UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended Commission File Number
July 31, 2004 000-50421
CONN'S, INC.
(Exact name of registrant as specified in its charter)
A Delaware Corporation 06-1672840
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
3295 College Street
Beaumont, Texas 77701
(409) 832-1696
(Address, including zip code, and telephone
number, including area code, of registrant's
principal executive offices)
NONE
(Former name, former address and former
fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES __X__ NO _____
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES _____ NO __X__
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of August 30, 2004:
Class Outstanding
- ---------------------------------------- -------------------------
Common stock, $.01 par value per share 23,204,488
TABLE OF CONTENTS
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PART I. FINANCIAL INFORMATION Page No.
--------------------- --------
Item 1. Financial Statements..............................................1
- -------
Consolidated Balance Sheets as of January 31, 2004 and
July 31, 2004....................................................1
Consolidated Statements of Operations for the three and
six months ended July 31, 2003 and 2004..........................2
Consolidated Statements of Stockholders' Equity for the
six months ended July 31, 2004...................................3
Consolidated Statements of Cash Flows for the six months
ended July 31, 2003 and 2004.....................................4
Notes to Consolidated Financial Statements........................5
Item 2. Management's Discussion and Analysis of Financial Condition
- ------- and Results of Operations.......................................10
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......23
- -------
Item 4. Controls and Procedures..........................................23
- -------
PART II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings................................................24
- -------
Item 4. Submission of Matters to a Vote of Security Holders..............24
- -------
Item 5. Other Information................................................25
- -------
Item 6. Exhibits.........................................................25
- -------
SIGNATURE ................................................................ 26
i
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Conn's, Inc.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
January 31, July 31,
2004 2004
------------- -------------
Assets (unaudited)
Current assets
Cash and cash equivalents $ 12,942 $ 6,328
Accounts receivable, net 16,802 28,715
Interest in securitized asset 77,138 84,312
Inventories 53,742 57,827
Deferred income taxes 4,148 4,526
Prepaid expenses and other assets 3,031 2,125
------------- -------------
Total current assets 167,803 183,833
Debt issuance and other costs 250 281
Non-current deferred tax asset 3,945 4,329
Property and equipment
Land 10,708 11,583
Buildings 13,108 14,685
Equipment And Fixtures 7,574 8,398
Transportation Equipment 2,845 3,200
Leasehold Improvements 48,504 52,973
------------- -------------
Subtotal 82,739 90,839
Less accumulated depreciation (27,914) (30,940)
------------- -------------
Total property and equipment, net 54,825 59,899
Goodwill, net 7,917 7,917
Other assets, net 20 84
------------- -------------
Total assets $ 234,760 $ 256,343
============= =============
Liabilities and Stockholders' Equity
Current Liabilities
Notes payable $ - $ 1,205
Current portion of long-term debt 338 318
Accounts payable 26,412 32,819
Accrued expenses 12,800 12,412
Income taxes payable 3,528 1,722
Deferred income taxes 313 399
Deferred revenue 6,225 6,425
Fair value of derivatives 1,121 702
------------- -------------
Total current liabilities 50,737 56,002
Long-term debt 14,174 14,005
Non-current deferred tax liability 477 593
Deferred gain on sale of property 811 727
Fair value of derivatives 202 -
Minority interest 1,769 1,960
Stockholders' equity
Common stock ($0.01 par value, 40,000,000 shares
authorized; 23,101,772 and 23,187,688 shares
issued and outstanding at January 31, 2004 and
July 31, 2004, respectively) 231 232
Additional paid-in capital 82,656 83,342
Accumulated other comprehensive income 5,032 6,248
Retained earnings 78,671 93,234
------------- -------------
Total stockholders' equity 166,590 183,056
------------- -------------
Total liabilities and stockholders' equity $ 234,760 $ 256,343
============= =============
See notes to consolidated financial statements.
1
Conn's, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except earnings per share)
Three Months Ended Six Months Ended
July 31, July 31,
---------------------- ----------------------
2003 2004 2003 2004
---------- ---------- ---------- ----------
Revenues
Product sales $ 93,185 $ 108,305 $ 190,395 $ 216,808
Service maintenance agreement
commissions (net) 4,669 5,776 9,670 11,436
Service revenues 4,900 4,770 9,376 9,149
---------- ---------- ---------- ----------
Total net sales 102,754 118,851 209,441 237,393
Finance charges and other 14,372 17,750 28,476 34,085
---------- ---------- ---------- ----------
Total revenues 117,126 136,601 237,917 271,478
Cost and Expenses
Cost of goods sold, including
warehousing and occupancy costs 72,682 85,704 149,674 170,479
Cost of parts sold, including
warehousing and occupancy costs 1,007 1,092 2,250 2,195
Selling, general and
administrative expense 32,399 37,521 64,154 72,383
Provision for bad debts 820 1,227 2,189 2,649
---------- ---------- ---------- ----------
Total cost and expenses 106,908 125,544 218,267 247,706
---------- ---------- ---------- ----------
Operating income 10,218 11,057 19,650 23,772
Interest expense 1,670 567 3,215 1,149
---------- ---------- ---------- ----------
Income before minority interest
and income taxes 8,548 10,490 16,435 22,623
Minority interest in limited
partnership - 131 - 246
---------- ---------- ---------- ----------
Income before income taxes 8,548 10,359 16,435 22,377
Provision for income taxes
Current 2,737 4,352 5,621 9,035
Deferred 288 (783) 206 (1,221)
---------- ---------- ---------- ----------
Total provision for income
taxes 3,025 3,569 5,827 7,814
---------- ---------- ---------- ----------
Net income 5,523 6,790 10,608 14,563
Less preferred dividends 586 - 1,173 -
---------- ---------- ---------- ----------
Net income available for common
shareholders $ 4,937 $ 6,790 $ 9,435 $ 14,563
========== ========== ========== ==========
Earnings per share
Basic $ 0.30 $ 0.29 $ 0.56 $ 0.63
Diluted $ 0.30 $ 0.29 $ 0.56 $ 0.61
Average common shares outstanding
Basic 16,720 23,179 16,720 23,163
Diluted 16,720 23,801 16,720 23,769
See notes to consolidated financial statements.
2
Conn's, Inc.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(unaudited)
(in thousands except descriptive shares)
Accum.
Other
Common Stock Compre-
------------------ hensive Paid-in Retained
Shares Amount Income Capital Earnings Total
-------- -------- ---------- ---------- ---------- ----------
Balance January 31, 2004 23,102 $ 231 $ 5,032 $ 82,656 $ 78,671 $ 166,590
Exercise of options to
acquire 83,652 shares
of common stock 84 1 - 653 - 654
Issuance of 2,264 shares
of common stock under
Employee Stock Purchase
Plan 2 - - 33 - 33
Net income - - - - 14,563 14,563
Reclassification adjustments
on derivative instruments
(net of tax of $196) - - 360 - - 360
Adjustment of fair value of
securitized assets (net of
tax of $467), net of reclass-
ification adjustments of
$4,940 (net of tax of $2,696) - - 856 - - 856
----------
Total comprehensive income - - - - - 15,779
-------- -------- ---------- ---------- ---------- ----------
Balance July 31, 2004 23,188 $ 232 $ 6,248 $ 83,342 $ 93,234 $ 183,056
======== ======== ========== ========== ========== ==========
See notes to consolidated financial statements.
3
Conn's, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Six Months Ended
July 31,
-----------------------------
2003 2004
------------- -------------
Cash flows from operating activities
Net income $ 10,607 $ 14,563
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 3,514 3,972
Amortization 123 15
Provision for bad debts 2,188 2,649
Promotional credit discounts (net) 757
Accretion from interests in securitized assets (6,040) (7,636)
Provision for deferred income taxes 527 (1,221)
Gain from sale of property and equipment (16) (14)
Gains from derivatives (net) (98) (36)
Minority interest in SRDS 190
Change in operating assets and liabilities:
Accounts receivable (3,793) (13,687)
Inventory (4,315) (4,085)
Prepaid expenses and other assets 1,175 905
Accounts payable 7,442 6,409
Accrued expenses (255) (389)
Income taxes payable 657 (1,807)
Deferred revenue (758) 201
Other current liabilities 45 -
------------- -------------
Net cash provided by operating activities 11,003 786
------------- -------------
Cash flows from investing activities
Purchase of property and equipment (2,364) (9,047)
Proceeds from sale of property 189 15
------------- -------------
Net cash used in investing activities (2,175) (9,032)
------------- -------------
Cash flows from financing activities
Net proceeds from exercise of stock options - 687
Net borrowing (payments) under line of credit (7,637) 1,049
Increase in debt issuance costs (429) (70)
Payment of promissory notes (976) (34)
------------- -------------
Net cash provided by (used in) financing activities (9,042) 1,632
------------- -------------
Net change in cash (214) (6,614)
Cash and cash equivalents
Beginning of the year 2,448 12,942
------------- -------------
End of period $ 2,234 $ 6,328
============= =============
See notes to consolidated financial statements.
4
CONN'S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
July 31, 2004
1. Significant Accounting Policies
Basis of Presentation. The accompanying unaudited, condensed, consolidated
financial statements have been prepared in accordance with accounting principles
generally accepted in the United States for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by accounting principles generally accepted in the United States for complete
financial statements. The accompanying financial statements reflect all
adjustments that are, in the opinion of management, necessary for a fair
statement of the results for the interim periods presented. All such adjustments
are of a normal recurring nature. Operating results for the three and six months
ended July 31, 2004 are not necessarily indicative of the results that may be
expected for the year ending January 31, 2005. The financial statements should
be read in conjunction with the Company's (as defined below) audited
consolidated financial statements and the notes thereto included in the
Company's Annual Report on Form 10-K filed on April 16, 2004.
The Company's balance sheet at January 31, 2004 has been derived from the
audited financial statements at that date but does not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial presentation. Please see the
Company's Form 10-K for the fiscal year ended January 31, 2004 for a complete
presentation of the audited financial statements at that date, together with all
required footnotes, and for a complete presentation and explanation of the
components and presentations of the financial statements.
