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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of l934
For the fiscal year ended January 31, 2008 Commission File Number 000-50421
CONN'S, INC.
(Exact Name of Registrant as Specified in its Charter)
A Delaware corporation 06-1672840
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
3295 College Street
Beaumont, Texas 77701
(Address of Principal Executive Offices)
(409) 832-1696
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Exchange on Which Registered
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Common Stock, par value $0.01 per share The NASDAQ Global Select Market, Inc.
Securities registered pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
Indicate by check mark whether the registrant (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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (ss.229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
One):
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of the voting and non-voting common equity held
by non-affiliates as of July 31, 2007, was approximately $205.8 million based on
the closing price of the registrant's common stock as reported on the NASDAQ
Global Select Market, Inc.
There were 22,374,966 shares of common stock, $0.01 par value per share,
outstanding on March 25, 2008.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Definitive Proxy Statement for the Annual Meeting
of Stockholders to be held June 3, 2008 (incorporated herein by reference in
Part III).
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TABLE OF CONTENTS
Page
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PART I
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ITEM 1. BUSINESS..............................................................3
ITEM 1A. RISK FACTORS.........................................................18
ITEM 1B. UNRESOLVED STAFF COMMENTS............................................27
ITEM 2. PROPERTIES...........................................................27
ITEM 3. LEGAL PROCEEDINGS....................................................28
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..................28
PART II
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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, AND RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.............................28
ITEM 6. SELECTED FINANCIAL DATA..............................................30
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.........................................................31
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...........57
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA..........................58
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE..........................................................83
ITEM 9A. CONTROLS AND PROCEDURES..............................................83
ITEM 9B. OTHER INFORMATION....................................................84
PART III
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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE...............85
ITEM 11. EXECUTIVE COMPENSATION...............................................85
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS...................................................85
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
INDEPENDENCE..................................................................85
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES...............................85
PART IV
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ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES...........................86
SIGNATURES....................................................................87
EXHIBIT INDEX.................................................................88
2
PART I
ITEM 1. BUSINESS.
Unless the context indicates otherwise, references to "we," "us," and
"our" refer to the consolidated business operations of Conn's, Inc. and all of
its direct and indirect subsidiaries, limited liability companies and limited
partnerships.
Overview
We are a specialty retailer of home appliances and consumer electronics.
We sell home appliances including refrigerators, freezers, washers, dryers,
dishwashers and ranges, and a variety of consumer electronics including LCD,
plasma and DLP televisions, camcorders, digital cameras, DVD players, video game
equipment, MP3 players and home theater products. We also sell home office
equipment, lawn and garden equipment, mattresses and furniture and we continue
to introduce additional product categories for the home and for consumer
entertainment, such as GPS devices, to help increase same store sales and to
respond to our customers' product needs. We offer over 2,800 product items, or
SKUs, at good-better-best price points representing such national brands as
General Electric, Whirlpool, Electrolux, Frigidaire, Maytag, LG, Mitsubishi,
Samsung, Sony, Toshiba, Hitachi, Serta, Simmons, Ashley, Lane, Hewlett Packard,
Compaq, Poulan, Husqvarna and Toro. Based on revenue in 2006, we were the 9th
largest retailer of home appliances and the 37th largest retailer of consumer
electronics in the United States.
We began as a small plumbing and heating business in 1890. We began
selling home appliances to the retail market in 1937 through one store located
in Beaumont, Texas. We opened our second store in 1959 and have since grown to
69 stores.
We have been known for providing excellent customer service for over 115
years. We believe that our customer-focused business strategies make us an
attractive alternative to appliance and electronics superstores, department
stores and other national, regional and local retailers. We strive to provide
our customers with:
o a high level of customer service;
o highly trained and knowledgeable sales personnel;
o a broad range of competitively priced, customer-driven, brand name
products;
o flexible financing alternatives through our proprietary credit
programs;
o next day delivery capabilities; and
o outstanding product repair service.
We believe that these strategies drive repeat purchases and enable us to
generate substantial brand name recognition and customer loyalty. During fiscal
2008, approximately 63% of our credit customers, based on the number of invoices
written, were repeat customers.
In 1994, we realigned and added to our management team, enhanced our
infrastructure and refined our operating strategy to position ourselves for
future growth. From fiscal 1994 to fiscal 1999, we selectively grew our store
base from 21 to 26 stores while improving operating margins from 5.2% to 8.7%.
