Definitive Prospectus
Table of Contents

Filed Pursuant to Rule 424(b)(4)

Registration No. 333-109046

 

4,150,000 Shares

LOGO

 

Common Stock

 


 

This is the initial public offering of common stock by Conn’s, Inc. We are selling 4,000,000 shares of our common stock. The selling stockholder identified in this prospectus is selling an additional 150,000 shares. We will not receive any of the proceeds from the sale of shares by the selling stockholder. Prior to this offering, there has been no public market for our common stock. We have been approved to list our common stock on the Nasdaq National Market under the symbol “CONN.”

 

You should consider the risks we have described in “ Risk Factors” beginning on page 7 before buying shares of our common stock.

 


 

     Per Share

     Total

Public offering price

   $ 14.00      $ 58,100,000

Underwriting discount

   $ .98      $ 4,067,000

Proceeds to us, before expenses

   $ 13.02      $ 52,080,000

Proceeds to selling stockholder

   $ 13.02      $ 1,953,000

 

The underwriters have an option to purchase up to an additional 622,500 shares from us at the initial public offering price, less the underwriting discount, within 30 days from the date of this prospectus to cover over-allotments of shares.

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

The underwriters expect to deliver the shares of our common stock to purchasers on or about December 1, 2003.

 


 

Stephens Inc. SunTrust Robinson Humphrey

 

The date of this prospectus is November 24, 2003


Table of Contents

[Map of Texas and Louisiana

indicating existing store locations

and new store locations under development]


Table of Contents

TABLE OF CONTENTS

 

     Page

Prospectus Summary

   1

Risk Factors

   7

Forward-Looking Statements

   17

Use of Proceeds

   18

Dividend Policy

   19

Capitalization

   20

Dilution

   22

Selected Consolidated Financial Data

   24

Pro Forma Statements of Operations

   26

Management's Discussion and Analysis of Financial Condition and Results of Operations

   28

Business

   49

Management

   67

Certain Relationships and Related Transactions

   73

Principal and Selling Stockholders

   76

Description of Capital Stock

   79

Shares Eligible for Future Sale

   83

Underwriting

   85

Legal Matters

   90

Experts

   90

Where You Can Find Additional Information

   90

Index to Consolidated Financial Statements

   F-1

 


 

You should rely only on the information contained in this prospectus. We have not, and the underwriters have not, authorized any person to provide you with different information. You should not rely on any information provided by anyone that is different or inconsistent. Information on our website is not incorporated into this prospectus by reference and should not be considered part of this prospectus. You should assume that the information appearing in this prospectus is accurate only as of the date on the front cover of this prospectus or other date stated in this prospectus. Our business, financial condition, results of operations and prospects may have changed since that date.


Table of Contents

PROSPECTUS SUMMARY

 

This summary highlights information contained elsewhere in this prospectus. Because it is a summary, it may not contain all of the information that is important to you. You should read carefully this entire prospectus, especially “Risk Factors” and our consolidated financial statements and related notes, before making a decision to invest in our common stock.

 

Effective August 1, 2001, we changed our fiscal year end from July 31 to January 31. As a result, we have a six month transitional fiscal period ended January 31, 2002. We sometimes refer to our twelve month fiscal years ended July 31, 1999, 2000 and 2001 and January 31, 2003, 2004 and 2005 as “fiscal 1999,” “fiscal 2000,” “fiscal 2001,” “fiscal 2003,” “fiscal 2004” and “fiscal 2005,” respectively.

 

Unless we indicate otherwise, the information set forth in this prospectus includes reference to our subsidiary prior to our reincorporation immediately prior to the closing of this offering and reflects a 70-for-1 stock split effected as a stock dividend in July 2002.

 

Conn’s, Inc.

 

Our Business

 

We are a specialty retailer of home appliances and consumer electronics operating 45 stores in the southwestern United States. 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, VCRs, DVD players and home theater products. We also sell home office equipment, lawn and garden products and bedding, and we continue to introduce additional product categories for the home 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, Mitsubishi, Sony, Panasonic, Thomson Consumer Electronics, Simmons, Hewlett Packard and Compaq. Based on revenue in 2002, we were the 12th largest retailer of home appliances in the United States, and we are either the first or second leading retailer of home appliances in terms of market share in the majority of our existing markets.

 

We are known for providing excellent customer service, and 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 believe these strategies drive repeat purchases and enable us to generate substantial brand name recognition and customer loyalty. During fiscal 2003, approximately 54% of our credit customers, based upon 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 increased our number of stores by more than 73% from 26 to 45 currently. In addition, we have grown our revenues, operating income and net income from continuing operations at compounded annual growth rates of 20.2%, 20.3 % and 27.7%, respectively, since fiscal 1999 to fiscal 2003. We have achieved average annual same store sales growth of 10.9% over the three fiscal year period ended July 31, 2001, and 8.4% over the two year period ended January 31, 2003. We plan to continue growing by expanding into the Dallas/Fort Worth market with at least three new stores in the second half of fiscal 2004, two of which were opened in September 2003 and October 2003.

 

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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 the execution of the following strategies:

 

    Providing a high level of customer service.    Emphasizing customer service as a key component of our culture has allowed us to achieve customer satisfaction levels at rates between 90% and 95%. We measure customer satisfaction in our customer service on the sales floor, in our delivery operation and in our service department by sending survey cards to all customers for 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.

 

    Developing and retaining highly trained and knowledgeable sales personnel.    We require all sales personnel to specialize in home appliances, consumer electronics or “track” products. Track products include small appliances, computers, camcorders, DVD players, cameras and telephones that are sold within the interior of a large colorful track that circles the interior floor of our stores. All new sales personnel must complete an intensive two-week classroom training program followed by an additional week of on-the-job training riding in a delivery and service truck to observe how we serve our customers after the sale is made.

 

    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. To facilitate our responsiveness to customer demand, 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.

 

    Offering flexible financing alternatives through our proprietary credit programs.    Historically, we have financed over 56% 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. Approximately 60% of customers who have active credit accounts with us take advantage of our monthly in-store payment option, which we believe results in additional sales to these customers.

 

    Maintaining same day and next day distribution capabilities.    We maintain four regional distribution centers and two related facilities that cover all of our major markets. Using our fleet of transfer and delivery vehicles, we are able to deliver products from these facilities on the day of, or the day after, the sale to approximately 95% of our customers.

 

    Providing outstanding product repair service.    We service every product that we sell, and we service only the products that we sell, ensuring that our customers will receive our service technicians’ exclusive attention for their product repair needs.

 

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.

 

    Increasing same store sales.    We plan to increase our same store sales by remerchandising our product offerings in response to changes in consumer demands, training our sales personnel to increase sales closing rates, updating stores every three years on average and continuing to emphasize a high level of customer service. As an example, we have recently developed a new strategy for the merchandising of our track products, including separate merchandising plans and displays, separate sales and managerial personnel, convenient check-out procedures and diversified inventory.

 

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    Opening new stores.    We plan to continue the pace of our new store openings in our five existing major markets, in adjacent markets and in new markets by opening one to three additional new stores in fiscal 2004 and an additional four to six new stores in fiscal 2005. Our prototype store for future expansion, which has from 20,000 to 24,000 square feet of retail selling space, is approximately 15% larger than our average existing store.

 

    Existing and adjacent markets.    We intend to increase our market presence by opening new stores in our existing markets and in markets adjacent to our five existing major markets. New store openings in these locations will allow us to leverage our existing distribution network and advertising programs and capitalize on our brand name recognition and reputation.

 

    New markets.    In fiscal 2004, we opened three new stores in the Dallas/Fort Worth metroplex. We also have identified several additional markets that meet our criteria for site selection, including the Rio Grande Valley in southwest Texas, New Orleans and central Louisiana around Shreveport, Monroe and Alexandria. We intend to enter these new markets, along with others in neighboring states, over the next several years.

 

    Updating, expanding or relocating stores.    Over the last three years, we have updated, expanded or relocated all of our stores. We have implemented our larger prototype store model at all locations where the physical space would accommodate the required design changes. After updating, expanding or relocating a store, we expect to increase sales significantly at those stores.

 

About Us

 

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 45 stores, selling home appliances, consumer electronics, home office equipment, lawn and garden products and bedding.

 

We were formed as a Delaware corporation in January 2003 with an initial capitalization of $1,000 to become the holding company for Conn Appliances, Inc., a Texas corporation. We have had no operations to date. Immediately before the closing of the initial public offering of our common stock described in this prospectus, Conn Appliances, Inc., our current parent company, will become our operating subsidiary, and the common and preferred shareholders of Conn Appliances, Inc. will become common and preferred stockholders of Conn’s, Inc. on a share-for-share basis. As used in this prospectus, “Conn’s,” “we,” “us” and “our” refer to Conn’s, Inc. and its consolidated subsidiaries, including Conn Appliances, Inc. and its subsidiaries, and “Conn Texas” refers to Conn Appliances, Inc. and its subsidiaries.

 

Our principal executive offices are located at 3295 College Street, Beaumont, Texas 77701. Our telephone number at that address is (409) 832-1696. Our website address is www.conns.com. Information contained on our website is not part of this prospectus.

 

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Table of Contents

The Offering

 

Common stock offered by us

   4,000,000 shares

Common stock offered by the selling stockholder

   150,000 shares

Common stock to be outstanding after the offering

   22,412,040 shares

Use of proceeds

   To reduce a portion of our existing debt, to redeem a portion of our outstanding preferred stock and for general corporate purposes, including continued growth and expansion of our business.

Proposed Nasdaq National Market symbol

   “CONN”

 


 

The number of shares of common stock to be outstanding after this offering excludes:

 

    2,859,767 shares available for future issuance under our director and employee stock option plans, of which 1,223,890 shares are issuable upon the exercise of outstanding stock options at July 31, 2003, at a weighted average exercise price of $8.31 per share; and

 

    1,267,085 shares available for future issuance under our employee stock purchase plan.

 


 

Except as otherwise noted, all information in this prospectus assumes:

 

    the completion of the Delaware reorganization whereby Conn Texas will become our wholly-owned subsidiary immediately prior to the closing of this offering;

 

    that all of the preferred stockholders of Conn Texas who will become our preferred stockholders as a result of the Delaware reorganization will elect to redeem their Conn’s preferred stock for cash in response to the call for redemption that we will make immediately after the closing of this offering, except for Thomas J. Frank, Sr., our Chairman of the Board and Chief Executive Officer, Stephens Group, Inc., Stephens Inc. and affiliates of Stephens Group, Inc. (the “SGI Affiliates”) who own shares of our preferred stock, all of whom we expect will elect to redeem their preferred stock for shares of our common stock; and

 

    that the underwriters do not exercise their over-allotment option.

 

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Table of Contents

Summary Consolidated Financial Data

 

The following restated summary consolidated financial data for the fiscal years ended July 31, 1999, 2000, and 2001, the six month period ended January 31, 2002, and the fiscal year ended January 31, 2003, are derived from our consolidated financial statements which have been audited by Ernst & Young LLP, independent auditors. The data should be read in conjunction with the consolidated financial statements, related notes and other financial information included herein. The summary consolidated financial data for the twelve month period ended January 31, 2002 and for the six month periods ended July 31, 2002 and 2003 are derived from unaudited financial statements. The unaudited financial statements include all adjustments, consisting of normal recurring accruals, which we consider necessary for a fair presentation of the financial position and the results of operations for these periods. Operating results for the six months ended July 31, 2003 are not necessarily indicative of the results that may be expected for the entire year ending January 31, 2004.

 

   

Twelve Months

Ended

July 31,


   

Six Months

Ended

January 31,

2002


   

Twelve Months

Ended

January 31,


   

Six Months

Ended

July 31,


 
    1999

    2000

    2001

      2002

    2003

    2002

    2003

 
    (dollars and shares in thousands, except per share amounts)  

Statement of Operations Data (1):

                                                               

Total revenues

  $ 234,492     $ 276,933     $ 327,257     $ 206,896     $ 378,525     $ 445,973     $ 218,064     $ 237,917  

Operating income

    20,509       28,425       31,366       19,437       35,944       39,180       18,775       19,650  

Interest expense, net

    6,024       4,836       3,754       2,940       4,855       7,237       3,125       3,216  

Net income from continuing operations

    8,761       14,598       17,733       10,553       19,959       20,601       10,094       10,607  

Discontinued operations, net of tax

    224       30       (546 )     —         (389 )     —         —         —    

Net income

    8,985       14,628       17,187       10,553       19,570       20,601       10,094       10,607  

Less preferred stock dividends (2)

    (1,857 )     (2,046 )     (2,173 )     (1,025 )     (1,939 )     (2,133 )     (1,067 )     (1,173 )
   


 


 


 


 


 


 


 


Net income available for common stockholders

  $ 7,128     $ 12,582     $ 15,014     $ 9,528     $ 17,631     $ 18,468     $ 9,027     $ 9,434  
   


 


 


 


 


 


 


 


Earnings per common share:

                                                               

Basic

  $ 0.41     $ 0.73     $ 0.87     $ 0.56     $ 1.03     $ 1.10     $ 0.54     $ 0.56  

Diluted

  $ 0.41     $ 0.72     $ 0.87     $ 0.55     $ 1.01     $ 1.10     $ 0.54     $ 0.56  

Average common shares outstanding:

                                                               

Basic

    17,489       17,350       17,169       17,025       17,060       16,724       16,728       16,720  

Diluted

    17,489       17,384       17,194       17,327       17,383       16,724       16,728       16,720  

Other Financial Data:

                                                               

Stores open at end of period

    26       28       32       36       36       42       39       42  

Same store sales growth (3)

    13.6 %     8.9 %     10.3 %     16.7 %     15.6 %     1.3 %     6.8 %     (0.9 )%

Inventory turns (4)

    5.5       5.6       5.9       7.5       6.8       6.1       7.6       7.3  

Gross margin percentage (5)

    38.2 %     38.8 %     38.3 %     38.4 %     38.4 %     37.9 %     38.6 %     36.1 %

Operating margin (6)

    8.7 %     10.3 %     9.6 %     9.4 %     9.5 %     8.8 %     8.6 %     8.3 %

Return on average equity (7)

    40.2 %     42.8 %     36.7 %     35.9 %     34.9 %     28.3 %     29.9 %     23.9 %

Capital expenditures

  $ 6,781     $ 6,920     $ 14,833     $ 10,551     $ 15,547     $ 15,070     $ 9,319     $ 2,364  

 

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     As of July 31, 2003

     Actual

  

Pro

Forma(8)


  

Pro Forma

As Adjusted(8)


Balance Sheet Data:

                    

Working capital

   $ 76,347    $ 74,616    $ 104,522

Total assets

     190,005      188,274      204,914

Total debt

     43,380      43,380      8,500

Preferred stock

     15,226      —        —  

Total stockholders’ equity

     94,667      92,936      144,456

(1)   Information excludes the operations of the rent-to-own division that we sold in February 2001.
(2)   Dividends were not actually declared or paid but are presented for purposes of earnings per share calculation.
(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 beginning and ending inventory; information for the six months ended January 31, 2002 and July 31, 2002 and 2003 has been annualized for comparison purposes.
(5)   Gross margin percentage is defined as total revenues less cost of goods 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 beginning and ending equity; information for the six months ended January 31, 2002 and July 31, 2002 and 2003 has been annualized for comparison purposes.
(8)   The pro forma and pro forma as adjusted balance sheet data assumes that all of our preferred stockholders, except Thomas J. Frank, Sr., Stephens Group, Inc., Stephens Inc. and the SGI Affiliates, elect to receive cash in response to the call for redemption of our preferred stock that we will make immediately after the closing of this offering. Because we are unable to determine the intent of our other preferred stockholders, we have assumed the most unfavorable treatment, from a cash flow standpoint, of the 11,895 shares of preferred stock assumed to be redeemed for $1.7 million in cash from these stockholders. The pro forma as adjusted balance sheet data give effect to our sale of 4,000,000 shares of common stock at $14.00 per share yielding proceeds, net of expenses, of $51.5 million and the application of the estimated net proceeds as described in “Use of Proceeds” to retire current debt of $5.3 million, the current portion of long-term debt of $8.0 million and long-term debt of $21.6 million.

