31, 2004, 2005 and 2006
Consolidated Statements of Cash Flows for the Years Ended
January 31, 2005 and 2006
(2) Financial Statement Schedule: Report of Independent Auditors
on Financial Statement Schedule for the three years in the
period ended January 31, 2006; Schedule II -- Valuation and
Qualifying Accounts. The financial statement schedule should
be read in conjunction with the consolidated financial
statements in our 2006 Annual Report to Stockholders.
Financial statement schedules not included in this report have
been omitted because they are not applicable or the required
information is shown in the consolidated financial statements
or notes thereto.
(3) Exhibits: A list of the exhibits filed as part of this report
is set forth in the Index to Exhibits, which immediately
precedes such exhibits and is incorporated herein by
reference.
77
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of l934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CONN'S, INC.
(Registrant)
/s/ Thomas J. Frank, Sr.
----------------------------------------------
Date: March 30, 2006 Thomas J. Frank, Sr.
Chairman of the Board and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Thomas J. Frank. Sr. Chairman of the Board and March 30, 2006
- ------------------------------------------------------------ Chief Executive Officer
Thomas J. Frank, Sr. (Principal Executive Officer)
/s/ David L. Rogers Chief Financial Officer March 30, 2006
- ------------------------------------------------------------ (Principal Financial and Accounting
David L. Rogers Officer)
/s/ Marvin D. Brailsford
- ------------------------------------------------------------ Director March 30, 2006
Marvin D. Brailsford
/s/ Jon E.M.Jacoby
- ------------------------------------------------------------ Director March 30, 2006
Jon E.M. Jacoby
/s/ Bob L. Martin
- ------------------------------------------------------------ Director March 30, 2006
Bob L. Martin
/s/ Douglas H. Martin
- ------------------------------------------------------------ Director March 30, 2006
Douglas H. Martin
/s/ Scott L. Thompson Director March 30, 2006
- ------------------------------------------------------------
Scott L. Thompson
/s/ William T. Trawick
- ------------------------------------------------------------ Director March 30, 2006
William T. Trawick
/s/ Theodore M. Wright
- ------------------------------------------------------------ Director March 30, 2006
Theodore M. Wright
78
EXHIBIT INDEX
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
April 30, 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 April 30, 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 April 30, 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 Securities and
Exchange 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 Securities and
Exchange 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
79
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 Securities and Exchange 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 October 31, 2005, by and among Conn Appliances,
Inc. and the Borrowers thereunder, the Lenders party thereto, JPMorgan
Chase Bank, National Association, 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. Quarterly Report on Form 10-Q (file no. 000-50421) as
filed with the Securities and Exchange Commission on December 1,
2005).
10.9.1 Letter of Credit Agreement dated November 12, 2004 by and between Conn
Appliances, Inc. and CAI Credit 10.9.1 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).
80
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
Securities and Exchange 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
Securities and Exchange 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
Securities and Exchange 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 (incorporated
herein by reference to Exhibit 10.14.1 to Conn's, Inc. Form 10-Q for
the quarterly period ended July 31, 2005 (File No. 000-50421) as filed
with the Securities and Exchange Commission on August 30, 2005).
81
10.14.2 Second Amendment to Servicing Agreement dated November 28, 2005, by
and among Conn Funding II, L.P., as 10.14.2 Issuer, CAI, L.P., as
Servicer, and Wells Fargo Bank, National Association, as Trustee
(incorporated herein by reference to Exhibit 10.14.2 to Conn's, Inc.
Form 10-Q for the quarterly period ended July 31, 2005 (File No.
000-50421) as filed with the Securities and Exchange Commission on
August 30, 2005).
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
(incorporated herein by reference to Exhibit 10.15.1 to Conn's, Inc.
Form 10-Q for the quarterly period ended July 31, 2005 (file No.
000-50421) as filed with the Securities and Exchange Commission on
August 30, 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 2007 Bonus Program (incorporated herein by reference to Form 8-K (file
no. 000-50421) filed with the Securities and Exchange Commission on
March 30, 2006).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
10.19 Dealer Agreement between Conn Appliances, Inc. and Voyager Service
Programs, Inc. effective as of January 1, 1998 (filed herewith).