Since fiscal 1999, we have generated significant growth in our number of stores,
revenue and profitability. Specifically:
o we have grown from 26 stores to 69 stores, an increase of over
165%, with several more stores currently under development;
o total revenues have grown 251%, at a compounded annual rate of
15.0%, from $234.5 million in fiscal 1999, to $824.1 million in
fiscal 2008;
3
o net income from continuing operations has grown 351%, at a
compounded annual rate of 18.5%, from $8.8 million in fiscal
1999 to $39.7 million in fiscal 2008; and
o our same store sales growth from fiscal 1999 through fiscal 2008
has averaged 8.1%; it was 3.2% for fiscal 2008. See additional
discussion about same store sales under Management's Discussion
and Analysis of Financial Condition and Results of Operations.
Our principal executives offices are located at 3295 College Street,
Beaumont, Texas 77701. Our telephone number is (409) 832-1696, and our corporate
website is www.conns.com. We do not intend for information contained on our
website to be part of this Form 10-K.
Corporate Reorganization
We were formed as a Delaware corporation in January 2003 with an initial
capitalization of $1,000 to become the holding company of Conn Appliances, Inc.,
a Texas corporation. Prior to the completion of our initial public offering (the
IPO) in November 2003, we had no operations. As a result of the IPO, Conn
Appliances, Inc. became our wholly-owned subsidiary and the common and preferred
stockholders of Conn Appliances, Inc. exchanged their common and preferred stock
on a one-for-one basis for the common and preferred stock of Conn's, Inc.
Immediately after the IPO, all preferred stock and accumulated dividends were
redeemed, either through the payment of cash or through the conversion of
preferred stock to common stock.
Industry Overview
The home appliance and consumer electronics industry includes major home
appliances, small appliances, home office equipment and software, LCD, plasma
and DLP televisions, and audio, video and portable electronics. Sellers of home
appliances and consumer electronics include large appliance and electronics
superstores, national chains, small regional chains, single-store operators,
appliance and consumer electronics departments of selected department and
discount stores and home improvement centers.
Based on data published in Twice, This Week in Consumer Electronics, a
weekly magazine dedicated to the home appliances and consumer electronics
industry in the United States, the top 100 major appliance retailers reported
sales of approximately $24.0 billion in 2006, up approximately 5.3% from
reported sales in 2005 of approximately $22.8 billion. The retail appliance
market is large and concentrated among a few major dealers. Sears has been the
leader in the retail appliance market, with a market share of the top 100
retailers of approximately 37% in 2006 and 39% in 2005. Lowe's and Home Depot
held the second and third place positions, respectively, in national market
share in 2006. Based on revenue in 2006, we were the 9th largest retailer of
home appliances in the United States.
As measured by Twice, the top 100 consumer electronics retailers in the
United States reported equipment and software sales of $113.1 billion in 2006, a
4.2% increase from the $108.5 billion reported in 2005. According to the
Consumer Electronics Association, or CEA, total industry manufacturer sales of
consumer electronics products in the United States, are projected to exceed
$171.6 billion in 2008, up 6.1% from $161.7 billion in 2007. The consumer
electronics market is highly fragmented. We estimate, based on data provided in
Twice, that the two largest consumer electronics superstore chains together
accounted for approximately 35% of the total electronics sales attributable to
the 100 largest retailers in 2006. Based on revenue in 2006, we were the 37th
largest retailer of consumer electronics in the United States. New entrants in
both the home appliances and consumer electronics industries have been
successful in gaining market share by offering similar product selections at
lower prices.
In the home appliance market, many factors drive growth, including
consumer confidence, household formations and new product introductions. Product
design and innovation is rapidly becoming a key driver of growth in this market.
Products recently introduced include high efficiency, front-loading laundry
appliances and three door refrigerators, and variations on these products,
including new features. Additionally, product appearance, including new color
options and stainless steel appliances, is stimulating consumer interest.