 

A reconciliation of “actual” information to “pro forma” and “pro forma as adjusted” information” is as follows (in thousands):

 

     Working
Capital


    Total
Assets


   

Total

Debt


    Preferred
Stock


    Total
Stockholders’
Equity


 

As reported

   $ 76,347     $ 190,005     $ 43,380     $ 15,226     $ 94,667  

Pro forma adjustments:

                                        

Declaration of preferred dividends

     —         —         —         10,194       —    

Preferred stock redemption:

                                        

Cash payments

     (1,731 )     (1,731 )             (1,731 )     (1,731 )

Conversion of preferred stock to common stock

     —         —         —         (23,689 )     (23,689 )

Issuance of common stock

     —         —         —         —         17  

Additional paid in capital resulting from preferred conversion to common

     —         —         —         —         23,672  
    


 


 


 


 


Pro forma totals

     74,616       188,274       43,380       —         92,936  

Pro forma as adjusted adjustments:

                                        

Net proceeds of offering

     51,520       51,520       —         —         51,520  

Retire current portion of debt

     —         (13,266 )     (13,266 )     —         —    

Retire noncurrent portion of debt

     (21,614 )     (21,614 )     (21,614 )     —         —    
    


 


 


 


 


Pro forma as adjusted totals

   $ 104,522     $ 204,914     $ 8,500     $ —       $ 144,456  
    


 


 


 


 


 

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RISK FACTORS

 

An investment in our common stock involves risks and uncertainties. You should consider carefully the following information about these risks and uncertainties, together with the other information contained in this prospectus, 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.

 

Risks Related to our Business

 

Our success depends substantially on our ability to open and operate profitably new stores in existing, adjacent and new geographic markets.

 

We plan to open an additional one to three new stores in fiscal 2004 and to continue our expansion by opening an additional four to six new stores in fiscal 2005. These new stores include at least three new stores in the Dallas/Fort Worth metroplex, where we have not previously operated prior to September 2003. We have not yet selected sites for all of the stores that we plan to open within the next 18 months. We may not be able to open all of these stores, and any new stores that we open may not be profitable. Either 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:

 

    competition in existing, adjacent and new markets;

 

    competitive conditions, consumer tastes and discretionary spending patterns in adjacent and new markets that are different from those in our existing markets;

 

    a lack of consumer demand for our products at levels that can support new store growth;

 

    limitations created by covenants and conditions under our credit facilities and our asset-backed securitization program;

 

    the availability of additional financial resources;

 

    the substantial outlay of financial resources required to open new stores and the possibility that we may recognize little or no related benefit;

 

    an inability or unwillingness of vendors to supply product on a timely basis at competitive prices;

 

    the failure to open enough stores in new markets to achieve a sufficient market presence;

 

    the inability to identify suitable sites and to negotiate acceptable leases for these sites;

 

    unfamiliarity with local real estate markets and demographics in adjacent and new markets;

 

    problems in adapting our distribution and other operational and management systems to an expanded network of stores;

 

    difficulties associated with the hiring, training and retention of additional skilled personnel, including store managers; and

 

    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.

 

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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 master 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 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 $46 million was drawn as of July 31, 2003. The Series B program consists of $200 million in private bond placements that was fully drawn as of July 31, 2003.

 

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:

 

    conditions in the securities and finance markets generally;

 

    conditions in the markets for securitized instruments;

 

    the credit quality and performance of our financial instruments;

 

    our ability to obtain financial support for required credit enhancement;

 

    our ability to service adequately our financial instruments;

 

    the absence of any material downgrading or withdrawal of ratings given to our securities previously issued in securitizations; and

 

    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. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Off-Balance Sheet Financing Arrangements.”

 

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An increase in short-term 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 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 2004 will be approximately $10 million and that capital expenditures during future years will likely exceed this amount. We expect that cash provided by operating activities, available borrowings under our credit facility, access to the unfunded portion of our asset-backed securitization program and the net proceeds of this offering will be sufficient to fund our operations, store expansion and updating activities and capital expenditure programs through at least January 31, 2005. 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.

 

Historically, we have financed over 56% 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 60% 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 require us to increase the provision for bad debts on our statement of operations and result in an adverse effect on our earnings. See “Business—Finance Operations.”

 

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, 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.

 

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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:

 

    expansion by our existing competitors or entry by new competitors into markets where we currently operate;

 

    lower pricing;

 

    aggressive advertising and marketing;

 

    extension of credit to customers on terms more favorable than we offer;

 

    larger store size, which may result in greater operational efficiencies, or innovative store formats; and

 

    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 DVD players, digital television and digital radio, 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

 

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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 sell excess inventory.

 

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, Mitsubishi, Sony, Hitachi, Panasonic, Thomson Consumer Electronics, Toshiba, 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 65.3% of our purchases for fiscal 2003, and the top two suppliers represented more than 29.2% of our total purchases. See “Business—Products and Merchandising—Purchasing.” 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 July 31, 2003, we had $31.9 million in accounts payable and $50.4 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 2003 and the two quarters included in the six month period ended July 31, 2003 were 14.7%, 0.1%, (3.2%), (3.7%), 1.1% and (2.5%), respectively. Even though we achieved double-digit same store sales growth in the past, we may not be able to increase same store sales in the future. This is reflected in the declining rate of increases or, in some cases, actual decreases, in same store sales that have occurred over the last several quarters. A number of factors have historically affected, and will continue to affect, our comparable store sales results, including:

 

    changes in competition;

 

    general economic conditions;

 

    new product introductions;

 

    consumer trends;

 

    changes in our merchandise mix;

 

    changes in the relative sales price points of our major product categories;

 

    the impact of our new stores on our existing stores, including potential decreases in existing stores’ sales as a result of opening new stores;

 

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    weather conditions in our markets;

 

    timing of promotional events; and

 

    our ability to execute our business strategy effectively.

 

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 2003, we generated 27.1% and 25.1% of our net sales and 29.6% and 26.4% of our net income in the fiscal quarters ended January 31 (which include the holiday selling season) and July 31 (which include the effects of summer air conditioner sales), respectively. We also incur significant additional expenses during these fiscal quarters 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 quarters ending January 31 and July 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 these fiscal quarters, 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. See “Business—Regulation.”

 

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 are the defendant, could adversely affect our business.

 

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 credit; therefore, similar litigation could be brought against us. Additionally, we have been 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. While we believe we are in full compliance with applicable laws and regulations, if we are found liable in the class action lawsuit or 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. See “Business—Legal Proceedings.”

 

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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, C. William Frank, our Executive Vice President and Chief Financial Officer, David R. Atnip, our Senior Vice President and Secretary/Treasurer, and other key personnel. We have entered into employment agreements with each of these named individuals, all of which include confidentiality and other customary provisions. 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 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 45 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:

 

    power loss, computer systems failures and Internet, telecommunications or data network failures;

 

    operator negligence or improper operation by, or supervision of, employees;

 

    physical and electronic loss of data or security breaches, misappropriation and similar events;

 

    computer viruses;

 

    intentional acts of vandalism and similar events; and

 

    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

 

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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.

 

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.

 

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 applied for registration of our trademark “Conn’s” and our logo. We intend to protect vigorously our trademark against infringement or misappropriation by others. A third party, however, could 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.

 

Risks Related to our Common Stock and this Offering

 

Because of its significant stock ownership, a trust to be established by Stephens Group, Inc. will be able to exert significant control over our future direction.

 

Prior to the completion of this offering, Stephens Group, Inc., Stephens Inc. and the SGI Affiliates will have contributed all of the shares of our stock owned by them to a voting trust, which will contain approximately 60.8% of our outstanding common stock after completion of this offering. The trustee of the voting trust was appointed by Stephens Group, Inc. but is not a director, officer or employee of Stephens Group, Inc., Stephens Inc. or any of their affiliates. The trustee is required under the terms of the voting trust agreement to vote the shares in the voting trust “for” or “against” those proposals submitted to our stockholders (including proposals involving the election of directors) in the same proportion as votes cast “for” and “against” those proposals by all other stockholders. As long as these shares continue to be held in the voting trust, the voting power of all of our other stockholders will be magnified by the operation of the voting trust, and Stephens Group, Inc. and its affiliates will not be able to exercise voting control over our business. However, if the voting trust were terminated, depending upon the number of shares then outstanding and the number of shares voted on a particular matter, Stephens Group, Inc. and its affiliates might be able to exercise substantial influence over all matters requiring our stockholders’ approval, including the election of our entire board of directors, amendment of our certificate of incorporation and approval of significant corporate transactions. Our board of directors has the authority to make decisions affecting our management policies, operations, affairs and capital structure, including decisions to issue additional stock, implement stock repurchase programs and incur indebtedness. This concentration of ownership may delay, prevent or deter a change in control, deprive our stockholders of an opportunity to receive a premium for their common stock as part of a sale of us or our assets and adversely affect the market price of our common stock. The trust expires in November 2013, and Stephens Group, Inc. has the right in certain circumstances to terminate the trust prior to its expiration. See “Principal and Selling Stockholders.” If the trust were terminated, Stephens Inc. might be prohibited from making a market in our common stock.

 

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You will not have control over management’s use of the proceeds from this offering.

 

We expect to use the net proceeds from this offering to reduce a portion of our existing debt, to redeem a portion of our outstanding preferred stock and for general corporate purposes. However, we will have broad discretion in how we use the net proceeds from this offering. We may ultimately decide to use the proceeds for purposes other than the purposes indicated in this prospectus. We may decide not to use proceeds for any one or more of the indicated purposes. You will not have the opportunity to evaluate the economic, financial or other information on which we base our decisions on how to use the net proceeds or to approve these decisions. See “Use of Proceeds.”

 

The price of our common stock after this offering may be lower than the offering price you pay and may be volatile.

 

Our common stock has not been sold in a public market prior to this offering. An active trading market in our common stock may not develop after this offering. If an active trading market develops, it may not continue and the trading price of our common stock may fluctuate widely as a result of a number of factors that are beyond our control, including our perceived prospects, changes in analysts’ recommendations or projections and changes in overall market valuation. The stock market has experienced extreme price and volume fluctuations that have affected the market prices of the stocks of many companies. These broad market fluctuations could adversely affect the market price of our common stock. A significant decline in our stock price could result in substantial losses for individual stockholders and could lead to costly and disruptive securities litigation. The selling price for shares of our common stock in this offering was not established in a competitive market but was negotiated with the representatives of the underwriters based on a number of factors. The price of our common stock that will prevail in the market after this offering may be higher or lower than the offering price.

 

You will incur immediate and substantial dilution in the book value of your investment.

 

The initial public offering price of our common stock will be substantially higher than the current net tangible book value per share of the outstanding common stock. If you purchase shares of our common stock in this offering, you will incur immediate and substantial dilution in the amount of $7.91 per share. The exercise of outstanding options or the issuance of additional shares in the future may result in further dilution. See “Dilution.”

 

Substantial amounts of our common stock could be sold in the near future, which could depress our stock price.

 

Prior to this offering, there has been no public market for our common stock. We cannot predict the effect, if any, that public sales of shares of common stock after this offering, or the perception that these sales could occur, and the availability of shares of common stock for sale will have on the market price of our common stock prevailing from time to time. All of our currently outstanding shares of common stock are “restricted securities” under the Securities Act of 1933, as amended. These shares are eligible for future sale in the public market at prescribed times pursuant to Rule 144 under the Securities Act or otherwise. Certain of our stockholders, owning approximately 16,950,000 shares, or 75.5%, of our common stock after this offering, have agreed not to sell or otherwise dispose of any of their shares for a period of 180 days after this date of this prospectus. Additionally, to the extent that other persons who participate in our directed share program purchase shares in the directed share program in excess of $50,000, we will require these persons, as a condition to their participation in the directed share program, to agree to similar restrictions on their ability to sell or otherwise dispose of the shares purchased in the directed share program. Sales of a significant number of shares of our common stock in the public market could adversely affect the market price of the common stock. See “Shares Eligible for Future Sale” and “Underwriting.”

 

Our anti-takeover provisions and Delaware law could prevent or delay a change in control of our company, even if such a change of control would be beneficial to our stockholders.

 

Provisions of our certificate of incorporation and bylaws, as well as provisions of Delaware law, could discourage, delay or prevent a merger, acquisition or other change in control of our company, even if such a

 

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change in control would be beneficial to our stockholders. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors and take other corporate actions. As a result, these provisions could limit the price that investors are willing to pay in the future for shares of our common stock. These provisions might also discourage a potential acquisition proposal or tender offer, even if the acquisition proposal or tender offer is at a price above the then current market price for our common stock. These provisions include:

 

    a board of directors that is classified such that only one-third of directors are elected each year;

 

    authorization of “blank check” preferred stock that our board of directors could issue to increase the number of outstanding shares and thwart a takeover attempt;

 

    limitations on the ability of stockholders to call special meetings of stockholders;

 

    a prohibition against stockholder action by written consent and a requirement that all stockholder actions be taken at a meeting of our stockholders; and

 

    advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings.

 

In addition, we are subject to Section 203 of the Delaware General Corporation Law, which limits business combination transactions with 15% or greater stockholders that our board of directors has not approved. These provisions and other similar provisions make it more difficult for a third party to acquire us without negotiation. These provisions may apply even if some stockholders may consider the transaction beneficial. See “Description of Capital Stock.”

 

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FORWARD-LOOKING STATEMENTS

 

This prospectus 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. Specifically, this prospectus contains forward-looking statements relating to, among other things:

 

    our growth strategy and plans regarding opening new stores and entering adjacent and new markets, including our plans to expand into the Dallas/Fort Worth metroplex;

 

    our intention to update or expand existing stores;

 

    estimated capital expenditures and costs related to the opening of new stores or the update or expansion of existing stores;

 

    the sufficiency of the proceeds from this offering, our cash flows from operations, borrowings from our revolving line of credit and proceeds from securitizations to fund our operations, debt repayment and expansion;

 

    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;

 

    our relationships with key suppliers;

 

    the adequacy of our distribution and information systems and management experience to support our expansion plans;

 

    our expectations regarding competition and our competitive advantages;

 

    the outcome of litigation affecting our business; and

 

    nonpayment of dividends.

 

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 are described in “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this prospectus might not happen.

 

The forward-looking statements in this prospectus reflect our views and assumptions only as of the date of this prospectus. 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.

 

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USE OF PROCEEDS

 

We estimate that the net proceeds to us from this offering, after deducting underwriting discounts and other estimated expenses, will be approximately $50.9 million, or $59.0 million if the underwriters exercise their over-allotment option in full, in each case before considering $0.6 million of expenses that have already been incurred.

 

We intend to use approximately $34.9 million of the net proceeds from this offering to pay the following existing indebtedness:

 

    Revolving and Term Notes.    As of July 31, 2003, we had approximately $20.5 million in outstanding revolving debt and $13.5 million in outstanding term debt under our bank credit facility. The revolving notes mature on September 13, 2005 and provide for quarterly interest payments at a variable rate, which was 3.6% as of July 31, 2003. The term notes mature on September 13, 2005, and provide for aggregate quarterly payments of $1.5 million plus interest at a variable rate, which was 3.4% as of July 31, 2003. We intend to pay the outstanding revolving debt in full and pay $5.0 million of the outstanding term debt.

 

    Short-Term Notes.    As of July 31, 2003, we had approximately $1.8 million in outstanding notes payable to a bank and $3.5 million payable to an insurance company. These notes represent short-term borrowings under revolving agreements that bear interest as of July 31, 2003, at 3.5% (in the case of the bank debt, which is prime less 0.5%) and 7.5% (in the case of the insurance company debt, which is prime plus 1.0% with a floor of 7.5%). The bank debt matures in April 2004, and the insurance company debt matures in November 2003.

 

    Promissory Notes Payable to Former Stockholders.    As of July 31, 2003, we had approximately $4.0 million in outstanding notes payable to two former stockholders. One of the notes, with a balance of $3.4 million, is subordinated to our senior debt, bears interest at 9.0% and matures in July 2005. The other note, with a balance of $0.6 million, is unsecured, bears interest at 6.0% and matures in January 2005.

 

    Installment Obligations Payable to Financial Institutions.    As of July 31, 2003, we had approximately $0.1 million in outstanding notes payable to various financial institutions. These notes represent installment obligations that are due monthly and that had a weighted average interest rate of 4.1% as of July 31, 2003.

 

We expect to use up to approximately $1.7 million of the net proceeds from this offering to redeem outstanding shares of our preferred stock immediately after the closing of this offering. See “Certain Relationships and Related Transactions—Redemption of our Preferred Stock.”

 

We expect to use the remaining proceeds of approximately $14.9 million for general corporate purposes, including the continued growth and expansion of our business.