Principles of Consolidation. The consolidated financial statements include
the accounts of Conn's, Inc. and its subsidiaries, limited liability companies
and limited partnerships, all of which are wholly-owned (the "Company"). All
material intercompany transactions and balances have been eliminated in
consolidation. The consolidated financial statements additionally include the
financial statements of a single purpose entity meeting one or more of the
standards of Financial Accounting Standards Board ("FASB") Interpretation No.
46, Consolidation of Variable Interest Entities, an interpretation of Accounting
Research Bulletin No. 51 ("FIN 46"), as described below.
The Company enters into securitization transactions to sell its retail
installment and revolving customer receivables. These securitization
transactions are accounted for as sales in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishment of Liabilities, because the
Company has relinquished control of the receivables. Additionally, the Company
has transferred such receivables to a qualifying special purpose entity
("QSPE"). Accordingly, neither the transferred receivables nor the QSPE are
included in the consolidated financial statements of the Company.
Implementation of FIN 46. In January 2003, the FASB issued FIN 46 that
requires the consolidation of entities in which a company absorbs a majority of
the entity's expected losses, receives a majority of the entity's expected
residual returns, or both, as a result of ownership, contractual or other
financial interests in the entity. Currently, a company generally consolidates
entities when it has a controlling financial interest through ownership of a
majority voting interest in the entity. Although the Company itself does not
have a controlling financial interest in Specialized Realty Development
Services, LP ("SRDS"), SRDS is owned by various members of management and
individual investors of the Stephens Group, Inc. SRDS owns five retail stores
that it leases to the Company at July 31, 2004. The Company evaluated the
effects of the issuance of FIN 46 on the accounting for its leases with SRDS
and, as a result, determined that it is appropriate to consolidate the balance
sheets of SRDS with the balance sheets of the Company as of January 31, 2004 and
July 31, 2004. Additionally, commencing February 1, 2004 (the beginning of the
Company's 2005 fiscal year), the Company has determined that it is appropriate
to consolidate the operations of SRDS with those of the Company. The primary
effect of the consolidation on the Company's balance sheet at January 31, 2004
and July 31, 2004 was to increase cash, net property, debt and minority
interests by the amounts listed in the following table (dollars in thousands):
5
January 31, July 31,
2004 2004
----------- -----------
Increase in cash $ 1,024 $ 939
Increase in property and equipment, net 15,166 15,993
Increase in debt 14,421 14,972
Increase in minority interests 1,769 1,960
The Company has no financial obligation to the lenders for the outstanding
debt of SRDS.
Use of Estimates. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
Earnings Per Share. In accordance with SFAS No. 128, Earnings per Share,
the Company calculates basic earnings per share by dividing net income by the
weighted average number of common shares outstanding. Diluted earnings per share
include the dilutive effects of any stock options granted calculated under the
treasury method. Because there were no options outstanding in the prior year
interim periods that were valued in excess of the grant price, there were no
such shares included in the diluted outstanding share total.
Goodwill. Goodwill represents primarily the excess of purchase price over
the fair market value of net assets acquired. Effective February 1, 2002, the
Company adopted the provisions of SFAS No. 142, Goodwill and Other Intangible
Assets, whereby goodwill is no longer amortized, but rather the Company assesses
the potential future impairment of goodwill on an annual basis, or at any other
time when impairment indicators exist. The Company concluded that at January 31,
2004 and July 31, 2004 no impairment of goodwill existed.
Stock-Based Compensation. As permitted by SFAS No. 123, Accounting for
Stock-Based Compensation, the Company follows the intrinsic value method of
accounting for stock-based compensation issued to employees, as prescribed by
Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued
to Employees, and related interpretations. Since all options outstanding at July
31, 2004 were granted at or above fair value at the date of grant, no
compensation expense has been recognized under the Company's stock option plan
for any of the financial statements presented.
If compensation expense for the Company's stock option plan had been
recognized using the fair value method of accounting under SFAS No. 123, net
income available for common stockholders for the three months ended July 31,
2003 and 2004 would have decreased by 2.2% and 3.3%, respectively, and diluted
earnings per share would have decreased by 3.3% and 3.4%, respectively. Net
income available for common stockholders for the six months ended July 31, 2003
and 2004 would have decreased by 2.3% and 3.1%, respectively, and diluted
earnings per share would have decreased by 1.8% and 3.3%, respectively. For
post-IPO grants, the Company has used the Black-Scholes model to determine fair
value. Prior to the IPO, the fair value of the options issued was estimated
using the minimum valuation option-pricing model. The following table presents
the impact to earnings per share if the Company had adopted the fair value
recognition provisions of SFAS No. 123 (dollars in thousands except per share
data):
6
Three Months Ended Six Months Ended
July 31, July 31,
----------------------------------------------
2003 2004 2003 2004
---------- ---------- ---------- ----------
Net income available for common
stockholders as reported $ 4,937 $ 6,790 $ 9,435 $ 14,563
Stock-based compensation, net of
tax, that would have been
reported under SFAS 123 (110) (225) (220) (450)
---------- ---------- ---------- ----------
Pro forma net income $ 4,827 $ 6,565 $ 9,215 $ 14,113
========== ========== ========== ==========
Earnings per share-as reported:
Basic $ 0.30 $ 0.29 $ 0.56 $ 0.63
Diluted $ 0.30 $ 0.29 $ 0.56 $ 0.61
Pro forma earnings per share:
Basic $ 0.29 $ 0.28 $ 0.55 $ 0.61
Diluted $ 0.29 $ 0.28 $ 0.55 $ 0.59
Application of APB 21 to Cash Option Programs that Exceed One Year in
Duration: In February 2004, the Company began offering deferred interest payment
plans on certain products that extend beyond one year. In accordance with APB
21, Interest on Receivables and Payables, such sales are discounted to their
fair value resulting in a reduction in sales and receivables and the
amortization of the discount amount over the term of the deferred interest
payment plan. The difference between the gross sale and the discounted amount is
reflected as a deduction of "Product sales" in the consolidated statements of
operations and the amount of the discount being amortized in the current period
is recorded in "Finance charges and other". For the three and six months ended
July 31, 2004, "Product sales" were reduced by $716,000 and $929,000,
respectively, and "Finance charges and other" was increased by $143,000 and
$172,000, respectively, to effect the adjustment to fair value and to reflect
the appropriate amortization of the discount.
Reclassifications. Certain reclassifications have been made in the prior
year's financial statements to conform to current year's presentation.
2. Supplemental Disclosure of Revenue and Comprehensive Income
A summary of the classification of the amounts included as "Finance charges
and other" is as follows (in thousands):
Three Months Ended Six Months Ended
July 31, July 31,
----------------------------------------------
2003 2004 2003 2004
---------- ---------- ---------- ----------
Securitization income $ 9,522 $ 12,297 $ 19,953 $ 23,625
Income from receivables not sold 178 472 409 767
Insurance commissions 3,571 3,932 6,612 7,708
Other 1,101 1,049 1,502 1,985
---------- ---------- ---------- ----------
Finance charges and other $ 14,372 $ 17,750 $ 28,476 $ 34,085
========== ========== ========== ==========
The components of total comprehensive income for the three and six months
ended July 31, 2003 and 2004 are presented in the table below:
Three Months Ended Six Months Ended
July 31, July 31,
----------------------------------------------
2003 2004 2003 2004
---------- ---------- ---------- ----------
Net income $ 5,523 $ 6,790 $ 10,608 $ 14,563
Unrealized gain on derivative
instruments, net 649 278 1,393 556
Taxes on unrealized gain on
derivatives 22 (98) (242) (196)
Adjustment of fair value of
securitized assets 184 521 370 1,323
Taxes on adjustment of fair value (65) (184) (131) (467)
---------- ---------- ---------- ----------
Total comprehensive income $ 6,313 $ 7,307 $ 11,998 $ 15,779
========== ========== ========== ==========
7
3. Fair Value of Derivatives
The Company held interest rate swaps and collars with notional amounts
totaling $70.0 million and $20.0 million as of July 31, 2003 and 2004,
respectively, with terms extending to April, 2005, and were held for the purpose
of hedging against variable interest rate risk, primarily related to cash flows
from the Company's interest-only strip as well as variable rate debt.
In fiscal 2003, hedge accounting was discontinued for $50.0 million of
swaps previously designated as hedges and in fiscal 2004, hedge accounting was
discontinued for the remaining $20.0 million of swaps. In accordance with SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities, at the
time hedge accounting was discontinued, the Company began to recognize changes
in fair value of the swaps as interest expense and to amortize the amount of
accumulated other comprehensive loss related to those derivatives as interest
expense over the period that the forecasted transactions affected the
consolidated statements of operations. During the three and six months ended
July 31, 2004, the Company reclassified $278,000 and $556,000, respectively, of
losses previously recorded in accumulated other comprehensive income into the
consolidated statements of operations and recorded $(316,000) and $(621,000),
respectively, of interest reductions in the consolidated statement of operations
because of the change in fair value of the swaps.
Prior to discontinuing hedge accounting, the Company recorded hedge
ineffectiveness in each period, which arose from differences between the
interest rate stated in the derivative instrument and the interest rate upon
which the underlying hedged transaction was based. Ineffectiveness totaled
$111,000 and $(98,000), respectively, for the three and six months ended July
31, 2003 and is reflected in "Interest expense" in the consolidated statements
of operations.
4. Amendment to Bank Credit Facility
During the current fiscal year, the Company reduced its revolving line of
credit from $40.0 million to $30.0 million through an amendment executed April
21, 2004. The amendment also relaxed certain financial covenants and reduced the
pricing options for both the stand-by fee and the interest rate on outstanding
balances.
5. Letters of Credit
The Company had outstanding unsecured letters of credit aggregating $11.8
million and $12.7 million at January 31, 2004 and July 31, 2004, respectively,
which secure a portion of the QSPE's asset-backed securitization program and the
deductible under the Company's insurance program and to secure international
product purchases. The maximum potential amount of future payments under these
letters of credit is considered to be the aggregate face amount of each letter
of credit.