4
Technological advancements and the introduction of new products have
largely driven growth in the consumer electronics market. Recently, industry
growth has been fueled primarily by the introduction of products that
incorporate digital technology, such as portable and traditional DVD players,
digital cameras and camcorders, digital stereo receivers, satellite technology,
MP3 products and high definition flat-panel and projection televisions. Digital
products offer significant advantages over their analog counterparts, including
better clarity and quality of video and audio, durability of recording and
compatibility with computers. Due to these advantages, we believe that digital
technology will continue to drive industry growth as consumers replace their
analog products with digital products. We believe the following product
advancements will continue to fuel growth in the consumer electronics industry
and that they offer us the potential for significant sales growth:
o Digital Television (DTV and High Definition TV). The Federal
Communications Commission has set a date of February 17, 2009, for
all commercial television stations to transition from broadcasting
analog signals to digital signals. The Yankee Group, a
communications and networking research and consulting firm,
estimates that by the year 2010, HDTV signals will be in nearly 80
million homes in the United States. To view a digital
transmission, consumers will need either a digital television or a
set-top box converter capable of converting the digital broadcast
for viewing on an analog set. We believe the high clarity digital
flat-panel televisions in both LCD, and plasma formats has
increased the quality and sophistication of these entertainment
products and will be a key driver of digital television growth as
more digital and high definition content is made available either
through traditional distribution methods or through emerging
content delivery systems. As prices continue to drop on such
products, they become increasingly attractive to larger and more
diverse groups of consumers.
o Digital Versatile Disc (DVD). According to the CEA, the DVD player
has been the fastest growing consumer electronics product in
history. First introduced in March 1997, DVD players are currently
in 85% of U.S. homes. We believe newer technology, such as Blu-ray
high definition DVD, and portable players will continue to drive
consumer interest in this entertainment category.
o Portable electronics. GPS devices are growing in popularity with
consumers. With only 10% of U. S. drivers currently using GPS
devices, we believe this type of product represents a significant
consumer electronics growth opportunity.
Business Strategy
Our objective is to be the leading specialty retailer of home appliances
and consumer electronics in each of our markets. We strive to achieve this
objective through a continuing focus on superior execution in five key areas:
merchandising, consumer credit, distribution, product service and training.
Successful execution in each area relies on the following strategies:
o Offering a broad range of customer-driven, brand name products. We
offer a comprehensive selection of high-quality, brand name
merchandise to our customers at guaranteed low prices. Consistent
with our good-better-best merchandising strategy, we offer a wide
range of product selections from entry-level models through
high-end models. We maintain strong relationships with the
approximately 100 manufacturers and distributors that enable us to
offer over 2,800 SKUs to our customers. Our principal suppliers
include General Electric, Whirlpool, Frigidaire, Maytag, LG,
Mitsubishi, Samsung, Sony, Toshiba, Hitachi, Serta, Simmons,
Ashley, Lane, Hewlett Packard, Compaq, Poulan, Husqvarna and Toro.
To facilitate our responsiveness to customer demand, we test the
sales process of all new products and obtain customers' reactions
to new display formats before introducing these products and
display formats to all of our stores.
o Offering flexible financing alternatives through our proprietary
credit programs. In the last three years, we financed, on average,
approximately 59% of our retail sales through our internal credit
programs. We believe our credit programs expand our potential
customer base, increase our sales revenue and enhance customer
loyalty by providing our customers immediate access to financing
alternatives that our competitors typically do not offer. Our
credit department makes all credit decisions internally, entirely
independent of our sales personnel. We provide special
consideration to customers with credit history with us. Before
extending credit, we match our loss experience by product category
with the customer's credit worthiness to determine down payment
amounts and other credit terms. This facilitates product sales
while keeping our o credit risk within an acceptable range. We
provide a full range of credit products, including interest-free
programs for the highest credit quality customers and our
secondary portfolio for our credit challenged customers. The
secondary portfolio, which has generally lower average credit
scores than our primary portfolio, undergoes more intense internal
underwriting scrutiny to mitigate the inherently greater risk.
Approximately 56% of customers who have active credit accounts
with us take advantage of our in-store payment option and come to
our stores each month to make their payments, which we believe
results in additional sales to these customers. We contact
customers with past due accounts daily and attempt to work with
them to collect payments in times of financial difficulty or
periods of economic downturn. Our experience in credit
underwriting and the collections process has enabled us to achieve
an average net loss ratio of 2.9% over the past three years on the
credit portfolio that we service for a Qualifying Special Purpose
Entity or QSPE.