 

The amount of funds we actually use for any particular purpose will depend on many factors, including changes in our business strategy, material changes in our revenues, expenses and cash flow, and other factors described in “Risk Factors.” For example, if our future revenues and cash flow are less than we currently anticipate, we may need to support our ongoing business operations with proceeds of this offering that we would otherwise use to support growth and expansion. Accordingly, except for the required repayment of the $5.0 million in outstanding term debt and the payment to effect the redemption of our preferred stock, our management will have significant discretion over the use and investment of the net proceeds of this offering and may spend such proceeds for any purpose, including purposes not presently contemplated.

 

Pending the uses described above, we intend to invest the net proceeds of this offering in interest-bearing accounts, short-term interest-bearing investment grade securities or both.

 

We will not receive any proceeds from the sale of common stock by the selling stockholder.

 

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DIVIDEND POLICY

 

We have never paid cash dividends on our common stock. We currently intend to retain all of our earnings in the foreseeable future to finance the operation and expansion of our business. Additionally, our bank credit facility currently prohibits us from declaring or paying any dividends on our common stock. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources.” Our future dividend policy will also depend on the requirements of any future financing arrangements to which we may be a party and other factors considered relevant by our board of directors.

 

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CAPITALIZATION

 

The following table sets forth our capitalization as of July 31, 2003, on:

 

    an actual basis;

 

    a pro forma basis reflecting the receipt of cash by all of our preferred stockholders except Thomas J. Frank, Sr., Stephens Group, Inc., Stephens Inc. and the SGI Affiliates upon the redemption of our preferred stock immediately following the closing of this offering; and

 

    a pro forma as adjusted basis (1) reflecting the receipt of cash by all of our preferred stockholders except Thomas J. Frank, Sr., Stephens Group, Inc., Stephens Inc. and the SGI Affiliates upon the redemption of our preferred stock immediately following the closing of this offering; (2) giving effect to our sale of 4,000,000 shares of common stock after deducting underwriting discounts and estimated offering expenses; and (3) reflecting our application of the estimated net proceeds of the offering as described in “Use of Proceeds.”

 

You should read the following table together with our consolidated financial statements and the related notes included elsewhere in this prospectus.

 

     As of July 31, 2003

 
     Actual

    Pro Forma

   

Pro Forma

As Adjusted


 
     (dollars in thousands, except per share amounts)  

Long-term debt, including current portion

   $ 38,105     $ 38,105     $ 8,500  (1)

Stockholders’ equity:

                        

Preferred stock, $0.01 par value: 300,000 shares authorized, actual; 1,000,000 shares authorized, pro forma and pro forma as adjusted; 174,648 shares issued and outstanding, actual; and no shares issued and outstanding, pro forma and pro forma as adjusted

     15,226       —    (2)     —    

Common stock, $0.01 par value: 30,000,000 shares authorized, actual; 40,000,000 shares authorized pro forma and pro forma as adjusted; 17,175,480 shares issued and outstanding, actual; 18,867,530 shares issued and outstanding, pro forma; and 22,867,530 shares issued and outstanding, pro forma as adjusted

     172       189  (3)     229  (4)

Paid-in capital

     —         23,672  (5)     75,152  (6)

Retained earnings

     78,739       68,545  (7)     68,545  

Accumulated other comprehensive income

     4,141       4,141       4,141  

Treasury stock

     (3,611 )     (3,611 )     (3,611 )
    


 


 


Total stockholders’ equity

     94,667       92,936       144,456  
    


 


 


Total capitalization

   $ 132,772     $ 131,041     $ 152,956  
    


 


 



(1)   Long-term debt is reduced by $29.6 million to reflect the use of the estimated net proceeds of this offering to repay a portion of long-term debt outstanding.
(2)   Preferred stock is adjusted to reflect the redemption of 11,895 shares for $1.7 million in cash and the conversion of the remaining 162,753 shares to common stock.
(3)   Common stock is adjusted to reflect the conversion of the preferred stock to 1,692,050 equivalent common shares at $0.01 par value.
(4)   Common stock is adjusted to reflect the sale of 4,000,000 shares in this offering with a par value of $0.01 per share.

 

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(5)   Paid-in capital is adjusted to reflect the conversion of preferred stock with a book value at the time of conversion of $23.7 million to the common stock with an aggregate par value of $16,921.
(6)   Paid-in capital is adjusted to reflect the estimated net proceeds of the offering of $51.5 million.
(7)   Retained earnings is adjusted to reflect the accumulated dividends on the preferred stock.

 

The amounts above reflect balances at July 31, 2003, except that the redemption price of the preferred stock is determined as of November 30, 2003, to reflect the accumulation of dividends through the estimated date of the closing of the offering.

 

The number of shares of common stock issued and outstanding on an actual basis, a pro forma basis and a pro forma as adjusted basis is based on the number of shares issued and outstanding as of July 31, 2003. It excludes:

 

    2,859,767 shares available for future issuance under our director and employee stock option plans, of which 1,223,890 shares are issuable upon the exercise of stock options outstanding at July 31, 2003, at a weighted average exercise price of $8.31 per share; and

 

    1,267,085 shares available for future issuance under our employee stock purchase plan.

 

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DILUTION

 

If you invest in our common stock, your interest will be diluted to the extent of the difference between the initial public offering price per share of our common stock and the pro forma as adjusted net tangible book value per share of our common stock immediately after the offering.

 

The actual net tangible book value of Conn Texas common stock as of July 31, 2003, was $61.3 million, or approximately $3.67 per share. Net tangible book value per share represents the amount of our total tangible assets less our total liabilities and the liquidation value of the outstanding Conn Texas preferred stock, divided by the number of shares of Conn Texas common stock outstanding as of July 31, 2003. All of the Conn Texas preferred stock will be converted into an equal number of shares of our preferred stock in connection with the Delaware reorganization that will take place immediately prior to the closing of this offering, and we will redeem all of our preferred stock shortly after the closing of the offering. Assuming that Thomas J. Frank, Sr., Stephens Group, Inc., Stephens Inc. and the SGI Affiliates elect to receive shares of our common stock in redemption of their shares of preferred stock and that all of our other preferred stockholders elect to receive cash, the pro forma net tangible book value of our common stock as of July 31, 2003, after giving effect to the redemption but not the issuance of shares of our common stock in this offering, would be $85.0 million, or approximately $4.62 per share. The pro forma net tangible book value of the common stock would be $86.7 million, or approximately $4.68 per share, if all of the holders of preferred stock elected to receive common stock in the redemption.

 

Dilution in pro forma as adjusted net tangible book value per share represents the difference between the amount per share paid by purchasers of shares of our common stock in this offering and the pro forma as adjusted net tangible book value per share of our common stock immediately afterwards. After giving effect to the sale by us of 4,000,000 shares of our common stock at an initial public offering price of $14.00 per share and deduction of estimated underwriting discounts and offering expenses payable by us, our pro forma as adjusted net tangible book value as of July 31, 2003, would be approximately $136.5 million, or $6.09 per share. This represents an immediate increase in pro forma as adjusted net tangible book value of $1.47 per share to existing stockholders and an immediate dilution in pro forma as adjusted net tangible book value of $7.91 per share to new investors purchasing shares of common stock in this offering. The following table illustrates this dilution on a per share basis.(1)

 

Initial public offering price

          $ 14.00
           

Actual net tangible book value as of July 31, 2003

   $ 3.67       

Increase attributable to redemption of preferred stock(1)

     .95       

Pro forma net tangible book value

     4.62       

Increase attributable to new investors

     1.47       
    

      

Pro forma as adjusted net tangible book value after giving effect to the offering

            6.09
           

Dilution to new investors

          $ 7.91
           


(1)   If all preferred stockholders elect to receive common stock in the redemption, the increase attributable to redemption of preferred stock would be $1.01 per share, the pro forma net tangible book value would be $4.68 per share, the increase attributable to new investors would be $1.46 per share, the pro forma as adjusted net tangible book value after giving effect to the offering would be $6.14 per share and the dilution to new investors would be $7.86 per share.

 

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The following table summarizes, on a pro forma as adjusted basis as of July 31, 2003, the total number of shares of our common stock purchased, the total consideration paid for these shares and the average price per share paid by existing stockholders and by new investors in this offering, calculated after deducting estimated underwriting discounts and offering expenses (in thousands):

 

     Shares Purchased

    Total Consideration

   

Average

Price
Per Share


     Number

   Percent

    Amount

   Percent

   

Existing stockholders

   18,867    82.5 %   $ 23,861    31.7 %   $ 1.26

New investors

   4,000    17.5       51,520    68.3       12.88
    
  

 

  

 

Total

   22,867    100.0 %   $ 75,381    100.0 %   $ 3.30
    
  

 

  

 

 

If the underwriters exercise their over-allotment option in full, sales in this offering will reduce the number of shares of common stock held by our existing stockholders to approximately 80.3% of the total shares of common stock outstanding after the offering and will increase the number of shares held by new investors to 4,622,500 shares, or approximately 19.7% of the total shares of common stock outstanding after the offering.

 

The above tables exclude 150,000 shares of common stock to be sold by the selling stockholder to new investors in this offering. In addition, the table includes 455,490 shares of treasury stock previously repurchased by us.

 

The above tables also assume no exercise of any outstanding stock options. As of July 31, 2003, there were options outstanding to purchase 1,223,890 shares of common stock at a weighted average exercise price of $8.31 per share. To the extent that any options that are outstanding or that will be issued in the future are exercised, purchasers of the common stock in this offering may incur further dilution. See “Capitalization” and “Management – Employee Equity Incentive Plans – Amended and Restated 2003 Incentive Stock Option Plan.”

 

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SELECTED CONSOLIDATED FINANCIAL DATA

 

The following restated summary consolidated financial data for the fiscal years ended July 31, 1998, 1999, 2000 and 2001, the six month period ended January 31, 2002, and the fiscal year ended January 31, 2003, are derived from our consolidated financial statements which have been audited by Ernst & Young LLP, independent auditors. The data should be read in conjunction with the consolidated financial statements, related notes and other financial information included herein. The summary consolidated financial data for the twelve month period ended January 31, 2002 and for the six month periods ended July 31, 2002 and 2003 are derived from unaudited financial statements. The unaudited financial statements include all adjustments, consisting of normal recurring accruals, which we consider necessary for a fair presentation of the financial position and the results of operations for these periods. Operating results for the six months ended July 31, 2003 are not necessarily indicative of the results that may be expected for the entire year ending January 31, 2004.

 

    Twelve Months Ended July 31,

   

Six Months

Ended

January 31,

2002


   

Twelve Months

Ended

January 31,


   

Six Months Ended

July 31,


 
    1998

    1999

    2000

    2001

      2002

    2003

    2002

    2003

 
    (dollars and shares in thousands, except per share amounts)  

Statement of Operations Data (1):

                                                                       

Net sales

  $ 194,412     $ 208,378     $ 249,077     $ 292,388     $ 182,611     $ 335,548     $ 389,496     $ 190,323     $ 209,441  

Finance charges and other

    10,877       26,114       27,856       34,869       24,285       42,977       56,477       27,741       28,476  
   


 


 


 


 


 


 


 


 


Total revenues

    205,289       234,492       276,933       327,257       206,896       378,525       445,973       218,064       237,917  

Operating expense:

                                                                       

Cost of goods sold, including warehousing and occupancy costs

    135,813       144,842       169,411       201,963       127,543       233,226       276,956       133,889       151,924  

Selling, general and administrative expense

    50,085       69,141       78,304       92,194       58,630       106,949       125,712       63,913       64,155  

Provision for bad debts

    —         —         793       1,734       1,286       2,406       4,125       1,487       2,188  
   


 


 


 


 


 


 


 


 


Total operating expense

    185,898       213,983       248,508       295,891       187,459       342,581       406,793       199,289       218,267  
   


 


 


 


 


 


 


 


 


Operating income

    19,391       20,509       28,425       31,366       19,437       35,944       39,180       18,775       19,650  

Interest expense, net

    2,622       6,024       4,836       3,754       2,940       4,855       7,237       3,125       3,216  
   


 


 


 


 


 


 


 


 


Earnings before income taxes

    16,769       14,485       23,589       27,612       16,497       31,089       31,943       15,650       16,434  

Provision for income taxes

    6,329       5,724       8,991       9,879       5,944       11,130       11,342       5,556       5,827  
   


 


 


 


 


 


 


 


 


Net income from continuing operations

    10,440       8,761       14,598       17,733       10,553       19,959       20,601       10,094       10,607  

Discontinued operations, net of tax

    17       224       30       (546 )     —         (389 )     —         —         —    
   


 


 


 


 


 


 


 


 


Net income

    10,457       8,985       14,628       17,187       10,553       19,570       20,601       10,094       10,607  

Less preferred stock dividends (2)

    (5 )     (1,857 )     (2,046 )     (2,173 )     (1,025 )     (1,939 )     (2,133 )     (1,067 )     (1,173 )
   


 


 


 


 


 


 


 


 


Net income available for common stockholders

  $ 10,452     $ 7,128     $ 12,582     $ 15,014     $ 9,528     $ 17,631     $ 18,468     $ 9,027     $ 9,434  
   


 


 


 


 


 


 


 


 


Earnings from continuing operations per share (3):

                                                                       

Basic

  $ 0.60     $ 0.39     $ 0.73     $ 0.91     $ 0.56     $ 1.06     $ 1.10     $ 0.54     $ 0.56  

Diluted

  $ 0.60     $ 0.39     $ 0.72     $ 0.90     $ 0.55     $ 1.04     $ 1.10     $ 0.54     $ 0.56  

Earnings per common share:

                                                                       

Basic

  $ 0.60     $ 0.41     $ 0.73     $ 0.87     $ 0.56     $ 1.03     $ 1.10     $ 0.54     $ 0.56  

Diluted

  $ 0.60     $ 0.41     $ 0.72     $ 0.87     $ 0.55     $ 1.01     $ 1.10     $ 0.54     $ 0.56  

Average common shares outstanding:

                                                                       

Basic

    17,368       17,489       17,350       17,169       17,025       17,060       16,724       16,728       16,720  

Diluted

    17,368       17,489       17,384       17,194       17,327       17,383       16,724       16,728       16,720  

Other Financial Data:

                                                                       

Stores open at end of period

    25       26       28       32       36       36       42       39       42  

Same store sales growth (4)

    9.7 %     13.6 %     8.9 %     10.3 %     16.7 %     15.6 %     1.3 %     6.8 %     (0.9 )%

Inventory turns (5)

    5.4       5.5       5.6       5.9       7.5       6.8       6.1       7.6       7.3  

Gross margin percentage (6)

    33.8 %     38.2 %     38.8 %     38.3 %     38.4 %     38.4 %     37.9 %     38.6 %     36.1 %

Operating margin (7)

    9.4 %     8.7 %     10.3 %     9.6 %     9.4 %     9.5 %     8.8 %     8.6 %     8.3 %

Return on average equity (8)

    34.7 %     40.2 %     42.8 %     36.7 %     35.9 %     34.9 %     28.3 %     29.9 %     23.9 %

Capital expenditures

  $ 6,344     $ 6,781     $ 6,920     $ 14,833     $ 10,551     $ 15,547     $ 15,070     $ 9,319     $ 2,364  

Balance Sheet Data:

                                                                       

Working capital

  $ 43,848     $ 46,100     $ 33,888     $ 40,752     $ 45,546     $ 45,546     $ 69,984     $ 50,570     $ 76,347  

Total assets

    109,113       123,152       116,075       134,425       145,644       145,644       181,558       171,778       190,005  

Total debt

    65,599       62,651       30,735       31,445       38,750       38,750       51,992       48,105       43,380  

Preferred stock

    18,632       18,632       18,520       15,400       15,226       15,226       15,226       15,226       15,226  

Total stockholders’ equity

    17,089       26,458       41,785       54,879       62,860       62,860       82,669       72,129       94,667  

 

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Table of Contents

(1)   Information excludes the operations of the rent-to-own division that we sold in February 2001.
(2)   Dividends were not actually declared or paid but are presented for purposes of earnings per common share calculations.
(3)   After reduction for preferred stock dividends.
(4)   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.
(5)   Inventory turns are defined as the cost of goods sold, excluding warehousing and occupancy cost, divided by the average of beginning and ending inventory; information for the six months ended January 31, 2002 and the six months ended July 31, 2002 and 2003 has been annualized for comparison purposes.
(6)   Gross margin percentage is defined as total revenues less cost of goods sold, including warehousing and occupancy cost, divided by total revenues.
(7)   Operating margin is defined as operating income divided by total revenues.
(8)   Return on average equity is calculated as current period net income from continuing operations divided by the average of beginning and ending equity; information for the six months ended January 31, 2002 and the six months ended July 31, 2002 and 2003 has been annualized for comparison purposes.