As part of the asset-backed securitization program, the Company arranged
for the issuance of a stand-by letter of credit in the amount of $10.0 million
to provide assurance to the trustee of the asset-backed securitization program
that monthly funds collected by the Company would be remitted as required under
the base indenture and other related documents. The letter of credit has a term
of one year and expires in August 2005, at which time the Company expects to
renew such obligation. The letter of credit is callable, at the option of the
trustee, if the Company does not honor its obligation to remit funds under the
basic indenture and other related documents. The Company also has an obligation
to maintain the current letters of credit and to provide additional letters of
credit under its insurance program in amounts considered sufficient by the
carrier to cover expected losses of claims that remain open after the expiration
of the initial policy coverage period. The letter of credit in the amount of
$1.6 million at July 31, 2004 is callable, at the option of the insurance
company, if the Company does not honor its requirement to fund deductible
amounts as billed.
In addition to the above, the Company obtained a commitment in June 2004
for $1.5 million in trade letters of credit to secure product purchases under an
international arrangement. At July 31, 2004, there was $1.1 million drawn under
this commitment.
8
6. Contingencies
In December 2002, Martin E. Smith, as named plaintiff, filed a lawsuit
against the Company in the state district court in Jefferson County, Texas, that
attempts to create a class action for breach of contract and violations of state
and federal consumer protection laws arising from the terms of the Company's
service maintenance agreements. The lawsuit alleges an inappropriate overlap in
the product warranty periods provided by the manufacturer and the periods
covered by the service maintenance agreements that the Company sells. The
lawsuit seeks unspecified actual damages as well as an injunction against the
Company's current practices and extension of affected service contracts. The
Company believes that the warranty periods covered in its service maintenance
agreements are consistent with industry practice. The Company also believes that
it is premature to predict whether class action status will be granted or, if
granted, the outcome of this litigation. There is not currently a basis on which
to estimate a range of potential loss in this matter.
9
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-Looking Statements
This report contains forward-looking statements. We sometimes use words
such as "believe," "may," "will," "estimate," "continue," "anticipate,"
"intend," "expect," "project" and similar expressions, as they relate to us, our
management and our industry, to identify forward-looking statements.
Forward-looking statements relate to our expectations, beliefs, plans,
strategies, prospects, future performance, anticipated trends and other future
events. We have based our forward-looking statements largely on our current
expectations and projections about future events and financial trends affecting
our business. Actual results may differ materially. Some of the risks,
uncertainties and assumptions about us that may cause actual results to differ
from these forward-looking statements include, but are not limited to:
o the success of our growth strategy and plans regarding opening new
stores and entering adjacent and new markets, including our plans to
continue expanding into the Dallas/Fort Worth metroplex;
o our ability to update or expand existing stores;
o our ability to estimate required capital expenditures and costs
related to the opening of new stores or to update or expand existing
stores;
o our cash flows from operations, borrowings from our revolving line of
credit and proceeds from securitizations to fund our operations, debt
repayment and expansion;
o technological and market developments, growth trends and projected
sales in the home appliance and consumer electronics industry,
including digital products like DVD players, HDTV, digital radio, home
networking devices and other new products, and our ability to
capitalize on such growth;
o changes in laws and regulations and/or interest, premium and
commission rates allowed by regulators on our credit, credit insurance
and service maintenance agreements as allowed by those laws and
regulations;
o our relationships with key suppliers;
o the adequacy of our distribution and information systems and
management experience to support our expansion plans;
o the accuracy of our expectations regarding competition and our
competitive advantages;
o the accuracy of our expectations regarding the similarity or
dissimilarity of our existing markets as compared to new markets we
enter;
o the outcome of litigation affecting our business; and
o non-payment of dividends.
Additional important factors that could cause our actual results to differ
materially from our expectations are discussed under "Risk Factors" in our Form
10-K filed with the Securities Exchange Commission on April 16, 2004. In light
of these risks, uncertainties and assumptions, the forward-looking events and
circumstances discussed in this report might not happen.
The forward-looking statements in this report reflect our views and
assumptions only as of the date of this report. We undertake no obligation to
update publicly or revise any forward-looking statements, whether as a result of
new information, future events or otherwise, except as required by law.
10
All forward-looking statements attributable to us, or to persons acting on
our behalf, are expressly qualified in their entirety by these cautionary
statements.
General
The following discussion and analysis is intended to provide you with a
more meaningful understanding of our financial condition and performance in the
indicated periods, including an analysis of those key factors that contributed
to our financial condition and performance and that are, or are expected to be,
the key "drivers" of our business.
We are a specialty retailer that sells major home appliances, including
refrigerators, freezers, washers, dryers and ranges, 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 require all sales personnel to specialize in home
appliances, consumer electronics, or "track" products which 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. We currently operate 47 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 a large portion of all of our customer receivables through an
asset-backed securitization facility, and we derive servicing fee income and
interest income from these assets. As part of our asset-backed securitization
facility, we have created a qualifying special purpose entity, which we refer to
as the QSPE or the issuer, to purchase customer receivables from us and to issue
asset-backed and variable funding notes to third parties. We transfer
receivables, consisting of retail installment contracts and revolving accounts
extended to our customers, to the issuer in exchange for cash and subordinated
securities. To finance its acquisition of these receivables, the issuer has
issued notes to third parties.
We also derive revenues from repair services on the products we sell and
from product delivery and installation services we provide to our customers.
Additionally, acting as an agent for unaffiliated companies, we sell credit
insurance and service maintenance agreements to protect our customers from
credit losses due to death, disability, involuntary unemployment and property
damage and product failure. We also derive revenues from the sale of extended
service maintenance agreements to protect the customers after the original
manufacturer's warranty or service maintenance agreement has expired.
Executive Overview
This narrative is intended to provide an executive level overview of our
operations for the three and six months ended July 31, 2004. A detailed
explanation of the changes in our operations for the three and six months ended
July 31, 2004 as compared to the prior year is included beginning on page 15. As
explained in that section, our pretax income for the quarter ended July 31, 2004
increased approximately 21.2%, as a result of higher revenues, lower selling,
general and administrative expenses and lower interest expense as a percentage
of revenues. Pretax income for the six months ended July 31, 2004 increased
36.2% due to higher revenues, higher gross margin percentage, lower selling,
general and administrative expenses and lower interest expense as a percentage
of revenues. Some of the more specific issues that impacted our operations are
presented as follows:
o Same store sales for the quarter and year-to-date grew 7.2% and 5.3%,
respectively, over the same periods for the prior year. We believe
that we were able to achieve this favorable increase by continuing the
emphasis of sales of our primary product categories, by focusing
specifically on our track sales, and by taking the opportunity to
promote bedding and lawn and garden products. It is our strategy to
continue this combination of emphasizing our primary product
categories and focusing on specialty product categories throughout the
balance of fiscal 2005.
o Our entry into the Dallas/Fort Worth market provided both a positive
and negative impact on our operations. Approximately, $9.5 million and
$17.7 million, respectively, of our product sales increase for the
quarter and year-to-date resulted from the opening of five new stores
in this market. However, our operating margins were negatively
impacted as we initially incurred substantial startup costs in
personnel and advertising to insure that our initial entry into the
market was well received. Our plans provide for the opening of three
additional stores in this market during the balance of fiscal 2005.
11
o Part of our increase in same store sales during the quarter and
year-to-date resulted from the continuation of deferred interest
payment plans and the introduction of "no interest" plans on certain
products that extend beyond one year. In accordance with APB No. 21,
such sales have been discounted to their fair value, resulting in a
reduction in both sales and receivables, and the discount amount is
being amortized over the applicable term of the deferred payment plan.
For the three and six months ended July 31, 2004, such extended
deferred interest payment and "no interest" plans generated $9.3
million and $11.7 million, respectively, in new financings. We reduced
"Product sales" by $716,000 and $929,000, respectively, and increased
"Finance charges and other" by $143,000 and $172,000, respectively, to
effect the adjustment to fair value and to reflect the appropriate
amortization of the discount amount. We expect to continue to offer
this type of extended term promotional credit in the future and expect
that funding for such programs will be provided out of operating cash
flow or through draws against our bank credit facility.
o Our gross margin for the quarter decreased from 37.1% to 36.5%,
primarily as a result of the use of promotional credit required to
increase same store sales. Our gross margin for the six months ended
July 31, 2004 increased from 36.1% to 36.4% primarily as a result of
our ability to drive same store sales in the quarter ended April 30,
2004 without the need to deeply discount prices as we did in the prior
year.
o Part of our improvement in operations for the three and six months
ended July 31, 2004 resulted from our ability to reduce Selling,
general and administrative (SG&A) expenses as a percent of revenues.
We decreased SG&A expense from 27.7% to 27.5% for the three months
ended July 31, 2004 and we reduced SG&A from 27.0% to 26.7% for the
six months ended July 31, 2004 These improvements resulted primarily
from decreases in payroll and payroll related expenses.
o Our operating margin was also positively impacted in the current
quarter and for the six months ended July 31, 2004 by approximately
0.1%, respectively, as a result of the implementation of FASB
Interpretation No. 46, Consolidation of Variable Interest Entities, An
Interpretation of Accounting Research Bulletin No. 51 ("FIN 46"). FIN
46 had the impact of reclassifying approximately $218,000 and
$435,000, respectively, of occupancy expense from SG&A expense to
interest expense in the current quarter and six months ended July 31,
2004.
o As a result of the completion of our initial public offering, we were
able to utilize the net proceeds of the offering to retire all of our
balance sheet debt (not including any debt of SRDS, which is reflected
in the consolidated financial statements as a result of FIN 46) and
thereby substantially reduce our interest expense in the current
quarter and the six months ended July 31, 2004.
o As a result of FIN 46, beginning February 1, 2004, we now eliminate
the pretax operating profit contributed from the consolidation of SRDS
through the minority interest line item in our consolidated statement
of operations.