5
o Maintaining next day distribution capabilities. We maintain five
regional distribution centers and three other related facilities
that cover all of the major markets in which we operate. These
facilities are part of a sophisticated inventory management system
that also includes a fleet of approximately 105 transfer and
delivery vehicles that service all of our markets. Our
distribution operations enable us to deliver products on the day
after the sale for approximately 93% of our customers who
scheduled delivery during that timeframe.
o Providing outstanding product repair service. We service every
product that we sell, and we service only the products that we
sell. In this way, we can assure our customers that they will
receive our service technicians' exclusive attention to their
product repair needs. All of our service centers are authorized
factory service facilities that provide trained technicians to
offer in-home diagnostic and repair service utilizing a fleet of
approximately 130 service vehicles as well as on-site service and
repairs for products that cannot be repaired in the customer's
home.
o Developing and retaining highly trained and knowledgeable sales
personnel. We require all sales personnel to specialize in home
appliances or consumer electronics. Some of our sales associates
qualify in more than one specialty. This specialized approach
allows the sales person to focus on specific product categories
and become an expert in selling and using products in those
categories. New sales personnel must complete an intensive
classroom training program and an additional week of on-the-job
training riding in a delivery truck and a service truck to observe
how we serve our customers after the sale is made.
o Providing a high level of customer service. We endeavor to
maintain a very high level of customer service as a key component
of our culture, which has resulted in average customer
satisfaction levels of approximately 91% over the past three
years. We measure customer satisfaction on the sales floor, in our
delivery operation and in our service department by sending survey
cards to all customers to whom we have delivered or installed a
product or made a service call. Our customer service resolution
department attempts to address all customer complaints within 48
hours of receipt.
Store Development and Growth Strategy
In addition to executing our business strategy, we intend to continue to
achieve profitable, controlled growth by increasing same store sales, opening
new stores and updating, expanding or relocating our existing stores.
o Increasing same store sales. We plan to continue to increase our
same store sales by:
o continuing to offer quality products at competitive prices;
o re-merchandising our product offerings in response to
changes in consumer interest and demand;
o adding new merchandise to our existing product lines;
o training our sales personnel to increase sales closing
rates;
o updating our stores as needed;
o continuing to promote sales of computers and smaller
electronics, such as video game equipment and GPS devices,
including the expansion of high margin accessory items;
6
o continuing to provide a high level of customer service in
sales, delivery and servicing of our products; and
o increasing sales of our merchandise, finance products,
service maintenance agreements and credit insurance through
direct mail and in-store credit promotion programs.
o Opening new stores. We intend to take advantage of our reliable
infrastructure and proven store model to continue the pace of our
new store openings by opening seven to ten new stores in fiscal
2009. This infrastructure includes our proprietary management
information systems, training processes, distribution o network,
merchandising capabilities, supplier relationships, product
service capabilities and centralized credit approval and
collection management processes. We intend to expand our store
base in existing, adjacent and new markets, as follows:
o Existing and adjacent markets. We intend to increase our
market presence by opening new stores in our existing
markets and in adjacent markets as we identify the need and
opportunity. New store openings in these locations will
allow us to maximize opportunity in those markets and
leverage our existing distribution network, advertising
presence, brand name recognition and reputation. In fiscal
2008, we opened new stores in Houston, Dallas, San Antonio
and Brownsville.
o New markets. During fiscal 2008, we opened our first store
in Oklahoma City, Oklahoma and have identified several new
markets that meet our criteria for site selection. We
intend to consider these new markets, as well as others,
over the next several fiscal years. We intend to first
address markets in states in which we currently operate. We
expect that this new store growth will include major
metropolitan markets in Texas and have also identified a
number of smaller markets within Texas and Louisiana in
which we expect to explore new store opportunities. Our
long-term growth plans include markets in other areas of
significant population density in neighboring states.
o Updating, expanding or relocating existing stores. Over the last
three years, we have updated, expanded or relocated many of our
stores. We continue to update our prototype store model and
implement it at new locations and in existing locations in which
the market demands support the required design changes. As we
continue to add new stores or replace existing stores, we intend
to modify our floor plan to include elements of this new model. We
continuously evaluate our existing and potential sites to ensure
our stores are in the o best possible locations and relocate
stores that are not properly positioned. We typically lease rather
than purchase our stores to retain the flexibility of managing our
financial commitment to a location if we later decide that the
store is performing below our standards or the market would be
better served by a relocation. After updating, expanding or
relocating a store, we expect to increase same store sales at
those stores.