 

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PRO FORMA STATEMENTS OF OPERATIONS

 

The following pro forma statements of operations for our fiscal year ended January 31, 2003 and the six months ended July 31, 2003 give effect to a) the preferred stock that will be converted to common stock after the closing of the offering; and b) the use of proceeds to repay debt and redeem stock. Debt repaid was outstanding for the entire period covered by the pro forma statements of operations that follow. The adjustments reflected below are presented as though each event took place as of February 1, 2002 and all preferred stockholders except Thomas J. Frank, Sr., Stephens Group, Inc., Stephens Inc. and the SGI Affiliates elected to receive cash in the aggregate amount of $1.7 million for their preferred stock.

 

     Year Ended January 31, 2003

    Six Months Ended July 31, 2003

 
     Actual

    Pro forma
Adjustments


    Pro forma
As Adjusted


    Actual

    Pro forma
Adjustments


    Pro forma
As Adjusted


 
     (dollars in thousands, except per share amounts)  

Revenues

                                                

Product sales

   $ 347,879             $ 347,879     $ 188,477             $ 188,477  

Service maintenance agreement commissions (net)

     22,961               22,961       11,588               11,588  

Service revenues

     18,656               18,656       9,376               9,376  
    


 


 


 


 


 


Total net sales

     389,496       —         389,496       209,441       —         209,441  

Finance charges and other

     56,477               56,477       28,476               28,476  
    


 


 


 


 


 


Total revenues

     445,973       —         445,973       237,917       —         237,917  

Cost and expenses

                                                

Cost of goods sold, including warehousing and occupancy costs

     272,559               272,559       149,674               149,674  

Cost of service parts sold, including warehousing and occupancy costs

     4,397               4,397       2,250               2,250  

Selling, general and administrative expense

     125,712               125,712       64,154               64,155  

Provision for bad debts

     4,125               4,125       2,188               2,188  
    


 


 


 


 


 


Total cost and expenses

     406,793       —         406,793       218,267       —         218,267  
    


 


 


 


 


 


Operating income

     39,180       —         39,180       19,650       —         19,650  

Interest expense

     7,237       (1,570 )(1)     5,667       3,216       (785 )(1)     2,431  
    


 


 


 


 


 


Earnings before income taxes

     31,943       1,570       33,513       16,434       785       17,219  

Provision for income taxes

                                                

Current

     (13,207 )     (565 )(2)     (13,772 )     (5,300 )     (283 )(2)     (5,583 )

Deferred

     1,865               1,865       (527 )             (527 )
    


 


 


 


 


 


Total provision for income taxes

     (11,342 )     (565 )     (11,907 )     (5,827 )     (283 )     (6,110 )
    


 


 


 


 


 


Net income

     20,601       1,005       21,606       10,607       502       11,109  

Less preferred dividends

     (2,133 )     2,133  (3)     —         (1,173 )     1,173  (3)     —    
    


 


 


 


 


 


Net income available for common stockholders

   $ 18,468     $ 3,138     $ 21,606     $ 9,434     $ 1,675     $ 11,109  
    


 


 


 


 


 


Earnings per share

                                                

Basic

   $ 1.10             $ 1.02     $ 0.56             $ 0.53  

Diluted

   $ 1.10             $ 1.02     $ 0.56             $ 0.53  

Average common shares outstanding

                                                

Basic

     16,724       4,400  (4)     21,124       16,720       4,400  (4)     21,120  

Diluted

     16,724       4,400  (4)     21,124       16,720       4,400  (4)     21,120  

 

See notes to pro forma financial statements.

 

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Table of Contents

(1)    Interest expense has been adjusted to reflect the reduction in interest expense as a result of the application of the estimated net proceeds of the offering to repay debt. A summary of the interest expense adjustment is as follows:

 

          Year Ended
January 31,
2003


    Six Months
Ended
July 31,
2003


 

Total interest reported

          $ 7,237     $ 3,216  
           


 


Amount of debt retired

          $ 34,880     $ 34,880  

Current interest rate

            4.5 %     4.5 %
           


 


Interest savings

            1,570       785  
           


 


Adjusted interest expense

          $ 5,667     $ 2,431  
           


 


(2)    Tax effect of interest adjustment at 36%.

                       

(3)    Preferred dividends are removed since the value of the preferred stock has been redeemed for cash or common stock.

                       

(4)    Redemption of preferred stock:

                       

Total preferred shares to be redeemed for common stock

     163                 

Per share value of preferred stock at November 30, 2003

   $ 145.55                 

Total value of preferred shares to be converted

   $ 23,689                 

Assumed initial public offering price

   $ 14.00                 

Number of common shares to be issued upon redemption

            1,692       1,692  

Debt retirement:

                       

Debt to be retired

   $ 34,880                 

Price per share:

                       

Proceeds, net of expenses

   $ 51,520                 

Number of shares sold

     4,000                 
    

                

Net price/share

   $ 12.88                 

Number of common share equivalents

            2,708       2,708  
           


 


Total share adjustment

            4,400       4,400  
           


 


 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

 

You should read the following discussion and analysis in conjunction with the consolidated financial statements and related notes included elsewhere in this prospectus. The information in this section contains forward-looking statements. Our actual results may differ significantly from the results suggested by these forward-looking statements. Some factors that may cause our results to differ from these statements are described below under “Application of Critical Accounting Policies” and in the “Risk Factors” section of this prospectus.

 

General

 

Our consolidated financial statements and related notes comprise over 30 pages. The following discussion and analysis is intended to provide you with a more insightful understanding of our financial condition and performance in the indicated periods, including an analysis of those key factors that contributed to our financial condition and performance and that are, or are expected to be, the key “drivers” of our business.

 

We are a specialty retailer 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, VCRs, DVD players and home theater products. We also sell home office equipment, lawn and garden products and bedding, and we continue to introduce additional product categories for the home to help increase same store sales and to respond to our customers’ product needs. We currently operate 45 retail locations in Texas and Louisiana.

 

Unlike many of our competitors, we provide in-house credit options for our customers. Historically, we have financed over 56% of our retail sales. We finance substantially all of our customer receivables through an asset-backed securitization facility, and we derive servicing fee income and interest income from these assets. See “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. We transfer receivables, consisting of retail installment contracts and revolving accounts extended to our customers, to the issuer in exchange for cash and subordinated securities. To finance its acquisition of these receivables, the issuer has issued notes to third parties.

 

We also derive revenues from repair services on the products we sell and from product delivery and installation services we provide to our customers. Additionally, acting as an agent for unaffiliated companies, we sell credit insurance to protect our customers from credit losses due to death, disability, involuntary unemployment and property damage.

 

During fiscal 2001, we sold the operations of our rent-to-own business. As a result of this sale, we restated our statements of operations for fiscal 2000 to reflect results of the rent-to-own division as discontinued operations.

 

Outlook

 

An explanation of the changes in our operations for the six months ended July 31, 2003 as compared to the six months ended July 31, 2002 is included beginning on page 31. As explained in that section, our pretax income for the six months ended July 31, 2003 increased approximately $0.8 million as a result of higher revenues and lower selling, general and administrative expenses as a percentage of revenues. These improvements in our operations were offset by a decline in retail product gross margins, a decline in the percentage of credit financed transactions, the conversion of $200.0 million of our asset-backed securitization facility from variable interest rates to higher fixed interest rates and several unusual charges or adjustments that negatively impacted our operations. These changes and adjustments included revision of previous estimates

 

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relative to non-cash revenue adjustments of approximately $0.6 million, one-time expenditures of approximately $0.7 million associated with a change in the methodology for calculating sales commissions and $0.3 million associated with the settlement of a dispute with a former shareholder.

 

After reviewing our performance for the six months ended July 31, 2003, we implemented several initiatives that we believe will help improve our future operating results, which include:

 

    using our direct mail marketing campaign as a single promotional activity rather than combining it with other promotional programs, which we believe will reduce the amount of the price discounts that are required in order to influence our customers’ purchasing decisions;

 

    identifying specific demographic make-up within a given U.S. Postal Service carrier route for our direct mail campaigns, which we believe will allow us to obtain better penetration rates for our promotional campaigns;

 

    communicating to our sales personnel an authorized credit limit in excess of the credit needed to complete a specific transaction for qualified customers, which we believe allows our sales personnel to make “add-on” sales;

 

    developing a new strategy for the merchandising of our track products, including separate merchandising plans and displays, separate sales and managerial personnel, convenient check-out procedures and diversified inventory, which we believe will increase sales within the track area, but which may decrease our gross product margin;

 

    reformatting our existing display space to provide additional footage to promote lawn and garden products since our stores are in a geographic area that is conducive to year-around use of these products; and

 

    implementing certain cost reduction measures that have reduced support, warehouse and delivery and service costs.

 

In addition, we believe our results for the second half of fiscal 2004 and fiscal 2005 will be positively impacted by the following:

 

    a modification of our sales commission plan, which we believe has further aligned our sales personnel compensation with our overall sales objectives;

 

    an increase in same store sales from the new stores opened in late 2002;

 

    an increase in overall retail sales from our expansion into the Dallas/Fort Worth market in September and October of fiscal 2004 and a higher penetration of credit sales at these new stores based on our strategic site-selection process and our planned direct marketing program in this market;

 

    a significant reduction in our total interest expense due to the use of proceeds from this offering to repay debt and the expiration of $50.0 million in interest rate swap contracts, assuming interest rates do not increase significantly prior to such expiration; and

 

    the introduction of a replacement service maintenance agreement, which we believe will encourage customers to purchase replacement coverage on smaller ticket items.

 

The consumer electronics industry depends on new products to drive same store sales increases. Typically, these new products, such as digital televisions and DVD players, are introduced at relatively high price points which are then gradually reduced as the product becomes more mainstream. To maintain positive same store sales growth, unit sales must increase at a rate greater than the decline in product prices. The affordability of the product helps the unit sales growth. However, as a result of relatively short product life cycles in the consumer electronics industry, which limit the amount of time available for sales 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 expect this trend to continue.

 

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Application of Critical Accounting Policies

 

In applying the accounting policies that we use to prepare our consolidated financial statements, we necessarily make accounting estimates that affect our reported amounts of assets, liabilities, revenues and expenses. Some of these accounting estimates require us to make assumptions about matters that are highly uncertain at the time we make the accounting estimates. We base these assumptions and the resulting estimates on authoritative pronouncements, historical information and other factors that we believe to be reasonable under the circumstances, and we evaluate these assumptions and estimates on an ongoing basis. We could reasonably use different accounting estimates, and changes in our accounting estimates could occur from period to period, with the result in each case being a material change in the financial statement presentation of our financial condition or results of operations. We refer to accounting estimates of this type as “critical accounting estimates.” We believe that the critical accounting estimates discussed below are among those most important to an understanding of our consolidated financial statements as of July 31, 2003.

 

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. The gain or loss recognized on these transactions is based on our best estimates of key assumptions, including forecasted credit losses, payment rates, forward yield curves, costs of servicing the accounts and appropriate discount rates. The use of different estimates or assumptions could produce different financial results. For example, if we had assumed a 10.0% reduction in net interest spread (which might be caused by rising interest rates), our interest in securitized assets would have been reduced by $2.8 million as of July 31, 2003, 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. This income is recorded as “Finance Charges and Other” in our consolidated statement of operations.

 

Deferred Tax Assets.    We have significant net deferred tax assets (approximately $7.7 million as of July 31, 2003), 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 future earnings would have been negative rather than positive, we would have adjusted the net deferred tax asset account downward to zero, which would have reduced net income by the amount of the deferred tax asset.

 

Intangible Assets.    We have significant intangible assets related primarily to goodwill and the costs of obtaining various loans and funding sources. The determination of related estimated useful lives and whether or not these assets are impaired involves significant judgments. Effective August 1, 2002, we adopted the provisions of SFAS No. 142, Goodwill and Other Intangible Assets. Prior to adoption of SFAS 142, we amortized goodwill over an estimated life of fifteen years on a straight-line basis. 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 July 31, 2003 was $7.9 million.

 

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

 

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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, at the time that they are earned. Where 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 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 Emerging Issues Task Force No. 00-21, Revenue Arrangements with Multiple Deliverables. The amounts of service maintenance agreement revenue deferred at January 31, 2002 and 2003 were $2.8 million and $3.8 million, respectively, and are included in “Deferred revenue” in the accompanying balance sheets.

 

Vendor Allowances.    We receive funds from vendors for price protection, product rebates, marketing and training and promotion programs which are recorded on the accrual basis as a reduction to the related product cost or advertising expense according to the nature of the program. We accrue rebates based on the satisfaction of terms of the program and sales of qualifying products even though funds may not be received until the end of a quarter or year. If the programs are related to product purchases, the allowances, credits or payments are recorded as a reduction of product cost; if the programs are related to promotion or marketing of the product, the allowances, credits, or payments are recorded as a reduction of advertising expense in the period in which the expense is incurred.

 

Results of Operations

 

The following table sets forth certain statement of operations information, excluding discontinued operations, as a percentage of total revenues for the periods indicated.

 

    Years Ended
July 31,


   

Six Months Ended

January 31,


   

Twelve
Months

Ended
January 31,
2002


   

Year
Ended

January 31,
2003


   

Six Months Ended

July 31,


 
    2000

    2001

    2001

    2002

        2002

    2003

 
    Restated     Restated     (Unaudited)     Restated     (Unaudited)     Restated     (Unaudited)     (Unaudited)  

Revenues:

                                               

Product sales

  79.2 %   79.4 %   80.0 %   78.7 %   78.8 %   78.0 %   77.5 %   79.2 %

Service maintenance agreement commissions (net)

  5.9     5.7     5.4     5.8     5.9     5.1     5.5     4.9  

Service revenues

  4.8     4.2     4.4     3.8     3.9     4.2     4.3     3.9  
   

 

 

 

 

 

 

 

Total net sales

  89.9     89.3     89.8     88.3     88.6     87.3     87.3     88.0  

Finance charges and other

  10.1     10.2     10.2     11.7     11.4     12.7     12.7     12.0  
   

 

 

 

 

 

 

 

Total revenues

  100.0     100.0     100.0     100.0     100.0     100.0     100.0     100.0  

Cost and expenses:

                                               

Cost of goods sold, including warehousing and occupancy costs

  60.1     60.8     60.8     60.7     60.7     61.1     60.5     62.9  

Cost of parts sold, including warehousing and occupancy costs

  1.1     1.0     1.0     1.0     1.0     1.0     0.9     0.9  

Selling, general and administrative expense

  28.3     28.2     28.3     28.3     28.3     28.2     29.3     27.0  

Provision for bad debts

  0.3     0.5     0.4     0.6     0.6     0.9     0.7     0.9  
   

 

 

 

 

 

 

 

Total costs and expenses

  89.7     90.4     90.4     90.6     90.5     91.2     91.4     91.7  
   

 

 

 

 

 

 

 

Operating income

  10.3     9.6     9.6     9.4     9.5     8.8     8.6     8.3  

Interest expense

  1.7     1.1     1.2     1.4     1.3     1.6     1.4     1.4  
   

 

 

 

 

 

 

 

Earnings from continuing operations before income taxes

  8.5     8.4     8.4     8.0     8.2     7.2     7.2     6.9  

Provision for income taxes

                                               

Current

  (3.5 )   (3.5 )   (3.1 )   (3.3 )   (3.4 )   (3.0 )   (3.0 )   (2.2 )

Deferred

  0.2     0.5     0.1     0.4     0.5     0.4     0.5     (0.2 )
   

 

 

 

 

 

 

 

Total provision for income taxes

  (3.2 )   (3.0 )   (3.0 )   (2.9 )   (2.9 )   (2.5 )   (2.5 )   (2.4 )
   

 

 

 

 

 

 

 

Net income from continuing operations

  5.3 %   5.4 %   5.4 %   5.1 %   5.3 %   4.6 %   4.6 %   4.5 %
   

 

 

 

 

 

 

 

 

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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.

 

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, in selling, general and administrative expense. It is our understanding that other retailers may include such costs as part of cost of goods sold.