Operational Changes and Resulting Outlook
Our continued growth in the Dallas/Fort Worth metroplex will require us to
develop an adequate distribution center for that market. The present cross-dock
facility located in that market contains approximately 36,000 square feet and
will accommodate a total of ten to twelve stores. We are currently in the
planning stages to develop a complete warehouse and distribution center for this
market that we expect to contain approximately 100,000 to 150,000 square feet.
Additional annual cost to lease and operate such a facility is projected at
approximately $1.0 million to $1.5 million. Based on our present growth plans in
this market, it is expected that we will need such a distribution center by
early fiscal 2006.
12
We expect to open our first store in McAllen, Texas in early September
2004. We believe that this store represents an opportunity to enter a market
that is currently substantially underserved.
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 that
are then gradually reduced as the product becomes more mainstream. To sustain
positive same store sales growth, unit sales must increase at a rate greater
than the decline in product prices. The affordability of the product helps the
unit sales growth. However, as a result of relatively short product life cycles
in the consumer electronics industry, which limit the amount of time available
for sales 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, although we have
experienced positive increases in unit prices in the last three fiscal quarters.
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, 2004.
Transfers of Financial Assets. We transfer customer receivables to the QSPE
that issues asset-backed securities to third party lenders using these accounts
as collateral, and we continue to service these accounts after the transfer. We
recognize the sale of these accounts when we relinquish control of the
transferred financial asset in accordance with SFAS No. 140, Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities.
As we transfer the accounts, we record an asset representing the interest only
strip which is the difference between the interest earned on customer accounts
and the cost associated with financing and servicing the transferred accounts,
including a provision for bad debts associated with the transferred accounts
discounted to a market rate of interest. The gain or loss recognized on these
transactions is based on our best estimates of key assumptions, including
forecasted credit losses, payment rates, forward yield curves, costs of
servicing the accounts and appropriate discount rates. The use of different
estimates or assumptions could produce different financial results. For example,
if we had assumed a 10.0% reduction in net interest spread (which might be
caused by rising interest rates or reductions in rates charged on the accounts
transferred), our interest in securitized assets would have been reduced by $3.8
million as of July 31, 2004, which may have an adverse effect on earnings. We
recognize income from our interest in these transferred accounts as gains on the
transfer of the asset, interest income and servicing fees This income is
recorded as "Finance charges and other" in our consolidated statements of
operations. If the assumption used for developing the reserve for doubtful
accounts on the books of the QSPE were changed by 0.5% from 3.5% to 4.0%, the
impact to recorded "Finance charges and other" would have been a reduction in
revenues and pretax income of $1.9 million.
Deferred Tax Assets. We have significant net deferred tax assets
(approximately $7.9 million as of July 31, 2004), which are subject to periodic
recoverability assessments. Realization of our net deferred tax assets may be
dependent upon whether we achieve projected future taxable income. Our estimates
regarding future profitability may change due to future market conditions, our
ability to continue to execute at historical levels and our ability to continue
our growth plans. These changes, if any, may require material adjustments to
these deferred tax asset balances. For example, if we had assumed that the
future tax rate at which these deferred items would reverse was 34.5% rather
than 35.3%, we would have reduced the net deferred tax asset account and net
income by approximately $181,000.
13
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 No. 142, we amortized goodwill over an estimated life
of fifteen years on a straight-line basis. Effective with the implementation of
SFAS No. 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. Our testing includes using
judgments to estimate the separate operations of our insurance agency and
secondary credit portfolio, including allocations for interest, overhead and
taxes. Once these separate operations have been determined, we apply a multiple
of earnings based on existing market conditions and estimated operating cash
flow and compare the resulting estimated entity values to the recorded goodwill.
Changes in strategy or market conditions could significantly impact these
judgments and require adjustments to recorded asset balances. For example, if we
had reason to believe that our recorded goodwill had become impaired due to
decreases in the fair market value of the underlying business, we would have to
take a charge to income for that portion of goodwill that we believe is
impaired. Our goodwill balance at July 31, 2004 was $7.9 million.
Property, Plant and Equipment. Our accounting policies regarding land,
buildings, and equipment include judgments regarding the estimated useful lives
of such assets, the estimated residual values to which the assets are
depreciated, and the determination as to what constitutes increasing the life of
existing assets. These judgments and estimates may produce materially different
amounts of depreciation and amortization expense that would be reported if
different assumptions were used. These judgments may also impact the need to
recognize an impairment charge on the carrying amount of these assets as the
cash flows associated with the assets are realized. In addition, the actual life
of the asset and residual value may be different from the estimates used to
prepare financial statements in prior periods.
Revenue Recognition. Revenues from the sale of retail products are
recognized at the time the product is delivered to the customer. Such revenues
are recognized net of any adjustments for sales incentive offers such as
discounts, coupons, rebates, or other free products or services. We sell service
maintenance agreements and credit insurance contracts on behalf of unrelated
third parties. For contracts where the third parties are the obligors on the
contract, commissions are recognized in revenues at the time of sale, and in the
case of retrospective commissions, at the time that they are earned. Where we
sell service maintenance renewal agreements in which we are deemed to be the
obligor on the contract at the time of sale, revenue is recognized ratably, on a
straight-line basis, over the term of the service maintenance agreement. These
service maintenance agreements are renewal contracts that provide our customers
protection against product repair costs arising after the expiration of the
manufacturer's warranty and the third party obligor contracts. These agreements
typically range from 12 months to 36 months. These agreements are separate units
of accounting under Emerging Issues Task Force No. 00-21, Revenue Arrangements
with Multiple Deliverables. The amount of service maintenance agreement revenue
deferred at July 31, 2004 and January 31, 2004 was $3.1 million, respectively,
and is included in "Deferred revenue" in the accompanying balance sheets.
Vendor Allowances. We receive funds from vendors for price protection,
product rebates, marketing and training and promotion programs which are
recorded on the accrual basis as a reduction to the related product cost or
advertising expense according to the nature of the program. We accrue rebates
based on the satisfaction of terms of the program and sales of qualifying
products even though funds may not be received until the end of a quarter or
year. If the programs are related to product purchases, the allowances, credits
or payments are recorded as a reduction of product cost; if the programs are
related to promotion or marketing of the product, the allowances, credits, or
payments are recorded as a reduction of advertising expense in the period in
which the expense is incurred.
14
Results of Operations
The following table sets forth certain statement of operations information
as a percentage of total revenues for the periods indicated:
Three Months Ended Six Months Ended
July 31, July 31,
------------------ ------------------
2003 2004 2003 2004
-------- -------- -------- --------
Revenues:
Product sales 79.5 % 79.3 % 80.0 % 79.9 %
Service maintenance agreement
commissions (net) 4.0 4.2 4.1 4.2
Service revenues 4.2 3.5 3.9 3.3
-------- -------- -------- --------
Total net sales 87.7 87.0 88.0 87.4
Finance charges and other 12.3 13.0 12.0 12.6
-------- -------- -------- --------
Total revenues 100.0 100.0 100.0 100.0
Costs and expenses:
Cost of goods sold, including
warehousing and occupancy cost 62.1 62.7 63.0 62.8
Cost of parts sold, including
warehousing and occupancy cost 0.9 0.8 0.9 0.8
Selling, general and administrative
expense 27.7 27.5 27.0 26.7
Provision for bad debts 0.6 0.9 0.8 1.0
-------- -------- -------- --------
Total costs and expenses 91.3 91.9 91.7 91.3
-------- -------- -------- --------
Operating income 8.7 8.1 8.3 8.7
Interest expense 1.4 0.4 1.4 0.4
-------- -------- -------- --------
Earnings before income taxes and
minority interest 7.5 7.7 6.9 8.3
Minority interest 0.0 0.1 0.0 0.1
-------- -------- -------- --------
Earnings before income taxes 7.3 7.6 6.9 8.2
Provision for income taxes 2.6 2.6 2.4 2.9
-------- -------- -------- --------
Net income 4.7 % 5.0 % 4.5 % 5.3 %
======== ======== ======== ========
The table above identifies several changes in our operations for the
current quarter and six months ended, including changes in revenue and expense
categories expressed as a percentage of revenues for "Service revenues," "Cost
of goods and parts sold," "Selling, general and administrative expense" and
"Interest expense." These changes are discussed in the Executive Overview
section on page 11 and in more detail in the discussion of operating results
beginning in the analysis below.
Same store sales growth is calculated by comparing the reported sales by
store for all stores that were open throughout a period to reported sales by
store for all stores that were open through the prior period. Sales from closed
stores have been removed from each period. Sales from relocated stores have been
included in each period because each store was relocated within the same general
geographic market. Sales from expanded stores have been included in each period.
The presentation of gross margins may not be comparable to other retailers
since we include the cost of our in-home delivery service as part of selling,
general and administrative expense. Similarly, we include the cost 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 their cost of goods sold.
Three Months Ended July 31, 2004 Compared to Three Months Ended July 31, 2003
Revenues. Total revenues increased by $19.5 million, or 16.6%, from $117.1
million for the three months ended July 31, 2003 to $136.6 million for the three
months ended July 31, 2004. The increase was attributable to increases in net
sales of $16.1 million, or 15.7%, and $3.4 million, or 23.5%, in finance charges
and other revenue. Of the $16.1 million increase in net sales, $7.1 million
resulted from a same store sales increase of 7.2%, $9.8 million was generated by
five retail locations that were not open for three consecutive months in each
period, $(716,000) resulted from discounts of promotional credit sales and
$(129,000) resulted from a net decrease in service revenues. Of the $16.1
million increase in net sales, $15.1 million was attributable to increases in
product sales and $1.0 million was attributable to net changes in service
maintenance agreement commissions and service revenues. Of the $15.1 million
increase in product sales, approximately $7.6 million was attributable to
increases in unit sales and approximately $7.5 million was attributable to
increases in unit price points. Increased sales in bedding, lawn and garden,
computers and other new product categories included in the track accounted for
much of the increase in same store sales.
15
The following table presents the makeup of net sales by product category in
each quarter, including service maintenance agreement commissions and service
revenues, expressed both in dollar amounts and as a percent of total net sales.