10.19.1 Amendment #1 to Dealer Agreement by and among Conn Appliances, Inc.,
CAI, L.P., Federal Warranty Service Corporation and Voyager Service
Programs, Inc. effective as of July 1, 2005 (filed herewith).
10.19.2 Amendment #2 to Dealer Agreement by and among Conn Appliances, Inc.,
CAI, L.P., Federal Warranty Service Corporation and Voyager Service
Programs, Inc. effective as of July 1, 2005 (filed herewith).
10.19.3 Amendment #3 to Dealer Agreement by and among Conn Appliances, Inc.,
CAI, L.P., Federal Warranty Service Corporation and Voyager Service
Programs, Inc. effective as of July 1, 2005 (filed herewith).
10.19.4 Amendment #4 to Dealer Agreement by and among Conn Appliances, Inc.,
CAI, L.P., Federal Warranty Service Corporation and Voyager Service
Programs, Inc. effective as of July 1, 2005 (filed herewith).
10.20 Service Expense Reimbursement Agreement between Affiliates Insurance
Agency, Inc. and American Bankers Life Assurance Company of Florida,
American Bankers Insurance Company Ranchers & Farmers County Mutual
Insurance Company, Voyager Life Insurance Company and Voyager Property
and Casualty Insurance Company effective July 1, 1998 (filed
herewith).
10.20.1 First Amendment to Service Expense Reimbursement Agreement by and
among CAI, L.P., Affiliates Insurance Agency, Inc., American Bankers
Life Assurance Company of Florida, Voyager Property & Casualty
Insurance Company, American Bankers Life Assurance Company of Florida,
American Bankers Insurance Company of Florida and American Bankers
General Agency, Inc. effective July 1, 2005 (filed herewith).
82
10.21 Service Expense Reimbursement Agreement between CAI Credit Insurance
Agency, Inc. and American Bankers Life Assurance Company of Florida,
American Bankers Insurance Company Ranchers & Farmers County Mutual
Insurance Company, Voyager Life Insurance Company and Voyager Property
and Casualty Insurance Company effective July 1, 1998 (filed
herewith).
10.21.1 First Amendment to Service Expense Reimbursement Agreement by and
among CAI Credit Insurance Agency, Inc., American Bankers Life
Assurance Company of Florida, Voyager Property & Casualty Insurance
Company, American Bankers Life Assurance Company of Florida, American
Bankers Insurance Company of Florida, American Reliable Insurance
Company, and American Bankers General Agency, Inc. effective July 1,
2005 (filed herewith).
10.22 Consolidated Addendum and Amendment to Service Expense Reimbursement
Agreements by and among Certain Member Companies of Assurant
Solutions, CAI Credit Insurance Agency, Inc. and Affiliates Insurance
Agency, Inc. effective April 1, 2004 (filed herewith).
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).
23.1 Consent of Ernst & Young LLP (filed herewith).
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 Financial 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.
83
Schedule II-Valuation and Qualifying Accounts
Conn's, Inc.
- -----------------------------------------------------------------------------------------------------------------------------
Col A Col B Col C Col D Col E
- -----------------------------------------------------------------------------------------------------------------------------
Additions
- -----------------------------------------------------------------------------------------------------------------------------
Balance at Charged to Charged to
Beginning of Costs and Other Accounts Deductions Balance at
Description Period Expenses Describe Describe(1) End of Period
- -----------------------------------------------------------------------------------------------------------------------------
Year ended January 31, 2004
Reserves and allowances from asset accounts:
Allowance for doubtful accounts 117 4,657 - (2,855) 1,919
Year ended January 31, 2005
Reserves and allowances from asset accounts:
Allowance for doubtful accounts 1,919 5,637 - (5,345) 2,211
Year ended January 31, 2006
Reserves and allowances from asset accounts:
Allowance for doubtful accounts 2,211 3,769 - (5,066) 914
(1) Uncollectible accounts written off, net of recoveries