 

Six Months Ended July 31, 2002 (Unaudited), Compared to the Six Months Ended July 31, 2003 (Unaudited)

 

Revenues.    Total revenues increased by $19.8 million, or 9.1%, from $218.1 million for the six months ended July 31, 2002, to $237.9 million for the six months ended July 31, 2003. The increase was attributable to increases of $19.1 million, or 10.1%, in net sales and $0.7 million, or 2.5%, in finance charges and other revenues. Of the $19.1 million increase in net sales, $19.9 million was generated by six retail locations that were not open for six consecutive months in both periods. However, same store sales decreased $1.6 million, or 0.9%, for those stores that were open all six months in both periods. Increases in delivery and installation charges of $0.8 million accounted for the balance of the net sales increase. The change in net sales was primarily due to increased unit volume of sales representing an increase of approximately $51.4 million in sales that were offset by deteriorating price points that represent a decrease in sales of approximately $32.3 million. The addition of a second line of computers, increased sales of our bedding and lawn and garden product lines and a significant increase in projection television sales accounted for much of the increased unit volume of sales.

 

We believe that at least a portion of the decrease in same store sales was the result of a temporary negative impact on our existing stores caused by opening new stores in existing markets. For example, after opening our Sugarland store in the Houston market in January 2003, retail sales in the market increased by 3.3% during the six months ended July 31, 2003 compared to the 2002 period, but our same store sales for the existing 16 stores in this market that were open for a full six months in both periods decreased by 1.8%. Likewise, our San Antonio/Austin market experienced a 23.6% total increase in retail sales as we opened four new stores in the area while our same store sales for our nine existing stores in this market were flat compared to the 2002 period. In addition, in an effort to reduce our delinquency rates, we increased down payment and verification requirements on certain of our credit accounts, which led to lower approval rates, and we modified the selection criteria for our direct mail program, which resulted in fewer credit applications being processed as a percentage of sales. We have since modified our down payment requirements and the selection criteria for our direct mail program to previous levels, which we believe will increase our credit penetration while maintaining our historical delinquency and charge-off rates.

 

As reflected in the table below, product sales and net sales are increasing at a slower rate than they did in the past. This slowing trend results primarily from a decline in same store sales within the last 18 months, indicating that some of our stores may be reaching maturity as it relates to market penetration. However, we believe that we have positioned many of our stores to have a potential for additional same store sales increases by remerchandising our product offerings, training sales personnel to increase closing rates, regularly updating our stores, continuing to emphasize a high level of customer service and developing our track area; we do expect that much of our future sales increases will continue to come both from existing stores and new stores.

 

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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 percentage of total net sales.

 

     Six Months Ended July 31,

   

Percent

Increase

(Decrease)


 
     2002

    2003

   
     Amount

   %

    Amount

   %

   
     (dollars in thousands)        

Major home appliances

   $ 76,728    40.3 %   $ 82,848    39.6 %   8.0 %

Consumer electronics

     66,949    35.2       76,112    36.3     13.7  

Home office equipment

     12,256    6.4       12,236    5.8     (0.2 )(1)

Delivery and installation

     3,110    1.6       3,916    1.9     25.9  (2) 

Other (including lawn and garden and bedding)

     9,993    5.3       13,365    6.4     33.7  (3)
    

  

 

  

 

Total product sales

     169,036    88.8       188,477    90.0     11.5  %

Service maintenance agreement commissions

     11,937    6.3       11,588    5.5     (2.9 )(4)

Service revenues

     9,350    4.9       9,376    4.5     0.3  (5)
    

  

 

  

 

Total net sales

   $ 190,323    100.0 %   $ 209,441    100.0 %   10.0 %
    

  

 

  

 


(1)   The decrease in net sales of home office equipment was due to deteriorating price points which are expected to continue in this category.
(2)   The increase in delivery and installation revenues reflects growth in appliance and electronic sales and a price increase for delivery and installation charges.
(3)   The increase in other sales was due primarily to increasing maturity of the lawn and garden and bedding product lines that were added in early fiscal 2000. Increases in sales of these products are expected to continue, but at a decreasing rate.
(4)   The decrease in service maintenance agreement commissions reflects the impact of deteriorating price points for and increases in consumer confidence in consumer electronic items; many price points for computers and projection televisions have deteriorated to the point where consumers are willing to risk replacement of the product rather than purchase the service maintenance agreement. In addition, our new sales compensation program de-emphasizes the sale of service maintenance agreements.
(5)   The relatively small increase in service revenues is attributable to a more stringent review of billings made to manufacturers for covered warranty services. As a result of these billing reviews, service revenues for the six months ended July 31, 2003 were somewhat softened; however, retrospective settlements that are included in the line item entitled “Finance charges and other” were positively impacted by approximately $0.7 million during this period.

 

Revenue from finance charges and other increased by approximately $0.7 million, or 2.5%, from $27.8 million for the six months ended July 31, 2002, to $28.5 million for the six months ended July 31, 2003. This increase in revenue resulted from an increase in securitization income and other of $1.4 million which was offset by a $0.7 million decrease in insurance commissions. Additionally, during the 2003 period, we replaced a number of manual functions associated with the processing of non-cash revenue adjustments in our credit control group with an auto-post function. While we were able to reduce personnel costs associated with this function, we experienced a one-time revenue decrease of approximately $0.6 million as we converted estimates to actual adjustments. Had we not incurred this revenue adjustment, our percentage increase in finance charges and other would have been 4.7%.

 

Cost of Goods Sold.    Cost of goods sold, including warehousing and occupancy cost, increased by $18.0 million, or 13.5%, from $133.9 million for the six months ended July 31, 2002, to $151.9 million for the six months ended July 31, 2003. This increase primarily resulted from the 10.1% net sales increase as well as an increase in cost of retail products sold as a percentage of net product sales from 78.0% in the 2002 period to 79.4% in the 2003 period. The overall increase in cost of goods sold as a percentage of net sales was primarily

 

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caused by the continued deterioration of retail price points and margins for consumer electronics products, over-discounting in connection with the promotion of products for store grand openings in February and March 2003, and sales of relatively lower margin lawn and garden and computer products growing at a more rapid rate than sales of higher margin home appliance products.

 

Selling, General and Administrative Expenses.    Selling, general and administrative expenses increased by $0.3 million, or 0.4%, from $63.9 million for the six months ended July 31, 2002, to $64.2 million for the six months ended July 31, 2003. This increase was considerably less than the 9.1% increase in total revenues as we began to focus on cost reductions, including salaries and payroll related costs, advertising and telephone expenses. These cost reductions were partially offset by one-time expenditures of approximately $0.6 million associated with a change in methodology of calculating commissions for sales personnel and $0.3 million for the settlement of a dispute with a former shareholder.

 

Provision for Bad Debts.    The provision for bad debts increased by $0.7 million, or 47.1%, from $1.5 million for the six months ended July 31, 2002, to $2.2 million for the six months ended July 31, 2003. The increase in the bad debt provision resulted from a change in eligibility requirements under the new asset securitization program that we implemented in September 2002, which resulted in our retaining a larger amount of receivables that had become ineligible for transfer to the QSPE, as well as an increase in charge-offs associated with our credit insurance and service programs. While this increase was substantial in percentage terms, we believe that this increase does not necessarily represent a trend. Since most of the higher risk receivables have now been retained by us as a result of the modifications that were made to eligibility requirements for account transfer to the QSPE in September 2002, we believe that bad debt expense percentage increases will begin to decline in the future.

 

Interest Expense.    Interest expense increased by $0.1 million, or 2.9%, from $3.1 million for the six months ended July 31, 2002, to $3.2 million for the six months ended July 31, 2003. The increase was attributable to the following:

 

    increasing interest rates accounted for an increase of approximately $0.1 million in our interest expense;

 

    average outstanding debt increased from $45.0 million in the 2002 period to $48.7 million in the 2003 period, which resulted in an increase in interest expense of $0.1 million; and

 

    the expiration of $30.0 million in our interest rate hedges resulted in a decrease of $0.1 million over the 2002 period.

 

Provision for Income Taxes.    The provision for income taxes increased by $0.3 million, or 4.9%, from $5.6 million for the six months ended July 31, 2002, to $5.9 million for the six months ended July 31, 2003. The increase in the tax provision was directly related to the increase in pretax profits of $0.8 million, or 5.0%. The effective tax rate for the two periods was consistent at 35.5%.

 

Net Income.    As a result of the above factors, net income increased by $0.5 million, or 5.1%, from $10.1 million for the six months ended July 31, 2002, to $10.6 million for the six months ended July 31, 2003.

 

Twelve Months Ended January 31, 2002 (Unaudited), Compared to Fiscal Year Ended January 31, 2003

 

Revenues.    Total revenues increased by $67.5 million, or 17.8%, from $378.5 million for the twelve months ended January 31, 2002, to $446.0 million for the fiscal year ended January 31, 2003. The increase was attributable to increases of $53.9 million, or 16.1%, in net sales and $13.5 million, or 31.4%, in finance charges and other revenues. Of the $53.9 million increase in net sales, $46.9 million was generated by 11 retail locations that were not open for 12 consecutive months in both periods, $3.9 million resulted from a same store sales increase of 1.3%, $1.1 million resulted from increases in delivery and installation revenue, and $2.0 million resulted from increases in other revenue sources. The increase in net sales was due to increased unit volume of

 

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sales of approximately $69.4 million offset by deteriorating price points of approximately $15.5 million. The addition of a second line of computers, increased sales of our bedding and lawn and garden product lines and a significant increase in projection television sales accounted for much of the increased unit volume of sales and the same store sales increase.

 

We believe that at least a portion of the relatively small same store sales increase during fiscal 2003 resulted from our opening of four new stores in the San Antonio/Austin market. While net sales in this market increased by 40.2% during fiscal 2003 compared to the 2002 period, same store sales for the five existing stores in this market that were open for a full twelve months in both periods decreased by 1.1%. We have experienced a temporary negative impact on our existing stores when we have opened new stores in existing markets. Other factors that contributed to the relatively small increase in same store sales in fiscal 2003 included higher than normal sales in the 2002 period due to the increase in product sales during the three months following the September 11th attacks and the major replacement of products following major flooding in the Houston market in June 2001. These events that increased sales in fiscal 2002 did not occur in fiscal 2003. We do, however, believe that many of our stores may be reaching maturity levels as it relates to market penetration and that same store sales will likely increase at much smaller percentages than in the past. While we believe that we have positioned many of our stores to have a potential for additional same store sales increases, we do expect that much of our future sales increases will come from new stores rather than from substantial increases in sales from existing stores.

 

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 percentage of total net sales.

 

    

Twelve Months

Ended

January 31, 2002


   

Fiscal Year

Ended

January 31, 2003


   

Percent

Increase


 
     Amount

   %

    Amount

   %

   
     (dollars in thousands)        

Major home appliances

   $ 127,781    38.1 %   $ 147,605    37.9 %   15.5 %

Consumer electronics

     131,716    39.3       155,623    40.0     18.2  

Home office equipment

     24,816    7.4       25,865    6.6     4.2 (1)

Delivery and installation

     5,510    1.6       6,436    1.6     16.8  

Other (including lawn and garden and bedding)

     8,521    2.5       12,350    3.2     44.9 (2)
    

  

 

  

 

Total product sales

     298,344    88.9       347,879    89.3     16.6  

Service maintenance agreement commissions

     22,282    6.6       22,961    5.9     3.0 (3)

Service revenues

     14,922    4.5       18,656    4.8     25.0  
    

  

 

  

 

Total net sales

   $ 335,548    100.0 %   $ 389,496    100.0 %   16.1 %
    

  

 

  

 


(1)   The relatively small increase in home office equipment was due to deteriorating price points which are expected to continue in this category.
(2)   The increase in other sales was due primarily to the increasing maturity of the lawn and garden and bedding product lines that were added in early fiscal year 2000. Increases are expected to continue, but at a decreasing rate.
(3)   The relatively small increase in service maintenance agreement commissions reflects the impact of deteriorating price points of consumer electronic items and increased consumer confidence in newer products, which has resulted in fewer customers purchasing extended service maintenance agreements.

 

Revenue from finance charges and other increased approximately $13.5 million, or 31.4%, from $43.0 million for the twelve months ended January 31, 2002, to $56.5 million for the twelve months ended January 31, 2003. This increase in revenue resulted from increases in net insurance commissions and other of $3.5 million, or 26.8%. Income from sales of receivables to the QSPE increased approximately $10.0 million, or 33.5%, resulting

 

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primarily from a 15.9% growth in the credit portfolio and lower credit losses as a percentage of the average outstanding portfolio balance.

 

Cost of Goods Sold.    Cost of goods sold, including warehousing and occupancy cost, increased by $43.8 million, or 18.8%, from $233.2 million for the twelve months ended January 31, 2002, to $277.0 million for fiscal 2003. This percentage increase was generally consistent with the 16.1% net sales increase, although cost of goods sold continued to increase as a percentage of net product sales from 77.0% in the 2002 period to 78.3% in fiscal 2003. The overall increase in cost of goods sold as a percentage of net sales was primarily caused by the continued deterioration of retail price points for consumer electronics products and sales of relatively lower margin lawn and garden and computer products growing at a more rapid rate than higher margin home appliance products. Labor and other cost increases added $1.0 million to cost of goods sold in fiscal 2003, and the expansion of our San Antonio distribution facility added approximately $0.5 million to occupancy costs in fiscal 2003.

 

Selling, General and Administrative Expenses.    Selling, general and administrative expenses increased by $18.8 million, or 17.5%, from $106.9 million for the twelve months ended January 31, 2002, to $125.7 million for fiscal 2003. This percentage increase was generally consistent with the 17.8% increase in total revenues.

 

Provision for Bad Debts.    The provision for bad debts increased by $1.7 million, or 71.4%, from $2.4 million for the twelve months ended January 31, 2002, to $4.1 million for fiscal 2003. The increase in the bad debt provision resulted from a change in eligibility requirements under the new asset securitization program that we implemented in September 2002, which resulted in our retaining a larger amount of receivables that had become ineligible for transfer to the QSPE, as well as an increase in charge-offs associated with our credit insurance and service programs.

 

Interest Expense.    Interest expense increased by $2.4 million, or 49.1%, from $4.9 million for the twelve months ended January 31, 2002, to $7.3 million for fiscal 2003. The increase was attributable to the following:

 

    declining interest rates caused the net payments on our interest rate hedges to increase by $1.9 million over the 2002 period;

 

    imperfect matching of interest rate hedges and hedged obligations resulted in an increase in interest expense of $0.5 million;

 

    average outstanding debt increased from $33.5 million in the 2002 period to $49.0 million in fiscal 2003, which resulted in an increase in interest expense of $1.0 million; and

 

    declining interest rates accounted for a decrease of approximately $1.0 million in our interest expense.

 

Provision for Income Taxes.    The provision for income taxes increased by $0.2 million, or 1.9%, from $11.1 million for the twelve months ended January 31, 2002, to $11.3 million for fiscal 2003. The increase was directly related to the increase in pretax profits of $0.8 million, or 2.7%, and a decrease in state taxes paid. The effective tax rates for the two periods, which were 35.8% in the 2002 period and 35.5% in fiscal 2003, were relatively consistent, except for the decrease in the state tax rate.

 

Net Income.    As a result of the above factors, net income increased by $0.6 million, or 3.2%, from $20.0 million for the twelve months ended January 31, 2002, to $20.6 million for fiscal 2003.

 

Six Months Ended January 31, 2001 (Unaudited), Compared to Six Month Fiscal Period Ended January 31, 2002

 

Revenues.    Total revenues increased by $51.6 million, or 33.2%, from $155.3 million for the six months ended January 31, 2001, to $206.9 million for the six months ended January 31, 2002. The increase was attributable to increases of $43.2 million, or 31.0%, in net sales and $8.4 million, or 53.2%, in finance charges

 

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and other revenues. Of the $43.2 million increase in net sales, $22.4 million resulted from a same store sales increase of 16.7%, $20.3 million was generated by eight retail locations that were not open for six consecutive months in both periods, $0.4 million resulted from changes in delivery and installation revenue and $0.1 million resulted from increases in other revenue sources. As in fiscal 2003, the increase in net sales was due to increased unit volume of sales of approximately $42.2 million offset by deteriorating price points of approximately $2.9 million as we continued to experience relatively short product life cycles and significant price erosion in the consumer electronics category. The addition of a second line of computers, increased sales of our bedding and lawn and garden products lines and a significant increase in projection television sales, combined with the higher than normal sales during the three months following the September 11th attacks and the major replacement of products following major flooding in the Houston market in June 2001, accounted for much of the increase in same store sales.