Classifications of sales have been adjusted from previous filings to break out
the track area as a separate category.
Three Months Ended July 31,
----------------------------------------------
2003 2004 Percent
---------------------- ---------------------- Increase
Category Amount Percent Amount Percent (Decrease)
---------- ---------- ---------- ---------- ----------
Major home appliances $ 41,370 40.3 % $ 44,622 37.5 % 7.9 %
Consumer electronics 28,299 27.5 32,692 27.5 15.5
Track 14,536 14.1 18,865 15.9 29.8 (1)
Delivery/installation 1,701 1.7 1,937 1.6 13.9 (2)
Lawn and garden 3,930 3.8 5,501 4.6 40.0 (3)
Bedding 1,343 1.3 2,596 2.2 93.3 (3)
Other 1,976 1.9 2,092 1.8 5.9
---------- ---------- ---------- ---------- ----------
Total product sales 93,155 90.6 108,305 91.1 16.3
Service maintenance agreement
commissions 4,699 4.6 5,776 4.9 22.9
Service revenues 4,900 4.8 4,770 4.0 (2.7) (4)
---------- ---------- ---------- ---------- ----------
Total net sales $ 102,754 100.0 % $ 118,851 100.0 % 15.7 %
========== ========== ========== ========== ==========
______________________________________
(1) The increases are primarily due to the new emphasis on track sales.
(2) The increase is primarily due to a price increase charged to the
customer for delivery service.
(3) The increase is primarily due to continuing maturity of this new
product category and the continued sales emphasis on this product
category.
(4) The decrease in service revenues is attributable to a more stringent
review of the exclusions provided under the service maintenance
agreements for covered warranty service. As a result of these billing
reviews, service revenues for the three months ended July 31, 2004
were somewhat softened; however, retrospective warranty claim
settlements were positively impacted by approximately $677,000 during
the same period. Such settlements, which offset the decrease in
service revenues are reflected in the line item "Finance charges and
other."
Revenue from "Finance charges and other" increased by approximately $3.4
million, or 23.5%, from $14.4 million for the three months ended July 31, 2003
to $17.8 million for the three months ended July 31, 2004. This increase in
revenue resulted primarily from increases in insurance commissions and other
revenues of $603,000 and increases in securitization income of $2.8 million.
Both of these increases are attributable to higher product sales and increases
in our retained interest in assets transferred to the QSPE.
Cost of Goods Sold. Cost of goods sold, including warehousing and occupancy
cost, increased by $13.0 million, or 17.9%, from $72.7 million for the three
months ended July 31, 2003 to $85.7 million for the three months ended July 31,
2004. This increase was generally consistent with the 16.3% increase in net
product sales during the three months ended July 31, 2004, although cost of
products sold increased from 78.0% of net product sales in the quarter ended
July 31, 2003 to 79.1% for the quarter ended July 31, 2004. We attribute this
product gross margin decrease to more aggressive price discounting that was used
to drive same store sales. Cost of parts sold, including warehousing and
occupancy cost, increased approximately $85,000, or 8.4%, for the three months
ended July 31, 2004 as compared to the three months ended July 31, 2003.
16
Selling, General and Administrative Expense. Selling, general and
administrative expense increased by $5.1 million, or 15.8%, from $32.4 million
for the three months ended July 31, 2003 to $37.5 million for the three months
ended July 31, 2004. The decrease in expense as a percentage of total revenues
for this category resulted primarily from decreased payroll and payroll related
expense that was offset by higher advertising costs associated with our
Dallas/Fort Worth operations.
Provision for Bad Debts. The provision for bad debts increased by $406,000,
or 49.5%, during the three months ended July 31, 2004 as compared to the three
months ended July 31, 2003, resulting from higher losses associated with the
customer receivables not transferred to the QSPE. This number is higher for the
quarter, but in line with past losses as a percentage of revenue on a
year-to-date basis.
Interest Expense. Interest expense decreased by $1.1 million, or 66%, from
$1.7 million for the three months ended July 31, 2003 to $567,000 for the three
months ended July 31, 2004. The net decrease in interest expense was
attributable to the following factors:
o expiration of $50.0 million in our interest rate hedges resulted in a
decrease of 68.5%, or $638,000, from the prior period;
o discontinuation of hedge accounting for derivatives resulted in a
decrease in interest expense of approximately $147,000; and
o the decrease in our average outstanding debt from $ 46.9 million to
$738,000 (not including the impact of FIN 46 consolidation of $14.6
million, see below) resulted in a decrease in interest expense of
approximately $618,000;
that were offset by the following increases:
o the increase in interest rates and commitment fees of $81,000; and
o the implementation of FIN 46 resulted in reclassification of $219,000
in expenses previously reflected as occupancy cost in "Selling,
general and administrative expense" to "Interest expense."
Minority Interest. As a result of FIN 46, beginning February 1, 2004, we
now eliminate the pretax operating profit contributed from the consolidation of
SRDS through the minority interest line item in our consolidated statement of
operations, which for the three months ended July 31, 2004, was $131,000.
Provision for Income Taxes. The provision for income taxes increased by
$544,000, or 17.9%, from $3.0 million for the three months ended July 31, 2003
to $3.6 million for the three months ended July 31, 2004. This increase was
generally consistent with the increase in pretax income of 21.2% during the
three months ended July 31, 2004. Effective tax rates decreased from 35.4% in
fiscal 2004 to 34.4% in fiscal 2005 based on our expectation of the tax rate
that we will actually pay.
Net Income. As a result of the above factors, net income increased $1.3
million, or 23.0%, from $5.5 million for the three months ended July 31, 2003 to
$6.8 million for the three months ended July 31, 2004. Income available for the
common stockholder increased $1.9 million, or 37.6%, from $4.9 million to $6.8
million, during the three months ended July 31, 2004 as compared to the three
months ended July 31, 2003, resulting from improvements in operations and the
elimination of preferred stock dividends that were paid in the prior year. The
elimination of the preferred dividends in 2004 fiscal year resulted from the
impact of the initial public offering when all preferred stock was redeemed for
cash or was converted into common shares.
17
Six Months Ended July 31, 2004 Compared to Six Months Ended July 31, 2003
Revenues. Total revenues increased by $33.6 million, or 14.1%, from $237.9
million for the six months ended July 31, 2003 to $271.5 million for the six
months ended July 31, 2004. The increase was attributable to increases in net
sales of $28.0 million, or 13.4%, and $5.6 million, or 19.7%, in finance charges
and other revenue. Of the $28.0 million increase in net sales, $10.8 million
resulted from a same store sales increase of 5.3%, $18.3 million was generated
by five retail locations that were not open for six consecutive months in each
period, $(929,000) resulted from discounts of promotional credit sales and
$(227,000) resulted from a net decrease in service revenues. Of the $28.0
million increase in net sales, $26.4 million was attributable to increases in
product sales and $1.6 million was attributable to net changes in service
maintenance agreement commissions and service revenues. Of the $26.4 million
increase in product sales, approximately $12.4 million was attributable to
increases in unit sales and approximately $14.0 million was attributable to
increases in unit price points. Increased sales in bedding, lawn and garden,
computers and other new product categories included in the track accounted for
much of the increase in same store sales.
The following table presents the makeup of net sales by product category in
each period, including service maintenance agreement commissions and service
revenues, expressed both in dollar amounts and as a percent of total net sales.
Classifications of sales have been adjusted from previous filings to break out
the track area as a separate category.
Six Months Ended July 31,
----------------------------------------------
2003 2004 Percent
---------------------- ---------------------- Increase
Category Amount Percent Amount Percent (Decrease)
---------- ---------- ---------- ---------- ----------
Major home appliances $ 80,702 38.5 % $ 86,454 36.4 % 7.1 %
Consumer electronics 61,914 29.6 70,311 29.6 13.6
Track 30,070 14.4 37,044 15.6 23.2 (1)
Delivery/installation 3,151 1.5 3,785 1.6 20.1 (2)
Lawn and garden 7,830 3.7 10,054 4.2 28.4 (3)
Bedding 2,820 1.3 4,865 2.0 72.5 (3)
Other 3,907 1.9 4,295 1.9 9.9
---------- ---------- ---------- ---------- ----------
Total product sales 190,394 90.9 216,808 91.3 13.9
Service maintenance
agreement commissions 9,671 4.6 11,436 4.8 18.3
Service revenues 9,376 4.5 9,149 3.9 (2.4) (4)
---------- ---------- ---------- ---------- ----------
Total net sales $ 209,441 100.0 % $ 237,393 100.0 % 13.3 %
========== ========== ========== ========== ==========
______________________________________
(1) The increases are primarily due to the new emphasis on track sales.
(2) The increase is primarily due to a price increase charged to the
customer for delivery service.
(3) The increase is primarily due to continuing maturity of this new
product category and the continued sales emphasis on this product
category.
(4) The decrease in service revenues is attributable to a more stringent
review of the exclusions provided under the service maintenance
agreements for covered warranty service. As a result of these billing
reviews, service revenues for the three months ended July 31, 2004
were somewhat softened; however, retrospective warranty claim
settlements were positively impacted by approximately $826,000 during
the same period. Such settlements, which offset the decrease in
service revenues are reflected in the line item "Finance charges and
other."
Revenue from "Finance charges and other" increased by approximately $5.6
million, or 19.7%, from $28.5 million for the six months ended July 31, 2003 to
$34.1 million for the six months ended July 31, 2004. This increase in revenue
resulted primarily from increases in insurance commissions and other revenues of
$1.9 million and increases in securitization income of $3.7 million. Both of
these increases are attributable to higher product sales and increases in our
retained interest in assets transferred to the QSPE.
Cost of Goods Sold. Cost of goods sold, including warehousing and occupancy
cost, increased by $20.8 million, or 13.9%, from $149.7 million for the six
months ended July 31, 2003 to $170.5 million for the six months ended July 31,
2004. This increase was generally consistent with the 13.9% increase in net
product sales during the six months ended July 31, 2004. Cost of products sold
decreased from 78.7% of net product sales in the six months ended July 31, 2003
to 78.6% for the six months ended July 31, 2004. Cost of parts sold, including
warehousing and occupancy cost, increased approximately $142,000, or 6.9%, for
the six months ended July 31, 2004 as compared to the six months ended July 31,
2003.