 

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 percentage of total net sales.

 

     Six Months Ended January 31,

   

Percent

Increase


 
     2001

    2002

   
     Amount

   %

    Amount

   %

   
     (dollars in thousands)        

Major home appliances

   $ 49,669    35.6 %   $ 63,907    35.0 %   28.7 %

Consumer electronics

     56,110    40.2       75,355    41.2     34.3  

Home office equipment

     13,617    9.8       16,523    9.0     21.3  

Delivery and installation

     2,860    2.1       3,238    1.8     13.2  

Other (including lawn and garden and bedding)

     1,296    0.9       3,762    2.1     190.3 (1)
    

  

 

  

 

Total product sales

     123,552    88.6       162,785    89.1     31.8  

Service maintenance agreement commissions

     9,118    6.5       11,922    6.5     30.8  

Service revenues

     6,781    4.9       7,904    4.4     16.6  
    

  

 

  

 

Total net sales

   $ 139,451    100.0 %   $ 182,611    100.0 %   31.0 %
    

  

 

  

 


(1)   The increase in other sales was due primarily to the increasing maturity of the lawn and garden and bedding product lines that were added in early fiscal 2000. Future increases in these product lines are expected to continue, but at a decreasing rate.

 

Revenue from finance charges and other increased by $8.4 million, or 53.2%, from $15.8 million for the six months ended January 31, 2001, to $24.3 million for the six months ended January 31, 2002. This increase in revenue resulted primarily from an increase in income from sales of receivables to the QSPE of $6.7 million, or 66.0%, due primarily to a 21.9% increase in the credit portfolio and lower interest costs of securities issued by the QSPE. An increase in net insurance commissions and other totaling $1.7 million, or 32.7%, also contributed to the increase in revenues from finance charges and other.

 

Cost of Goods Sold.    Cost of goods sold, including warehousing and occupancy cost, increased by $31.6 million, or 33.0%, from $95.9 million for the six months ended January 31, 2001, to $127.5 million for the six months ended January 31, 2002. The 33.0% increase was generally consistent with the 31.0% net sales increase, although costs of retail products sold continued to increase as a percentage of net product sales from 76.4% in the 2001 period to 77.1% in the 2002 period. Sales of relatively lower margin consumer electronics and computer products continuing to grow at a more rapid rate than sales of relatively higher margin home appliance products was the primary reason for the increase in cost of goods sold as a percentage of net sales. Labor and other cost increases added $0.8 million to cost of goods sold in the 2002 period, and the expansion of our San Antonio distribution facility added approximately $0.2 million to occupancy costs in the 2002 period.

 

Selling, General and Administrative Expenses.    Selling, general and administrative expenses increased by $14.7 million, or 33.6%, from $43.9 million for the six months ended January 31, 2001, to $58.6 million for the

 

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six months ended January 31, 2002. This increase was generally consistent with the 33.2% increase in total revenues.

 

Provision for Bad Debts.    The provision for bad debts increased by $0.7 million, or 109.2%, from $0.6 million for the six months ended January 31, 2001, to $1.3 million for the six months ended January 31, 2002. The increase in bad debts resulted from an increase in the charge-offs associated with our credit insurance and service programs.

 

Interest Expense.    Interest expense increased by $1.1 million, or 59.8%, from $1.8 million for the six months ended January 31, 2001, to $2.9 million for the six months ended January 31, 2002. The increase was attributable to the following:

 

    declining interest rates caused the net payments on our interest rate hedges to increase by $1.9 million over the 2001 period;

 

    declining interest rates accounted for a reduction of approximately $0.5 million in interest expense; and

 

    our adoption of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, resulted in a decrease in interest expense of $0.3 million due to the recognition of the impact of imperfect matching of interest rate hedges and hedged obligations.

 

Provision for Income Taxes.    The provision for income taxes increased by $1.3 million, or 28.3%, from $4.6 million for the six months ended January 31, 2001, to $5.9 million for the six months ended January 31, 2002. The increase was directly related to the increase in pretax profits of $3.5 million, or 26.4%. The effective tax rates for the two periods were 35.5% in the 2001 period and 36.0% in the 2002 period.

 

Net Income from Continuing Operations.    As a result in the above factors, net income from continuing operations increased by $2.2 million, or 25.4%, from $8.4 million for the six months ended January 31, 2001, to $10.6 million for the six months ended January 31, 2002.

 

Fiscal Year Ended July 31, 2000, Compared to Fiscal Year Ended July 31, 2001

 

Revenues.    Total revenues increased by $50.3 million, or 18.2%, from $277.0 million in fiscal 2000 to $327.3 million in fiscal 2001. The increase was attributable to increases of $43.3 million, or 17.4%, in net sales and $7.0 million, or 25.2%, in finance charges and other revenues. Of the $43.3 million increase in net sales, $22.7 million resulted from a same store sales increase of 10.3%, $21.8 million was generated by eight retail locations that were not open for 12 consecutive months in both fiscal years and $0.9 million resulted from increases in delivery and installation revenue, offset by decreases of $2.1 in other revenue sources. As in prior periods, the increase in net sales was due to increased unit volume of sales of approximately $39.2 million and approximately $1.3 million from higher per unit price points. Increased sales of the lawn and garden product line that we added in the second quarter of fiscal 2000 and increases in bedding sales and other new product categories accounted for much of the increase in same store sales.

 

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The following table presents the makeup of net sales by product category in each fiscal year, including service maintenance agreement commissions and service revenues, expressed both in dollar amounts and as a percentage of total net sales.

 

     Fiscal Years Ended July 31,

   

Percent

Increase

(Decrease)


 
     2000

    2001

   
     Amount

   %

    Amount

   %

   
     (dollars in thousands)        

Major home appliances

   $ 101,657    40.8 %   $ 114,769    39.3 %   12.9 %

Consumer electronics

     83,883    33.7       107,548    36.8     28.2  

Home office equipment

     24,236    9.8       22,572    7.7     (6.9 )(1)

Delivery and installation

     4,284    1.7       5,271    1.8     23.0  

Other (including lawn and garden and bedding)

     5,282    2.1       9,687    3.3     83.4  (2)
    

  

 

  

 

Total product sales

     219,342    88.1       259,847    88.9     18.5  

Service maintenance agreement commissions

     16,314    6.5       18,742    6.4     14.9  

Service revenues

     13,421    5.4       13,799    4.7     2.8  
    

  

 

  

 

Total net sales

   $ 249,077    100.0 %   $ 292,388    100.0 %   17.4 %
    

  

 

  

 


(1)   The decrease was the result of a planned slow down in computer sales as we begin to replace the Compaq brand with Hewlett Packard products.
(2)   The increase in other sales was due primarily to the addition of the lawn and garden and bedding product lines that were introduced in early fiscal 2000. Future increases are expected to grow substantially in the next period and then increase at a decreasing rate thereafter.

 

Revenue from finance charges and other increased by approximately $7.0 million, or 25.2%, from $27.9 million in fiscal 2000, to $34.9 million in fiscal 2001. This increase in revenue resulted primarily from increases in net insurance commissions and other of $3.4 million, or 39.5%. Income from sales of receivables to the QSPE increased by $3.6 million, or 18.6%, resulting primarily from an 18.0% growth in the credit portfolio and a reduction in interest costs of securities issued by the QSPE.

 

Cost of Goods Sold.    Cost of goods sold, including warehousing and occupancy cost, increased by $32.6 million, or 19.2%, from $169.4 million in fiscal 2000 to $202.0 million in fiscal 2001. The 19.2% increase was generally consistent with the 17.4% increase in net sales, although cost of retail products sold increased from 75.9% of net product sales in fiscal 2000 to 76.5% in fiscal 2001. We attribute this margin decrease to a shift in product mix from relatively higher margin home appliances to relatively lower margin consumer electronics. The increase in warehousing and occupancy cost of $0.7 million, or 24.8%, resulted from the opening of our new warehouse facilities in Houston and San Antonio in August 2000 and June 2001, respectively.

 

Selling, General and Administrative Expenses.    Selling, general and administrative expenses increased by $13.9 million, or 17.7%, from $78.3 million in fiscal 2000 to $92.2 million in fiscal 2001. The increase was generally consistent with the 18.2% increase in total revenues.

 

Provision for Bad Debts.    The provision for bad debts increased by $0.9 million, or 118.6%, from $0.8 million in fiscal 2000 to $1.7 million in fiscal 2001. The increase resulted from an increase in the charge-offs associated with our insurance and service programs.

 

Interest Expense.    Interest expense decreased by $1.0 million, or 22.4%, from $4.8 million in fiscal 2000 to $3.8 million in fiscal 2001. The decrease was attributable to the following:

 

    average outstanding debt decreased from $57.1 million in fiscal 2000 to $33.3 million in fiscal 2001. This decrease in debt resulted in a decrease of approximately $1.9 million in interest expense. Debt decreases were attributable primarily to a decrease of available credit under our asset-backed securitization program and increased cash flow generated from operations;

 

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    declining interest rates accounted for approximately $0.1 million of the decrease;

 

    our adoption of SFAS 133 resulted in an increase in interest expense of $0.5 million due to recognition of the effects of imperfect matching of hedges and hedged obligations; and

 

    declining interest rates caused the net payments on our interest rate hedges to increase by $0.5 million over the prior fiscal year.

 

Provision for Income Taxes.    The provision for income taxes increased by $0.9 million, or 9.9%, from $9.0 million in fiscal 2000 to $9.9 million in fiscal 2001. The increase was directly related to the increase in pretax profits of $4.0 million, or 17.1%. However, we experienced an effective tax rate decrease from 38.1% in fiscal 2000 to 35.8% in fiscal 2001 as a result of an organizational restructuring in fiscal 2000 that reduced our Texas franchise taxes.

 

Net Income from Continuing Operations.    As a result of the above factors, net income from continuing operations increased by $3.1 million, or 21.5%, from $14.6 million in fiscal 2000 to $17.7 million in fiscal 2001.

 

Impact of Inflation

 

We do not believe that inflation has a material effect on our net sales or results of operations.

 

Seasonality and Quarterly Results of Operations

 

Our business is seasonal, with a higher portion of sales and operating profit realized during the quarters that end January 31 and July 31. These fiscal quarters reflect the holiday selling season and the impact that hot weather has on our sales of air conditioners and lawn and garden equipment. Over the four quarters of fiscal 2003, gross margins were 38.3%, 38.5%, 38.8% and 36.3%. During the same period, operating margins were 8.4%, 8.8%, 8.5% and 9.3%. 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:

 

    timing of new product introductions, new store openings and store relocations;

 

    sales contributed by new stores;

 

    increases or decreases in comparable store sales;

 

    adverse weather conditions;

 

    shifts in the timing of certain holidays or promotions; and

 

    changes in our merchandise mix.

 

Results for any quarter are not necessarily indicative of the results that may be achieved for a full fiscal year.

 

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The following table sets forth certain unaudited quarterly statement of operations information, excluding discontinued operations, for the ten quarters ended July 31, 2003. 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.

 

   

Twelve Months Ended

January 31, 2002


   

Twelve Months Ended

January 31, 2003


   

Six Months Ended

July 31, 2003


 
    Quarter
Ended
Apr. 30


    Quarter
Ended
July 31


    Quarter
Ended
Oct. 31


   

Quarter
Ended

Jan. 31


   

Quarter
Ended

Apr. 30


   

Quarter
Ended

July 31


   

Quarter
Ended

Oct. 31


   

Quarter
Ended

Jan. 31


   

Quarter
Ended

Apr. 30


   

Quarter
Ended

July 31


 

Total revenues

  $ 80,109     $ 91,516     $ 94,461     $ 112,349     $ 105,774     $ 112,290     $ 107,322     $ 120,586     $ 120,791     $ 117,126  

Percent of total revenues (1)

    21.2 %     24.2 %     25.0 %     29.6 %     23.7 %     25.1 %     24.1 %     27.1 %     25.9 %     25.1 %

Gross profit

  $ 31,435     $ 34,507     $ 36,716     $ 42,641     $ 40,475     $ 43,210     $ 41,617     $ 43,714     $ 42,555     $ 43,438  

Gross profit as a percentage of total revenues

    39.2 %     37.7 %     38.9 %     37.9 %     38.3 %     38.5 %     38.8 %     36.3 %     35.2 %     37.1 %

Operating profit

  $ 7,537     $ 8,967     $ 8,448     $ 10,991     $ 8,874     $ 9,900     $ 9,162     $ 11,408     $ 9,433     $ 10,218  

Operating profit as a percentage of total revenues

    9.4 %     9.8 %     8.9 %     9.8 %     8.4 %     8.8 %     8.5 %     9.5 %     7.8 %     8.7 %

(1)   The percentage for the six months ended July 31, 2003 is based on the last 12 months.

 

Liquidity and Capital Resources

 

We have historically financed our operations through a combination of cash flow generated from operations and external borrowings, including primarily bank debt and asset-backed securitization facilities. We have a bank credit facility under which we had outstanding term and revolving debt of $34.0 million as of July 31, 2003. Additionally, we were indebted to a bank, various insurance companies and two former stockholders in the approximate amount of $9.4 million as of July 31, 2003. We expect to use approximately $34.9 million of the offering proceeds to reduce a portion of these debt obligations. See “Use of Proceeds.”

 

During the six months ended July 31, 2003, net cash provided by operating activities increased $8.0 million, or 262.8%, from $3.0 million for the six months ended July 31, 2002, to $11.0 million for the six months ended July 31, 2003. The net increase in cash provided from operations resulted primarily from an increase in net income of $0.5 million and non-cash depreciation expense, bad debt provision, and deferred tax provision of $0.9 million, $0.7 million, and $1.5 million, respectively, a decrease in cash required for inventories of $2.4 million, a decrease in cash required for prepaid expenses and other assets of $2.3 million, a decrease of cash required for income taxes of $1.0 million, and an increase in cash generated of $3.3 million due to the timing of payment of accounts payable and accrued expenses. These increases in cash were offset by an increase of $3.7 million in net cash required to fund our receivables and securitized assets, an increase of cash used for deferred service contracts of $0.8 million, and a decrease of $0.1 million due to imperfect matching of interest rate hedges and hedged obligations.

 

We offer promotional credit programs to certain customers which provide for “same as cash” interest free periods of varying terms, generally three, six or 12 months. These promotional accounts are eligible for securitization up to the limits provided for in our securitization agreements. This limit is currently 18.0% of eligible securitized receivables. The percentage of eligible securitized receivables represented by promotional receivables was 10.4%, 10.1%, 12.0%, 14.4% and 11.8% as of July 31, 2000, July 31, 2001, January 31, 2002, January 31, 2003 and July 31, 2003, respectively. If we exceed this 18.0% limit, we would be required to use some of our other capital resources to fund the unpaid balance of the receivables for the promotional period. The weighted average promotional period was 10.7 months for promotional receivables outstanding as of July 31, 2002 and July 31, 2003. The weighted average remaining term on those same promotional receivables was 7.0 and 6.0 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.

 

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Net cash used by investing activities decreased $7.1 million, or 76.6%, from $9.3 million for the six months ended July 31, 2002, to $2.2 million for the six months ended July 31, 2003. The decrease in cash used resulted primarily from a reduction in purchases of property and equipment of $7.0 million and an increase in proceeds from sale of property of $0.1 million for the six months ended July 31, 2003. The decrease in cash expended for property and equipment resulted from fewer new store openings and relatively fewer stores that were updated in the 2003 period. Based on current plans, we do expect to increase the expenditure for property and equipment in the next six months as we open at least three new stores and a small warehouse in the Dallas/Fort Worth market.

 

Net cash required by financing activities increased $14.6 million from $5.6 million in net cash provided during the six months ended July 31, 2002, to $9.0 million in net cash used during the six months ended July 31, 2003. This change resulted primarily from the net effect of repayments of borrowings of $14.5 million under our bank credit facility in 2003 and a $0.2 million reduction of treasury stock repurchases made in 2002 that were not made in 2003.