18
Selling, General and Administrative Expense. Selling, general and
administrative expense increased by $8.2 million, or 12.8%, from $64.2 million
for the six months ended July 31, 2003 to $72.4 million for the six months ended
July 31, 2004. The decrease in expense as a percentage of total revenues for
this period results primarily from decreased payroll and payroll related
expense.
Provision for Bad Debts. The provision for bad debts increased by $461,000,
or 21.0%, during the six months ended July 31, 2004 as compared to the six
months ended July 31, 2003, resulting from the increase in customer receivables
that were not transferred to the QSPE. Bad debt expense as a percentage of
revenues increased from 0.9% for the six months ended July 31, 2003 to 1.0% for
the six months ended July 31, 2004.
Interest Expense. Interest expense decreased by $2.1 million, or 64.3%,
from $3.2 million for the six months ended July 31, 2003 to $1.1 million for the
six months ended July 31, 2004. The net decrease in interest expense was
attributable to the following factors:
o expiration of $80.0 million in our interest rate hedges resulted in a
decrease of 71.1% or $1.5 million from the prior period; and
o the decrease in our average outstanding debt from $ 48.1 million to
$204,000 (when ignoring the impact of FIN 46 consolidation of $14.6
million, see below) resulted in a decrease in interest expense of
approximately $1.2 million;
that were offset by the following increases:
o the increase in interest rates and commitment fees of $180,000;
o discontinuation of hedge accounting for derivatives resulted in an
increase in interest expense of $35,000; and
o the implementation of FIN 46 resulted in reclassification of $435,000
in expenses previously reflected as occupancy cost in "Selling,
general and administrative expense" to "Interest expense."
Minority Interest. As a result of FIN 46, beginning February 1, 2004, we
now eliminate the pretax operating profit contributed from the consolidation of
SRDS through the minority interest line item in our consolidated statement of
operations, which for the six months ended July 31, 2004, was $246,000.
Provision for Income Taxes. The provision for income taxes increased by
$2.0 million, or 34.1%, from $5.8 million for the six months ended July 31, 2003
to $7.8 million for the six months ended July 31, 2004. This increase was
generally consistent with the increase in pretax income of 36.2% during the six
months ended July 31, 2004. Effective tax rates decreased from 35.5% in fiscal
2004 to 34.9% in fiscal 2005 based on our expectation of the tax rate that we
will actually pay.
Net Income. As a result of the above factors, net income increased $4.0
million, or 37.3%, from $10.6 million for the six months ended July 31, 2003 to
$14.6 million for the six months ended July 31, 2004. Income available for the
common stockholder increased $5.2 million, or 54.4%, from $9.4 million to $14.6
million, during the six months ended July 31, 2004 as compared to the six months
ended July 31, 2003, resulting from improvements in operations and the
elimination of preferred stock dividends that were paid in the prior year. The
elimination of the preferred dividends in 2004 fiscal year resulted from the
impact of the initial public offering when all preferred stock was redeemed for
cash or was converted into common shares.
19
Liquidity and Capital Resources
Current Activities
Historically we have financed our operations through a combination of cash
flow generated from operations, external borrowings, including primarily bank
debt and asset-backed securitization facilities, and, most recently, our initial
public offering. As of January 31, 2004, we had $40.0 million under the
revolving line of credit (based on qualifying assets) and $8.0 million under our
unsecured bank line of credit available to us for general corporate purposes. As
of July 31, 2004, we had successfully reduced the revolving line of credit to
$30.0 million in exchange for an amendment to our bank credit facility that
reduces interest rates, standby rates and commitment fees among other
concessions.
A summary of the significant financial covenants that govern our bank
credit facility compared to our actual compliance status at July 31, 2004, is
presented below:
Required
Minimum/
Actual Maximum
------------- -------------
Debt service coverage ratio must exceed
required minimum 2.76 to 1.00 2.00 to 1.00
Total leverage ratio must be lower than
required maximum 2.06 to 1.00 3.00 to 1.00
Consolidated net worth must exceed required
minimum $176,124,000 $ 77,580,923
Charge-off ratio must be lower than required
maximum 0.02 to 1.00 0.05 to 1.00
Extension ratio must be lower than required
maximum 0.02 to 1.00 0.04 to 1.00
Delinquency ratio must be lower than
required maximum 0.07 to 1.00 0.12 to 1.00
We will continue to finance our operations and future growth through a
combination of cash flow generated from operations and external borrowings,
including primarily bank debt and the QSPE's asset-backed securitization
facilities. Based on our current operating plans, we believe that cash generated
from operations, available borrowings under our bank credit facility and
unsecured credit line, and access to the unfunded portion of the variable
funding portion of the QSPE's asset-backed securitization program will be
sufficient to fund our operations, store expansion and updating activities and
capital programs through at least January 31, 2006. However, there are several
factors that could decrease cash provided by operating activities, including:
o reduced demand for our products;
o more stringent vendor terms on our inventory purchases;
o increases in product cost that we may not be able to pass on to our
customers;
o reductions in product pricing due to competitor promotional
activities;
o changes in inventory requirements based on longer delivery times of
the manufacturers or other requirements which would negatively impact
our delivery and distribution capabilities;
o increases in the retained portion of our receivables portfolio under
our current QSPE's asset-backed securitization program as a result of
changes in performance;
o inability to expand our capacity for financing our receivables
portfolio under new or replacement QSPE asset-backed securitization
programs or a requirement that we retain a higher percentage of the
credit portfolio under such new programs;
o increases in program costs (interest and administrative fees relative
to our receivables portfolio associated with the funding of our
receivables); and
o increases in personnel costs required for us to stay competitive in
our markets.
During the six months ended July 31, 2004, net cash provided by operating
activities decreased $10.2 million from $11.0 million provided in the 2003
period to $786,000 provided in the 2004 period. The net decrease in cash
provided from operations resulted primarily from the expansion of promotional
credit programs over one year old that we planned to fund through our internal
operations rather than selling these receivables to the QSPE. We expect to
continue to increase our business using promotional credit. We believe that the
available balances under our bank credit facility are sufficient to fund the
increase in receivables or any increase in credit enhancement that we expect
through the end of fiscal 2006.
20
As noted above, we offer promotional credit programs to certain customers
that provide for "same as cash" interest free periods of varying terms,
generally three, six, or 12 months; we recently increased these terms to include
18 or 24 months that are not eligible to be funded through our asset-backed
securitization program. Early in the second quarter of this year, we began
offering "interest free" programs with 36-month terms that are also not eligible
to be funded through our asset-backed securitization program. The amounts
outstanding in promotional programs that are not eligible to be funded under our
asset-backed securitization program totaled $13.1 million at July 31, 2004. The
three, six, and 12 month "same as cash" promotional accounts are eligible for
securitization up to the limits provided for in our securitization agreements.
This limit is currently 20.0% of eligible securitized receivables. The
percentage of eligible securitized receivables represented by promotional
receivables was 11.7% and 14.0% as of July 31, 2003 and July 31, 2004,
respectively. This increase was the result of sales with the use of promotional
credit versus lower prices at retail. If we exceed this 20.0% limit, we would be
required to use some of our other capital resources to fund or carry the unpaid
balances of the receivables for the promotional period. The weighted average
promotional period was 10.7 months and 10.8 months for promotional receivables
outstanding as of July 31, 2003 and July 31, 2004, respectively. The weighted
average remaining term on those same promotional receivables was 6.0 months and
6.4 months, respectively. While overall these promotional receivables have a
much shorter weighted average term than non-promotional receivables, we receive
less income as a result of a reduced net interest margin used in the calculation
of the gain on the sale of receivables. As a result, the existence of the
interest free extended payment terms negatively impacts the gains as compared to
other receivables.
Net cash used by investing activities increased by $6.9 million from $2.2
million for the six months ended July 31, 2003 to $9.0 million for the six
months ended July 31, 2004. The increase in cash used in investing activities
resulted primarily from an increase in the purchase of property and equipment of
$6.7 million and a decrease in the proceeds from the sale of property of
$174,000. The increase in cash expended for property and equipment resulted
primarily from the opening of two new stores in the Dallas/Fort Worth market,
the reformatting of our stores to focus on track operations and the acquisition
another store location in the Dallas/Fort Worth market that will be opened later
in this fiscal year. Based on current plans, we expect to continue to increase
expenditures for property and equipment in the balance of fiscal 2005 as we open
additional stores, complete our track reformatting and improve our warehouse
facility in the Dallas/Fort Worth market.
Since we used the proceeds of our initial public offering to pay down all
interest bearing debt (other than that of SRDS), there were only insignificant
debt repayment transactions in the current six months, down $10.0 million from
the same prior year period. The exercise of stock options and the purchase of
stock under the Employee Stock Purchase Plan by various employees during the six
months ended July 31, 2004 represented the additional positive change in cash in
financing activities of $686,000.
Off-Balance Sheet Financing Arrangements
Since we extend credit in connection with a large portion of our retail,
service maintenance and credit insurance sales, we have created a qualified
special purpose entity, which we refer to as the QSPE or the issuer, to purchase
customer receivables from us and to issue asset-backed and variable funding
notes to third parties. We transfer receivables, consisting of retail
installment contracts and revolving accounts extended to our customers, to the
issuer in exchange for cash and unsecured promissory notes. To finance its
acquisition of these receivables, the issuer has issued the notes described
below to third parties. The unsecured promissory notes issued to us are
subordinate to these third party notes.
At July 31, 2004, the issuer has issued two series of notes: a Series A
variable funding note in the amount of $250 million purchased by Three Pillars
Funding Corporation and three classes of Series B notes in the aggregate amount
of $200 million. Private institutional investors, primarily insurance companies,
purchased the Series B notes at a weighted fixed rate of 5.1%.
We continue to service the transferred accounts for the QSPE, and we
receive a monthly servicing fee, so long as we act as servicer, in an amount
equal to .0025% multiplied by the average aggregate principal amount of
receivables serviced plus the amount of average aggregate defaulted receivables.
The issuer records revenues equal to the interest charged to the customer on the
receivables less losses, the cost of funds, the program administration fees paid
in connection with either Three Pillars Funding Corporation or the Series B note
holders, and the servicing fee.
21
The Series A variable funding note permits the issuer to borrow funds up to
$250 million to purchase receivables from us, thereby functioning as a "basket"
to accumulate receivables. When borrowings under the Series A variable funding
note approach $250 million, the issuer intends to refinance the receivables by
issuing a new series of notes and to use the proceeds to pay down the
outstanding balance of the Series A variable funding note, so that the basket
will once again become available to accumulate new receivables. As of July 31,
2004, borrowings under the Series A variable funding note were $83.3 million.
We are not directly liable to the lenders under the asset-backed
securitization facility. If the issuer is unable to repay the Series A 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 its restricted cash account. We are also contingently
liable under a $10.0 million letter of credit that secures our performance of
our obligations or services under the servicing agreement as it relates to the
transferred assets that are part of the asset-backed securitization facility.
The issuer is subject to certain affirmative and negative covenants
contained in the transaction documents governing the Series A variable funding
note and the Series B notes, including covenants that restrict, subject to
specified exceptions: the incurrence of non-permitted indebtedness and other
obligations and the granting of additional liens; mergers, acquisitions,
investments and disposition of assets; and the use of proceeds of the program.
The issuer also makes representations and warranties relating to compliance with
certain laws, payment of taxes, maintenance of its separate legal entity,
preservation of its existence, protection of collateral and financial reporting.
In addition, the program requires the issuer to maintain a minimum net worth.
A summary of the significant financial covenants that govern the issuer's
asset-backed credit facility compared to actual compliance status at July 31,
2004, is presented below:
Required
Minimum/
Actual Maximum
------------- -------------
Issuer interest must exceed required minimum $39.1 million $35.6 million
Gross loss rate must be lower than required
maximum 3.2% 10.0%
Net portfolio yield must exceed required
minimum 10.2% 2.0%
Payment rate must exceed required minimum 7.0% 3.0%
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 other
events pertaining to us. The issuer's obligations under the program are secured
by the receivables and proceeds.
22
Securitization Facilities
We finance most of our customer receivables through asset-backed
securitization facilities
-------------------------------
Series A
$250 million
|-----> Credit Rating: P1/A2
| Three Pillars Funding Corp.
| -------------------------------
------------------ -----------------> ------------------ |
|
Retail Qualifying |
Sales Special Purpose <------
Entity Entity |
("QSPE") |
------------------ <----------------- ------------------ |
| -------------------------------
1. Cash Proceeds | Series B
2. Subordinated Securities | $200 million
3. Right to Receive Cash Flows |-----> Private Institutional
Equal to Interest Rate Spread Investors
Class A: $120 mm (Aaa)
Class B: $57.8 mm (A2)
Class C: $22.2 mm (Baa2)
-------------------------------
Both the bank credit facility and the asset-backed securitization program
are significant factors relative to our ongoing liquidity and our ability to
meet the cash needs associated with the growth of our business. Our inability to
use either of these programs because of a failure to comply with their covenants
would adversely affect our continued growth. Funding of current and future
receivables under the QSPE's asset-backed securitization program can be
adversely affected if we exceed certain predetermined levels of re-aged
receivables, size of the secondary portfolio, the amount of promotional
receivables, write-offs, bankruptcies or other ineligible receivable amounts. If
the funding under the QSPE's asset-backed securitization program were reduced or
terminated, we would have to draw down our bank credit facility more quickly
than we have estimated.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest rates under our bank credit facility are variable and are
determined, at our option, as the base rate, which is the greater of prime rate
or federal funds rate plus 0.50% plus the base rate margin, which ranges from
0.50% 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
$20.0 million as of January 31, 2004 and July 31, 2004, with terms extending
through April, 2005, and were held for the purpose of hedging against variable
interest rate risk, primarily related to cash flows from our interest-only strip
as well as our variable rate debt. There have been no material changes in our
interest rate risks since January 31, 2004.
Item 4. Controls and Procedures
An evaluation was performed under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer, regarding the effectiveness of our disclosure controls and
procedures (as defined in 15d-15(e) of the Securities Exchange Act of 1934 (the
"Exchange Act") as of the end of the period covered by this quarterly report.
Based on that evaluation, our management, including our Chief Executive Officer
and our Chief Financial Officer, concluded that our disclosure controls and
procedures are effective in timely alerting them to material information
relating to our Company (including its consolidated subsidiaries) required to be
included in our periodic filings with the Securities and Exchange Commission.
There have been no changes in our internal control over financial reporting that
occurred during the quarter ended July 31, 2004 that have materially affected,
or are reasonably likely to materially affect, our internal control over
financial reporting.
23
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
In December 2002, Martin E. Smith, as named plaintiff, filed a lawsuit
against us in the state district court in Jefferson County, Texas, that attempts
to create a class action for breach of contract and violations of state and
federal consumer protection laws arising from the terms of our service
maintenance agreements. The lawsuit alleges an inappropriate overlap in the
warranty periods provided by the manufacturers of our products and the periods
covered by the service maintenance agreements that we sell. The lawsuit seeks
unspecified actual damages as well as an injunction against our current
practices and extension of affected service contracts. We believe that the
warranty periods provided by our service maintenance agreements are consistent
with industry practice. We believe that it is premature to predict whether class
action status will be granted or, if it is granted, the outcome of this
litigation. There is not currently a basis on which to estimate a range of
potential loss in this matter.
We are involved in routine litigation incidental to our business from time
to time. We do not expect the outcome of any of this routine litigation to have
a material effect on our financial condition or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
At the Annual Meeting of Stockholders held on June 3, 2004, the following
proposals were submitted to stockholders with the following results:
1. Approval of an amendment to our certificate of incorporation to allow
our board of directors to determine the size of the board of directors
and to remove the provisions providing for a classified board of
directors
Number of Shares
------------------------------------------
For 19,543,972
Against 3,604,127
Abstain 3,700
2. Election of two directors
Number of Shares
------------------------------------------------
For Withheld
-------------------- -----------------------
Marvin D. Brailsford 21,606,502 36,791
William T. Trawick 19,247,850 2,395,443
The following individuals are directors of the Company and their term
expires at the Company's Annual Meeting of Stockholders in 2005: Jon
E. M. Jacoby, Bob L. Martin and Scott L. Thompson. The following
individuals are directors of the Company and their term expires at the
Company's Annual Meeting of Stockholders in 2006: Thomas J. Frank,
Sr., Douglas H. Martin and Theodore M. Wright.
24
3. Approval of an amendment to the Conn's, Inc. Amended and Restated 2003
Incentive Stock Option Plan to provide for a maximum number of shares
with respect to which options may be granted during a specified period
to any single employee and to grant the chief executive officer the
authority to grant options to non-executive officers
Number of Shares
------------------------------------------
For 18,089,579
Against 1,455,837
Abstain
Item 5. Other Information
There have been no material changes to the procedures by which security
holders may recommend nominees to our board of directors since we last provided
disclosure in response to the requirements of Item 7(d)(2)(ii)(G) of Schedule
14A.
Item 6. Exhibits
The exhibits required to be furnished pursuant to Item 6 of Form 10-Q are
listed in the Exhibit Index filed herewith, which Exhibit Index is incorporated
herein by reference.
25
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
CONN'S, INC.
By: /s/ C. William Frank
-----------------------------
C. William Frank
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer
and duly authorized to sign
this report on behalf of the
registrant)
Date: August 31, 2004
26
INDEX TO EXHIBITS
Exhibit
Number Description
------- -----------
2 Agreement and Plan of Merger dated January 15, 2003, by and among
Conn's, Inc., Conn Appliances, Inc. and Conn's Merger Sub, Inc.
(incorporated herein by reference to Exhibit 2 to Conn's, Inc.
registration statement on Form S-1 (file no. 333-109046)).
3.1 Certificate of Incorporation of Conn's, Inc. (incorporated herein
by reference to Exhibit 3.1 to Conn's, Inc. registration
statement on Form S-1 (file no. 333-109046)).
3.1.1 Certificate of Amendment to the Certificate of Incorporation of
Conn's, Inc. filed on June 3, 2004 (incorporated herein by
reference to Exhibit 3.1.1 of Conn's quarterly report on Form
10-Q for the quarter ended April 30, 2004).
3.2 Bylaws of Conn's, Inc. (incorporated herein by reference to
Exhibit 3.2 to Conn's, Inc. registration statement on Form S-1
(file no. 333-109046)).
3.2.1 Amendment to the Bylaws of Conn's, Inc. (incorporated herein by
reference to Exhibit 3.2.1 of Conn's quarterly report on Form
10-Q for the quarter ended April 30, 2004).
4.1 Specimen of certificate for shares of Conn's, Inc.'s common stock
(incorporated herein by reference to Exhibit 4.1 to Conn's, Inc.
registration statement on Form S-1 (file no. 333-109046)).
10.1 Amended and Restated 2003 Incentive Stock Option Plan
(incorporated herein by reference to Exhibit 10.1 to Conn's, Inc.
registration statement on Form S-1 (file no. 333-109046)).
10.1.1 Amendment to the Conn's, Inc. Amended and Restated 2003 Incentive
Stock Option Plan (incorporated herein by reference to Exhibit
10.1.1 of Conn's quarterly report on Form 10-Q for the quarter
ended April 30, 2004).
10.2 2003 Non-Employee Director Stock Option Plan (incorporated herein
by reference to Exhibit 10.2 to Conn's, Inc. registration
statement on Form S-1 (file no. 333-109046)).
10.3 Employee Stock Purchase Plan (incorporated herein by reference to
Exhibit 10.3 to Conn's, Inc. registration statement on Form S-1
(file no. 333-109046)).