 

In September 2002, we increased our bank credit facility from $35.0 million to $55.0 million to provide our ongoing working capital needs. In April 2003, we amended and restated our bank credit facility in anticipation of this offering. The facility consists of a term loan and a revolving credit facility. The revolver portion of the credit facility provides for up to $40.0 million subject to a borrowing base equal to the lesser of: (1) 85% of eligible receivables plus 65% of eligible inventory plus the lesser of 40% of deferred sales proceeds and eligible unpurchased receivables; and (2) $20.0 million, which decreases to $15.0 million upon the closing of this offering. The revolver portion of the bank credit facility had a balance of $20.5 million at July 31, 2003. The term loan, which had an original principal amount of $15.0 million, had a balance of $13.5 million at July 31, 2003, and provides for quarterly principal payments of $1.5 million plus interest beginning on May 1, 2003. Both the term note and the revolver mature on September 13, 2005. Loans under the new 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 LIBOR rate for the applicable interest period, in each case plus an applicable interest margin. The interest margin is between 0.50% and 1.75% for base rate loans and between 1.50% and 2.75% for LIBOR alternative rate loans. The applicable interest margin was 1.50% for base rate loans and 2.50% for LIBOR alternative rate loans as of July 31, 2003. The interest margin will vary depending on our debt coverage ratio. We make a practice of entering into underlying debt agreements that support both the revolver and the term portions of the credit facility for periods of three months or less. We expect to use a portion of the proceeds from this offering to pay the outstanding revolving debt under this facility and all accrued interest, and we expect to be able to utilize the full amount of the revolving facility in the future as cash is required.

 

Approximately $10.0 million of the additional amount available under our increased bank credit facility was used to implement our new asset-backed securitization program, including funding of transaction expenses and required additional credit enhancements. In addition, the portion of each future receivable advanced in cash under the securitization program has been reduced from approximately 85% to approximately 80% of the face amount of the receivable. Since this results in an increase in the retained balance of accounts receivable, we must finance this increase through sources other than the securitization program itself. We have used, and will continue to require, a portion of our increased bank credit facility to finance this increased level of accounts receivable.

 

We are subject to certain affirmative and negative covenants contained in our bank credit facility, 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; dividends; stock redemptions; capital expenditures; loan guarantees; and use of proceeds of the credit facility. The exceptions provided in the credit facility could allow for transactions to occur outside of the credit facility limitations as follows: additional indebtedness and other obligations totaling approximately $55.0 million;

 

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granting of additional liens totaling approximately $32.5 million; capital expenditures of $17.5 million for any twelve month period; stock redemptions in the amount of $5.2 million for retiring or terminated employee/stockholders, $3.2 million of which is for one specific employee/stockholder; and $15.0 million in loan guarantees for the acquisition and development of sites with leases in favor of us. There are also covenants relating to compliance with certain laws, payments of taxes, maintenance of insurance and financial reporting. In addition, the credit facility requires us to maintain, as of each fiscal quarter end, a minimum net worth equal to $55.0 million plus 75% of net income after May 1, 2002, and 100% of any capital stock issued; as of each fiscal quarter end for the twelve month period ending on that date, a total leverage ratio of no greater than 3.50 to 1.00 from October 31, 2002 to the date of closing our initial public offering and 2.75 to 1.00 thereafter; a debt service coverage ratio no less than 1.75 to 1.00 from October 31, 2002 to the later of January 31, 2004 or the date of the closing of our initial public offering and 2.0 to 1.00 thereafter; and as of each fiscal quarter, an average receivables charge-off ratio no greater than .05 to 1.00, an average receivables extension ratio no greater than .04 to 1.00, and an average receivables delinquency ratio no greater than .12 to 1.00. We have been and are in compliance with such positive and negative covenants.

 

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.

 

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 the net proceeds from this offering will be sufficient to fund our operations, store expansion and updating activities and capital expenditure programs through at least January 31, 2005. However, there are several factors that could decrease cash provided by operating activities, including:

 

    reduced demand for our products;

 

    more stringent vendor terms on our inventory purchases;

 

    increases in product cost that we may not be able to pass on to our customers;

 

    reductions in product pricing due to competitor promotional activities;

 

    increases in the retained portion of our receivables portfolio under our current asset-backed securitization program as a result of changes in performance;

 

    inability to expand our capacity for financing our receivables portfolio under new or replacement asset-backed securitization programs or a requirement that we retain a higher percentage of the credit portfolio under such programs;

 

    increases in the program costs (interest and administrative fees relative to our receivables portfolio) associated with the funding of our receivables; and

 

    increases in personnel costs required for us to stay competitive in our markets.

 

If cash provided by operating activities during this period is less than we expect or if we need additional financing after January 31, 2005, we may need to increase our revolving credit facility or to undertake additional equity or debt offerings. We may not be able to obtain such financing on favorable terms, if at all.

 

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Off-Balance Sheet Financing Arrangements

 

Since we extend credit in connection with a large portion of our retail, service maintenance and credit insurance sales, we created a QSPE, which we also refer to as the issuer, 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. The subordinated securities issued to us accrue interest based on prime rates and are subordinate to these third party notes.

 

At July 31, 2003, 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 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 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 from borrowings under our bank credit facility, to 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 .0025% 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 noteholders, 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. SunTrust Robinson Humphrey, a division of SunTrust Capital Markets, Inc., is one of the underwriters for this offering.

 

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 to 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 July 31, 2003, borrowings under the Series A variable funding note were $46.0 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.

 

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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.

 

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 extensions, 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.

 

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.

 

In an attempt to acquire retail lease space at more competitive rates, in 2001 we asked some members of our management team and the SGI Affiliates to form Specialized Realty Development Services, LP, or SRDS, a real estate development company that would acquire land and develop projects for our purposes. In order to encourage these members of management and the SGI Affiliates to invest in SRDS, we entered into an arrangement with SouthTrust Bank, NA under which we guaranteed the construction debt of SRDS during the construction of these projects. SRDS is owned by certain members of our management, including Thomas J. Frank, Sr., William C. Nylin, Jr., C. William Frank, David R. Atnip, David W. Trahan, Timothy L. Frank, Robert B. Lee, Jr., Larry W. Coker and Walter M. Broussard, and certain of the SGI Affiliates. We do not own SRDS, and its assets, liabilities, results of operations and cash flows are not recorded on our consolidated financial statements; however, as SRDS drew on the guaranteed construction line of credit, we recorded this construction work in process as an asset and the amount of the guaranteed draws as a liability on our financial statements. As

 

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of July 31, 2003, total assets of SRDS were $13.4 million and total liabilities of SRDS were $11.6 million, which are reflected on SRDS’ balance sheet. As of July 31, 2003, four of the six projects SRDS is responsible for developing were operational and the amount of outstanding indebtedness we had guaranteed under this arrangement had been reduced to zero. We do not have any current obligation to guarantee additional SRDS construction debt, and we do not intend to guarantee any SRDS construction debt in the future.

 

We have leased each completed project from SRDS as a retail store location for an initial period of 15 years. At the time each lease was executed, our guarantee for the construction portion of the real estate loan was released and the related assets and guaranty obligations were removed from our financial statements. The lease then served as collateral for the loan. SRDS charges us annual lease rates of approximately 11.5% of the total cost of each project, which averages approximately $350,000 per year. In addition, we are responsible for the payment of all property taxes, insurance and common area maintenance expenses, which average approximately $70,000 per project per year. We are required to fund all leasehold improvements made to the buildings. Based on independent appraisals performed on each project, we believe that the terms of the leases that have replaced the guaranty obligations are generally more favorable than we could obtain in an arms’ length transaction. SRDS pays us an annual management fee of $5,000 for administrative services that we provide to SRDS.

 

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 $6,200 monthly 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 $291,000 in fiscal 2000 and fiscal 2001, $145,000 in the six month fiscal period ended January 31, 2002, $281,000 in fiscal 2003, and $141,000 during the six months ended July 31, 2003. 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.

 

Contractual Obligations

 

The following table presents a summary of all of our contractual obligations as of July 31, 2003, classified by payments due per period.

 

     Payments Due By Period

     Total

  

Less Than

1 Year


  

1-3

Years


  

3-5

Years


  

After

5 Years


     (in thousands)

Redemption of preferred stock(1)

   $ 25,420    $ 25,420    $ —      $ —      $ —  

Notes payable

     5,275      5,275      —        —        —  

Long term debt

     38,105      7,991      30,114      —        —  

Operating leases:

                                  

Real estate

     90,418      11,748      21,606      19,004      38,060

Equipment

     8,268      2,966      3,235      1,201      866
    

  

  

  

  

Total contractual cash obligations

   $ 167,486    $ 53,400    $ 54,955    $ 20,205    $ 38,926
    

  

  

  

  


(1)   Redemption of our preferred stock is contingent on the completion of this offering. The redemption, at the option of the stockholder, can be made in cash or in conversion to common shares at the offering price. We expect holders of 162,753 shares of preferred stock with a value of $23.7 million to convert such preferred stock to approximately 1,692,050 shares of common stock.

 

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Quantitative and Qualitative Disclosure 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 0.50% to 1.75%, or LIBOR plus the LIBOR margin, which ranges from 1.50% to 2.75%. Accordingly, changes in the prime rate, the federal funds rate or LIBOR, which are affected by changes in interest rates generally, will affect the interest rate on, and therefore our costs under, our bank credit facility. We are also exposed to interest rate risk associated with our interest only strip and the subordinated securities we receive from our sales of receivables to the QSPE.

 

We held interest rate swaps and collars with notional amounts totaling $100.0 million as of January 31, 2002 and January 31, 2003, with terms extending through 2005. At January 31, 2002, these instruments were accounted for as cash flow hedges. Of these instruments, $80.0 million were designated as hedges against our variable interest rate risk related to the cash flows from our interest only strip. The remaining $20.0 million of these instruments were designated as hedges against our variable rate debt.

 

In September 2002, we entered into a new agreement to sell customer receivables. As a result of that new agreement, we discontinued hedge accounting for the $80.0 million of financial instruments previously designated as hedges against our interest only strip. In accordance with SFAS 133, we recognized changes in fair value for those derivatives after September 2002 as interest expense, and we are amortizing the amount of accumulated other comprehensive loss related to those derivatives as interest expense over the remaining term of the instruments, which expire ending in November 2003. This change had no effect on the $20.0 million of instruments designated as hedges against our variable rate debt.

 

Ineffectiveness, which arises from differences between the interest rate stated in the derivative instrument and the interest rate upon which the underlying hedged transaction is based, totaled $0.5 million for the year ended July 31, 2001, $0.1 million for the six months ended January 31, 2002 and $0.5 million for the year ended January 31, 2003, and is reflected in “Interest Expense” in our consolidated statement of operations. Ineffectiveness for the year ended January 31, 2003 includes $0.4 million related to discontinued hedge accounting.

 

Recent Accounting Pronouncements

 

In June 2001, the Financial Accounting Standards Board finalized SFAS No. 142, Goodwill and Other Intangible Assets. SFAS 142 requires, among other things, that companies no longer amortize goodwill but instead test goodwill for impairment at least annually. In addition, SFAS 142 requires that we identify reporting units for the purposes of assessing potential future impairments of goodwill, reassess the useful lives of other existing recognized intangible assets and cease amortization of intangible assets with indefinite useful lives. Intangible assets with indefinite useful lives must be tested for impairment in accordance with the guidance in SFAS 142. We adopted the provisions of SFAS 142 beginning as of February 1, 2002, relative to all goodwill and other intangible assets recognized as of that date, regardless of when we acquired the asset. SFAS 142 required us to complete a transitional goodwill impairment test prior to July 31, 2002, and to reassess the useful lives of other intangible assets within the first interim quarter after our adoption of the pronouncement. We completed the transitional goodwill impairment test in July 2002 and the first annual review in November 2002 and determined that no impairment of goodwill existed. Application of the non-amortization provisions of SFAS 142 to goodwill and other intangible assets, which had previously been amortized over 15 years, resulted in an increase to net income of approximately $0.4 million, or $0.02 per diluted common share, for fiscal 2003, and $0.2 million, or $0.01 per diluted common share, for the six months ended July 31, 2003. As of January 31, 2003, we had unamortized goodwill and other intangible assets of approximately $7.9 million.

 

In November 2002, the Emerging Issues Task Force of the Financial Accounting Standards Board reached a consensus on Issue 02-16, addressing the accounting for cash consideration received by a customer from a

 

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vendor, including vendor rebates and refunds. The consensus reached states that consideration received should be presumed to be a reduction of the prices of the vendor’s products or services and should therefore be shown as a reduction of cost of sales in the income statement of the customer. The presumption can be overcome if the vendor receives an identifiable benefit in exchange for the consideration or the consideration represents a reimbursement of a specific incremental identifiable cost incurred by the customer in selling the vendor’s product or service. If one of these conditions is met, the cash consideration should be characterized as a reduction of those costs in the income statement of the customer. The consensus reached also concludes that if rebates or refunds can be reasonably estimated, such rebates or refunds should be recognized as a reduction of the cost of sales based on a systematic and rational allocation of the consideration to be received relative to the transactions that mark the progress of the customer toward earning the rebate or refund. The provisions of this consensus are applied prospectively and are consistent with our existing accounting policy.

 

In November 2002, the Emerging Issues Task Force of the Financial Accounting Standards Board reached a consensus on Issue 00-21, addressing how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. Revenue arrangements with multiple deliverables are divided into separate units of accounting if the deliverables in the arrangement meet the following criteria: (1) the delivered item has value to the customer on a stand alone basis; (2) there is objective and reliable evidence of the fair value of undelivered items; and (3) delivery of any undelivered item is probable. Arrangement consideration should be allocated among the separate units of accounting based on their relative fair values, with the amount allocated to the delivered item being limited to the amount that is not contingent on the delivery of additional items or meeting other specified performance conditions. The final consensus will be applicable to agreements entered into in fiscal periods beginning after June 15, 2003, with early adoption permitted. The provisions of this consensus are not expected to have a significant effect on our financial position or operating results.

 

In December 2002, the Financial Accounting Standards Board issued SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure. SFAS 148 amends SFAS No. 123, Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value-based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The disclosure provisions of SFAS 148 are effective for fiscal years ending after December 15, 2002, and have been incorporated into our consolidated financial statements and accompanying footnotes.

 

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 the consolidation of entities in which a company absorbs a majority of the entity’s expected losses, receives a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity. Currently, entities are generally consolidated by a company when it has a controlling financial interest through ownership of a majority voting interest in the entity. We are currently evaluating the effects of the issuance of FIN 46 on the accounting for our leases with SRDS. We do not anticipate the adoption of FIN 46 will have a material impact on our consolidated financial statements.

 

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BUSINESS

 

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, VCRs, DVD players and home theater products. We also sell home office equipment, lawn and garden products and bedding, and we continue to introduce additional product categories for the home to help increase same store sales and to respond to our customers’ product needs. In the last three years, we have introduced several new product lines, including lawn and garden, bedding and generators. We offer over 1,100 product items, or SKUs, at good-better-best price points representing such national brands as General Electric, Whirlpool, Frigidaire, Mitsubishi, Sony, Panasonic, Thomson Consumer Electronics, Simmons, Hewlett Packard and Compaq. Based on revenue in 2002, we were the 12th largest retailer of home appliances in the United States, and we are either the first or second leading retailer of home appliances in terms of market share in the majority of our existing markets.

 

We currently operate 45 retail stores located in Texas and Louisiana. We opened 11 stores in the twelve months ended January 31, 2002, of which four were relocations of existing stores, we opened twelve stores in fiscal 2003, of which five were relocations of existing stores, and we opened two stores in September 2003 and October 2003. We also closed one store during fiscal 2003. We plan to continue our growth program by opening an additional one to two new stores during fiscal 2004 and four to six new stores during fiscal 2005.

 

We have been known for providing excellent customer service for over 110 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:

 

    a high level of customer service;

 

    highly trained and knowledgeable sales personnel;

 

    a broad range of customer-driven, brand name products;

 

    flexible financing alternatives through our proprietary credit programs;

 

    same day and next day delivery capabilities; and

 

    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 2003, approximately 54% 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:

 

    we have grown from 26 stores to 45 stores, an increase of more than 73%, with three more stores currently under development;

 

    total revenues have grown at a compounded annual rate of 20.2% from $234.5 million in fiscal 1999, to $446.0 million in fiscal 2003;

 

    net income from continuing operations have grown at a compounded annual rate of 27.7% from $8.8 million in fiscal 1999, to $20.6 million in fiscal 2003; and

 

    our average same store sales growth from fiscal 1999 to fiscal 2003 has been 10.1%.