10.4 Conn's 401(k) Retirement Savings Plan (incorporated herein by
reference to Exhibit 10.4 to Conn's, Inc. registration statement
on Form S-1 (file no. 333-109046)).
10.5 Shopping Center Lease Agreement dated May 3, 2000, by and between
Beaumont Development Group, L.P., f/k/a Fiesta Mart, Inc., as
Lessor, and CAI, L.P., as Lessee, for the property located at
3295 College Street, Suite A, Beaumont, Texas (incorporated
herein by reference to Exhibit 10.5 to Conn's, Inc. registration
statement on Form S-1 (file no. 333-109046)).
10.5.1 First Amendment to Shopping Center Lease Agreement dated
September 11, 2001, by and among Beaumont Development Group,
L.P., f/k/a Fiesta Mart, Inc., as Lessor, and CAI, L.P., as
Lessee, for the property located at 3295 College Street, Suite A,
Beaumont, Texas (incorporated herein by reference to Exhibit
10.5.1 to Conn's, Inc. registration statement on Form S-1 (file
no. 333-109046)).
10.6 Industrial Real Estate Lease dated June 16, 2000, by and between
American National Insurance Company, as Lessor, and CAI, L.P., as
Lessee, for the property located at 8550-A Market Street,
Houston, Texas (incorporated herein by reference to Exhibit 10.6
to Conn's, Inc. registration statement on Form S-1 (file no.
333-109046)).
27
10.7 Lease Agreement dated December 5, 2000, by and between Prologis
Development Services, Inc., f/k/a The Northwestern Mutual Life
Insurance Company, as Lessor, and CAI, L.P., as Lessee, for the
property located at 4810 Eisenhauer Road, Suite 240, San Antonio,
Texas (incorporated herein by reference to Exhibit 10.7 to
Conn's, Inc. registration statement on Form S-1 (file no.
333-109046)).
10.7.1 Lease Amendment No. 1 dated November 2, 2001, by and between
Prologis Development Services, Inc., f/k/a The Northwestern
Mutual Life Insurance Company, as Lessor, and CAI, L.P., as
Lessee, for the property located at 4810 Eisenhauer Road, Suite
240, San Antonio, Texas (incorporated herein by reference to
Exhibit 10.7.1 to Conn's, Inc. registration statement on Form S-1
(file no. 333-109046)).
10.8 Lease Agreement dated August 18, 2003, by and between Robert K.
Thomas, as Lessor, and CAI, L.P., as Lessee, for the property
located at 4610-12 McEwen Road, Dallas, Texas (incorporated
herein by reference to Exhibit 10.8 to Conn's, Inc. registration
statement on Form S-1 (file no. 333-109046)).
10.9 Credit Agreement dated April 24, 2003, by and among Conn
Appliances, Inc. and the Borrowers thereunder, the Lenders party
thereto, JPMorgan Chase Bank, as Administrative Agent, Bank of
America, N.A., as Syndication Agent, and SunTrust Bank, as
Documentation Agent (incorporated herein by reference to Exhibit
10.9 to Conn's, Inc. registration statement on Form S-1 (file no.
333-109046)).
10.9.1 Amendment to Credit Agreement, dated April 7, 2004, by and among
Conn Appliances, Inc. and the Borrowers thereunder, the Lenders
party thereto, JPMorgan Chase Bank, as Administrative Agent, Bank
of America, N.A., as Syndication Agent, and SunTrust Bank, as
Documentation Agent (incorporated herein by reference to Exhibit
99.1 to Conn's current report on Form 8-K filed on April 23,
2004).
10.10 Receivables Purchase Agreement dated September 1, 2002, by and
among Conn Funding II, L.P., as Purchaser, Conn Appliances, Inc.
and CAI, L.P., collectively as Originator and Seller, and Conn
Funding I, L.P., as Initial Seller (incorporated herein by
reference to Exhibit 10.10 to Conn's, Inc. registration statement
on Form S-1 (file no. 333-109046)).
10.11 Base Indenture dated September 1, 2002, by and between Conn
Funding II, L.P., as Issuer, and Wells Fargo Bank Minnesota,
National Association, as Trustee (incorporated herein by
reference to Exhibit 10.11 to Conn's, Inc. registration statement
on Form S-1 (file no. 333-109046)).
10.12 Series 2002-A Supplement to Base Indenture dated September 1,
2002, by and between Conn Funding II, L.P., as Issuer, and Wells
Fargo Bank Minnesota, National Association, as Trustee
(incorporated herein by reference to Exhibit 10.12 to Conn's,
Inc. registration statement on Form S-1 (file no. 333-109046)).
10.13 Series 2002-B Supplement to Base Indenture dated September 1,
2002, by and between Conn Funding II, L.P., as Issuer, and Wells
Fargo Bank Minnesota, National Association, as Trustee
(incorporated herein by reference to Exhibit 10.13 to Conn's,
Inc. registration statement on Form S-1 (file no. 333-109046)).
10.14 Servicing Agreement dated September 1, 2002, by and among Conn
Funding II, L.P., as Issuer, CAI, L.P., as Servicer, and Wells
Fargo Bank Minnesota, National Association, as Trustee
(incorporated herein by reference to Exhibit 10.14 to Conn's,
Inc. registration statement on Form S-1 (file no. 333-109046)).
10.15 Form of Executive Employment Agreement (incorporated herein by
reference to Exhibit 10.15 to Conn's, Inc. registration statement
on Form S-1 (file no. 333-109046)).
10.16 Form of Indemnification Agreement (incorporated herein by
reference to Exhibit 10.16 to Conn's, Inc. registration statement
on Form S-1 (file no. 333-109046)).
28
31.1 Rule 13a-14(a)/15d-14(a) Certification (Chief Executive Officer)
(filed herewith).
31.2 Rule 13a-14(a)/15d-14(a) Certification (Chief Financial Officer)
(filed herewith).
32.1 Section 1350 Certification (Chief Executive Officer and Chief
Financial Officer) (furnished herewith).
99.1 Subcertification of Chief Operating Officer in support of Rule
13a-14(a)/15d-14(a) Certification (Chief Executive Officer)
(filed herewith).
99.2 Subcertification of Secretary/Treasurer in support of Rule
13a-14(a)/15d-14(a) Certification (Chief Executive Officer)
(filed herewith).
99.3 Subcertification of Chief Operating Officer and
Secretary/Treasurer in support of Section 1350 Certifications
(furnished herewith).
29
EXHIBIT 31.1
RULE 13a-14(a)/15d-14(a) CERTIFICATION
(CHIEF EXECUTIVE OFFICER)
I, Thomas J. Frank, Sr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Conn's, Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
/s/ Thomas J. Frank, Sr.
-------------------------------
Thomas J. Frank, Sr.
Chairman of the Board
and Chief Executive Officer
Date: August 31, 2004
30
EXHIBIT 31.2
RULE 13a-14(a)/15d-14(a) CERTIFICATION
(CHIEF FINANCIAL OFFICER)
I, C. William Frank, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Conn's, Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
/s/ C. William Frank
-------------------------------
C. William Frank
Executive Vice President
and Chief Financial Officer
Date: August 31, 2004
31
EXHIBIT 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Conn's, Inc. (the "Company") on
Form 10-Q for the period ended July 31, 2004 as filed with the Securities and
Exchange Commission on the date hereof (the "Report"), we, Thomas J. Frank, Sr.,
Chairman of the Board and Chief Executive Officer of the Company and C. William
Frank, Executive Vice President and Chief Financial Officer of the Company,
hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of our
knowledge:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
/s/ Thomas J. Frank Sr.
-------------------------------
Thomas J. Frank, Sr.
Chairman of the Board and
Chief Executive Officer
/s/ C. William Frank
-------------------------------
C. William Frank
Executive Vice President and
Chief Financial Officer
Dated: August 31, 2004
A signed original of this written statement required by Section 906 has been
provided to Conn's, Inc. and will be retained by Conn's, Inc. and furnished to
the Securities and Exchange Commission or its staff upon request. The foregoing
certification is being furnished solely pursuant to 18 U.S.C. Section 1350 and
is not being filed as part of the Report or as a separate disclosure document.
32
EXHIBIT 99.1
SUBCERTIFICATION OF CHIEF OPERATING OFFICER IN SUPPORT OF RULE
13a-14(a)/15d-14(a) CERTIFICATION (CHIEF EXECUTIVE OFFICER)
I, William C. Nylin Jr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Conn's, Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
/s/ William C. Nylin, Jr.
-------------------------------------
William C. Nylin, Jr.
President and Chief Operating Officer
Date: August 31, 2004
33
EXHIBIT 99.2
SUBCERTIFICATION OF SECRETARY/TREASURER IN SUPPORT OF RULE
13a-14(a)/15d-14(a) CERTIFICATION (CHIEF FINANCIAL OFFICER)
I, David R. Atnip, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Conn's, Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
/s/ David R. Atnip
-------------------------------------
David R. Atnip
Senior Vice President
and Secretary/Treasurer
Date: August 31, 2004
34
EXHIBIT 99.3
SUBCERTIFICATION OF CHIEF OPERATING OFFICER
AND SECRETARY/TREASURER IN SUPPORT OF
18 U.S.C. SECTION 1350 CERTIFICATION,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Conn's, Inc. (the "Company") on
Form 10-Q for the period ended July 31, 2004 as filed with the Securities and
Exchange Commission on the date hereof (the "Report"), we, William C. Nylin,
Jr., President and Chief Operating Officer of the Company and David R. Atnip,
Senior Vice President and Secretary/Treasurer of the Company, hereby certify,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that, to the best of our knowledge:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
/s/ William C. Nylin, Jr.
-------------------------------------
William C. Nylin, Jr.
President and Chief Operating Officer
/s/ David R. Atnip
-------------------------------------
David R. Atnip
Senior Vice President and
Secretary/Treasurer
Dated: August 31, 2004
A signed original of this written statement has been provided to Conn's, Inc.
and will be retained by Conn's, Inc. The foregoing certification is being
furnished solely to support certifications pursuant to 18 U.S.C. Section 1350
and is not being filed as part of the Report or as a separate disclosure
document.
35