 

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Industry Overview

 

The home appliance and consumer electronics industry includes major home appliances, small appliances, home office equipment, televisions and audio, video and mobile 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 newspaper dedicated to the consumer electronics, computer and major appliances industries in the United States, the top 100 major appliance retailers reported sales of approximately $15.2 billion in 2002, up approximately 9.5% from reported sales in 2001 of approximately $13.9 billion. We estimate sales for the appliance industry for 2002, based upon total estimated shipments including builders’ sales and those retailers not included in the top 100 retailers as compiled by the Association of Home Appliance Manufacturers, to be in excess of $24 billion. We estimate total sales in the major appliance industry will exceed $29 billion by 2005. 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 37% in 2002, down from approximately 40% in 2001.

 

As measured by Twice, the top 100 consumer electronics retailers in the United States reported sales of $101.5 billion in 2002, a 6.1% increase from the $95.7 billion reported in 2001. 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 one-third of the total electronics sales attributable to the 100 largest retailers in 2002. 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 speed ovens, custom refrigerators, appliances with stainless steel exteriors, personal garment dry cleaning appliances and energy-efficient 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 DVD players and digital camcorders, digital stereo receivers, satellite technology, cameras and 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 represent a significant potential market for us.

 

    Digital Television (DTV and High Definition TV).    The Federal Communications Commission has set a target of 2006 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 an estimated 4.3 million units in 2003 to 16.2 million units in 2007, representing a compounded annual growth rate of 39.3%. We believe the recent introduction of high clarity digital flat panel televisions in both liquid crystal display, or LCD, and plasma formats has increased the quality and sophistication of these entertainment products and will be a key driver of digital television growth.

 

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    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 41% of U.S. homes, and we believe that DVD players will reach a household penetration level of 70% by 2007. Sales of DVD players grew from 0.3 million units in 1997 to 17.1 million units in 2002 and are expected to further increase to 24.3 million units in 2004.

 

    Digital Radio.    The conversion to digital radio is taking place through two independent platforms, satellite and terrestrial. Digital satellite radio is currently being provided by Sirius Satellite Radio and XM Satellite Radio. As of June 30, 2003, Sirius Satellite Radio and XM Satellite Radio had approximately 105,000 and approximately 692,000 subscribers, respectively. The Yankee Group estimates that the number of U.S. satellite radio subscribers will reach approximately 21 million by 2006. The well-established terrestrial AM/FM radio stations began upgrading to digital radio in 2003.

 

Home appliance and electronics retailers typically provide few or no in-house financing options. Consumers see home appliances and electronics as necessary or desirable, but many customers are unable to afford them without financing, which may be difficult to obtain. Moreover, once customers purchase an item, they typically have to wait several days for delivery and may be unable to receive product service from the seller.

 

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 execution of the following strategies.

 

    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 customer satisfaction levels at rates between 90% and 95%. We measure customer satisfaction in our customer service on the sales floor, in our delivery operation and in our service department by sending survey cards to all customers for 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. We are working to expand this department to enable us to make customer satisfaction calls to every customer as soon as possible after a delivery is made or a service call is completed.

 

    Developing and retaining highly trained and knowledgeable sales personnel.    We require all sales personnel to specialize in home appliances, consumer electronics or “track” products. This approach allows the sales person to focus on a specific product category and become an expert in selling and using products in that category. New sales personnel must complete an intensive two-week classroom training program conducted at our corporate office followed by an additional week of on-the-job training riding in a delivery and service truck to observe how we serve our customers after the sale is made.

 

    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 Electric, Whirlpool, Frigidaire, Mitsubishi, Sony, Panasonic, Thomson Consumer Electronics, Simmons, 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 sale of all new products and obtain customers’ reactions to new display formats before introducing these products and display formats to our other stores.

 

   

Offering flexible financing alternatives through our proprietary credit programs.     Historically, we have financed over 56% 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

 

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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 creditworthiness to determine down payment amounts and other credit terms. This facilitates product sales while keeping our credit risk within an acceptable range. Approximately 60% 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 daily calling program, we contact customers with past due accounts 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 2.7% net loss ratio in fiscal 2003 and a 2.8% annualized net loss ratio for the six months ended July 31, 2003 on the credit portfolio that we service for the QSPE.

 

    Maintaining same day and next day distribution capabilities.    We maintain four regional distribution centers and two 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.

 

    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.

 

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.

 

    Increasing same store sales.    We plan to continue to increase our same store sales by:

 

    continuing to offer quality products at competitive prices;

 

    remerchandising our product offerings in response to changes in consumer demand;

 

    training our sales personnel to increase sales closing rates;

 

    updating our stores on a three-year rotating basis;

 

    focusing more specifically on sales of computers and smaller electronics within the interior track area of our stores, including the expansion of high margin accessory items;

 

    continuing to provide a high level of customer service in sales, delivery and servicing of our products;

 

    increasing sales of our merchandise, finance products, service maintenance agreements and credit insurance through direct mail and in-store credit promotion programs; and

 

    introducing a replacement service maintenance agreement that covers replacement of smaller ticket items.

 

   

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. This infrastructure includes our proprietary management information systems, training processes, distribution network, merchandising capabilities,

 

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supplier relationships and centralized credit approval and collection processes. We intend to expand our store base in existing, adjacent and new markets, as follows:

 

    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. New store openings in these locations will allow us to take advantage of our perceived market opportunity in those markets and leverage our existing distribution network, cluster advertising, brand name recognition and reputation.

 

    New markets.    In fiscal 2004, we opened three new stores in the Dallas/Fort Worth metroplex. We have identified several additional markets that meet our criteria for site selection, including the Rio Grande Valley in southwest Texas, New Orleans and central Louisiana around Shreveport, Monroe and Alexandria. We intend to enter these new markets, as well as some in neighboring states, over the next several fiscal years. We will 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. During fiscal 2004, we expect to open three to five stores in new markets in Texas and Louisiana.

 

    Updating, expanding or relocating existing stores.    Over the last three years, we have updated, expanded or relocated all of our stores. We have implemented our larger prototype store model at all locations at which the physical space would accommodate the required design changes. As we continue to add new stores or replace existing stores, we will modify our floor plan to include this new model. 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. This approach also conserves capital by avoiding large outlays for real estate purchases. After updating, expanding or relocating a store, we expect to increase sales significantly at those stores.

 

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Products and Merchandising

 

Product Categories.    Each of our stores sells five major categories of products: major home appliances, consumer electronics, home office equipment, delivery and installation services and other household products, including lawn and garden equipment and bedding. The following table presents a summary of net sales by major product category, service maintenance agreement commissions and service revenues, for fiscal 2000 and fiscal 2001, the six month fiscal period ended January 31, 2002, fiscal 2003 and the six months ended July 31, 2003.

 

    Twelve Months Ended July 31,

   

Six Months Ended

January 31, 2002(1)


   

Twelve Months

Ended

January 31, 2003


    Six Months Ended
July 31, 2003(2)


 
    2000

    2001

       
    Amount

  %

    Amount

  %

    Amount

  %

    Amount

  %

    Amount

  %

 
    (dollars in thousands)  

Major home appliances

  $ 101,657   40.8 %   $ 114,769   39.3 %   $ 63,907   35.0 %   $ 147,605   37.9 %   $ 82,848   39.6 %

Consumer electronics

    83,883   33.7       107,548   36.8       75,355   41.2       155,623   40.0       76,112   36.3  

Home office equipment

    24,236   9.8       22,572   7.7       16,523   9.0       25,865   6.6       12,236   5.8  

Delivery and installation

    4,284   1.7       5,271   1.8       3,238   1.8       6,436   1.6       3,916   1.9  

Other (including lawn and garden and bedding)

    5,282   2.1       9,687   3.3       3,762   2.1       12,350   3.2       13,365   6.4  
   

 

 

 

 

 

 

 

 

 

Total product sales

    219,342   88.1       259,847   88.9       162,785   89.1       347,879   89.3       188,477   90.0  

Service maintenance agreement commissions

    16,314   6.5       18,742   6.4       11,922   6.5       22,961   5.9       11,588   5.5  

Service revenues

    13,421   5.4       13,799   4.7       7,904   4.4       18,656   4.8       9,376   4.5  
   

 

 

 

 

 

 

 

 

 

Total net sales

  $ 249,077   100.0 %   $ 292,388   100.0 %   $ 182,611   100.0 %   $ 389,496   100.0 %   $ 209,441   100.0 %
   

 

 

 

 

 

 

 

 

 


(1)   Sales amounts and percentages for this period do not reflect the effect of summer air conditioner sales and lawn and garden product sales.
(2)   Sales amounts and percentages for this period do not reflect the holiday sales season.

 

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Within these major product categories (excluding service maintenance agreements 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, Mitsubishi, Sony, Panasonic, Thomson Consumer Electronics, Simmons, 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, washers, dryers, ranges, dishwashers, air conditioners and vacuum cleaners   General Electric, Frigidaire, Whirlpool, Maytag, KitchenAid, Sharp, Samsung, Friedrich, Roper, Hoover and Eureka

Consumer electronics

  Projection, plasma and LCD televisions, home theater systems, VCRs, camcorders, digital cameras, DVD players, audio components, compact disc players, speakers and portable electronics   Mitsubishi, Thomson Consumer Electronics, Sony, Toshiba, Sanyo, JVC, Panasonic, Hitachi, Yamaha, Polk, Kenwood and JBL

Home office equipment

  Computers, computer peripherals, personal digital assistants and telephones   Hewlett Packard, Compaq, Sony and Panasonic

Other

  Lawn and garden, bedding and generators   Poulan, Toro, Weedeater and Simmons

 

Purchasing.    We purchase products from approximately 50 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. We purchase a significant portion of our total inventory from a limited number of vendors. During fiscal 2003, we purchased 65.4% of our total inventory from six vendors, including 15.5%, 13.7% and 12.5% of our total inventory from Frigidaire, Whirlpool and Mitsubishi, respectively.

 

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 warrantied merchandise. Our established relationships with major appliance and electronic vendors 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 in our Houston and San Antonio markets to help sell scratched, used or discontinued merchandise. We have recently redesigned our approach to the merchandising of our “track” products, including computers and other small appliances and electronic products such as camcorders, DVD players, cameras and telephones, 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. We do, however, expect product margins to decrease because many of these products are sold at lower margins.

 

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

 

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call a special “hotline” number at the corporate office. Store operations management and our corporate office closely monitor the stores that do not have this price adjustment system. Personnel manning 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 30,000 customer satisfaction survey cards each month covering all deliveries and service calls. Based upon a response rate from our customers of approximately 20%, we consistently report customer satisfaction rates between 90% and 95%. We have already planned the physical facilities necessary to implement a proactive customer satisfaction call center, and once the center is fully operational, we expect to contact most customers within 48 hours of product delivery or completed service call to inquire about their satisfaction with their purchases or service call experience with us.

 

Store Operations

 

Stores.    We currently operate 45 retail 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 year we opened our first store in each market.

 

     Number of Stores

    

Market


   Stand-Alone

   Strip Mall

   First Store Opened

Houston

   8    10    1983

San Antonio/Austin

   7    6    1994

Golden Triangle (1)

   1    4    1937

Baton Rouge/Lafayette

   1    4    1975

Corpus Christi

   1    0    2002

Dallas

      3    2003
    
  
    
     18    26     
    
  
    

(1)   Beaumont, Nederland and Orange, Texas and Lake Charles, Louisiana

 

Our stores have an average selling space of approximately 19,000 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 and returns. Our clearance centers are located in the Houston and San Antonio/Austin markets and average 9,000 square feet of selling space. All stores and clearance centers 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.

 

Approximately 60% of our stores are in strip shopping centers and regional malls, with the balance being stand-alone buildings. All of our locations have parking available immediately adjacent to the store’s front entrance. Our storefronts have a distinctive exterior tower 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, lawn and garden products and bedding 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

 

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various home office and consumer electronic products such as computers, printers, DVD players, camcorders, digital cameras and telephones. During the six month period ended July 31, 2003, we redesigned our approach to merchandising of our track products to provide consumer-friendly point of sale transactions. The area inside the track now has its own manager, sales personnel and merchandising approach for its products, including a check-out area dedicated to the purchase of track products. The rear of the store contains a display for audio and stereo products, as well as cashier stations. To reach the cashiers at the rear of the store, our customers must walk past our products. We believe this increases sales to customers that 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 or relocated all of our stores in the last three years. We expect to continue to update stores on a three year cycle. 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 20,000 to 24,000 square feet of retail selling space, which is approximately 15% more than the average size of our existing stores and a rear storage area of between 5,000 and 7,000 square feet. We generally spend approximately $275,000 to $350,000 to update a store, and as a result of the updating, we expect to increase same store sales at those stores. Over the last three years, we have spent approximately $17.1 million updating, refurbishing or relocating our existing stores.

 

Site Selection.    Our stores are typically located near freeways or major travel arteries and in the vicinity of major retail shopping areas. We prefer to locate our stores in an area 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 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 may, however, elect to experiment with opening smaller numbers of new stores in outlying areas where customer demand for products and services outweighs the extra cost of failing to achieve full economies of scale. Other factors we consider when evaluating potential markets include the distance from our distribution centers, store locations of our competitors and population, demographics and growth potential of the market.

 

Store Economics.    We lease 40 of our 44 current store locations, with an average monthly rent of $21,000. Our average investment for the 13 stores we have opened in the last two years was approximately $1.1 million, including leasehold improvements, fixtures and equipment and inventory (net of accounts payable). For these same new stores, the net sales per store has averaged $0.7 million per month for the last 18 months or the actual time the store has been open, if less than 18 months.

 

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 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 allocations of overhead and advertising in the first full year of operation. Successful stores that have matured, which generally occurs after two to three years of operations, typically generate annual sales of approximately $12 million to $15 million and 5% to 9% in operating margins before allocations. Assuming that the store location is both visible and accessible from major thoroughfares and that major competition exists in the general area, we believe that there is a significant difference in sales volume between stores that are freestanding and stores that are located in strip malls. Most of our new and replacement stores, therefore, are stand-alone stores unless there is compelling demographic data to cause us to locate the store in a strip mall.

 

Personnel and Compensation.    We staff a typical store with a store manager, an assistant manager, 10 to 20 sales personnel and other support staff including cashiers and/or porters. 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 four district managers that oversee from eight to 12 stores in each market. Our district managers generally have five to 15 years of sales experience and report to our senior vice president of store operations, who has over 20 years of sales experience. We treat the track area of our stores as a store within a store with a separate staff and cashier function.

 

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We compensate home appliance and consumer electronics sales specialists on a straight commission arrangement, while we generally compensate store managers and cashiers on a salary basis plus incentives or at an hourly rate. Our store managers receive a base salary and monthly bonuses; in some instances, store managers receive earned commissions plus base salary. Our clearance centers are staffed with a manager and six to eight sales personnel who are paid on a straight commission arrangement. Sales personnel within the track area are compensated on an hourly basis plus a sales incentive. 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.

 

We attempt to identify store manager candidates early in their careers with us and place them in a defined program of training. They 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 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 or twelve 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.

 

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 creditworthy 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 these potential purchasers back into the original store location. This telephone program was responsible for an additional $15.3 million in revenue during fiscal 2003.

 

Our website, www.conns.com, offers a selection of products from our total product inventory and provides useful information to the consumer on pricing, features and benefits for each product. Our website also allows the customer to apply and be approved 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 3,140 visits per day from potential and existing customers. During fiscal 2003, our website was the initial source of approximately 54,000 credit applications that resulted in $25.8 million in sales completed in our stores. The website is linked to a call center, allowing us to better assist customers with their credit and product needs.

 

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Distribution and Inventory Management

 

We typically cluster our stores around four regional distribution centers located in Houston, San Antonio and Beaumont, Texas and Lafayette, Louisiana and a smaller warehouse facility in Austin, 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. As part of our entry into the Dallas market, we have leased a warehouse facility of approximately 36,000 square feet.

 

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 18-wheeler transport trucks that allow us to move products from market to market and from distribution centers to stores. At each distribution center or warehouse facility, we also maintain a fleet of home delivery vehicles that allow us to deliver directly to the customer. Our customers pay a delivery charge based on their choice of same day or next day delivery, and we are able to deliver our products on the same day as, or the next day after, the sale to approximately 95% of our customers.

 

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. Historically, we have financed over 56% of our retail sales through one of our two proprietary 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.

 

     Twelve Months Ended July 31,

    Six Months
Ended
January 31, 2002


    Twelve Months
Ended
January 31, 2003


    Six Months
Ended
July 31, 2003


 
     2000

    2001

       
     Amount