The addition of new stores and new and expanded product categories has
played, and we believe will continue to play, a significant role in our
continued growth and success. We currently operate 69 retail stores located in
Texas, Louisiana and Oklahoma. We opened six stores in each of fiscal 2006 and
2007 and seven stores in fiscal 2008. Additionally, we relocated one store
during fiscal 2008. We plan to continue our store development program by opening
an additional seven to ten new stores, or an approximately 10% increase in total
retail floor space, per year and continue to update a portion of our existing
stores each year. We believe that continuing our strategies of updating existing
stores, growing our store base and locating our stores in desirable geographic
markets are essential for our future success.
Customers
We do not have a significant concentration of sales with any individual
customer and, therefore, the loss of any one customer would not have a material
impact on our business. No single customer accounts for more than 10% of our
total revenues; in fact, no single customer accounted for more than $500,000
(less than 0.1%) of our total revenue of $824.1 million during the year ended
January 31, 2008.
7
Products and Merchandising
Product Categories. Each of our stores sells five major categories of
products: home appliances, consumer electronics, computers and peripheral
equipment, delivery and installation services and other household products,
including furniture, lawn and garden equipment and mattresses. The following
table, which has been adjusted from previous filings to ensure comparability,
presents a summary of total revenues for the years ended January 31, 2006, 2007,
and 2008:
Year Ended January 31,
--------------------------------------------------------------------
2006 2007 2008
---------------------- ---------------------- ----------------------
Amount % Amount % Amount %
----------- ---------- ----------- ---------- ----------- ----------
Home appliances............... $ 224,032 32.0% $ 231,156 30.4% $ 223,967 27.2%
Consumer electronics.......... 186,671 26.6 214,285 28.2 244,040 29.6
Track......................... 99,031 14.1 94,188 12.4 102,031 12.4
Delivery...................... 9,344 1.3 11,380 1.5 12,524 1.5
Lawn and garden............... 17,561 2.5 16,741 2.2 20,914 2.5
Bedding....................... 13,120 1.9 17,721 2.3 16,424 2.0
Furniture..................... 15,320 2.2 33,357 4.4 46,373 5.6
Other......................... 4,798 0.7 5,131 0.6 5,298 0.7
----------- ---------- ----------- ---------- ----------- ----------
Total product sales........ 569,877 81.3 623,959 82.0 671,571 81.5
Service maintenance agreement
commissions.................. 30,583 4.3 30,567 4.0 36,424 4.4
Service revenues.............. 20,278 2.9 22,411 3.0 22,997 2.8
----------- ---------- ----------- ---------- ----------- ----------
Total net sales............ 620,738 88.5 676,937 89.0 730,992 88.7
Finance charges and other..... 80,410 11.5 83,720 11.0 93,136 11.3
----------- ---------- ----------- ---------- ----------- ----------
Total revenues......... $ 701,148 100.0% $ 760,657 100.0% $ 824,128 100.0%
=========== ========== =========== ========== =========== ==========
Within these major product categories (excluding service maintenance agreements,
service revenues and delivery and installation), we offer our customers over
2,800 SKU's in a wide range of price points. Most of these products are
manufactured by brand name companies, including General Electric, Whirlpool,
Frigidaire, Maytag, LG, Mitsubishi, Samsung, Sony, Toshiba, Hitachi, Serta,
Simmons, Ashley, Lane, Hewlett Packard, Compaq, Poulan, Husqvarna and Toro. As
part of our good-better-best merchandising strategy, our customers are able to
choose from products ranging from low-end to mid- to high-end models in each of
our key product categories, as follows:
Category Products Selected Brands
-------- -------- ---------------
Home appliances Refrigerators, freezers, washers, General Electric, Frigidaire,
dryers, ranges, dishwashers, Whirlpool, Maytag, LG, KitchenAid,
built-ins, air conditioners and Sharp, Friedrich, Roper, Hoover and
vacuum cleaners Eureka
Consumer electronics LCD, plasma, and DLP televisions, Sony, Samsung, Mitsubishi, LG,
and home theater systems Toshiba, Hitachi, Yamaha and Bose
Track Computers, computer peripherals, Hewlett Packard, Compaq, Sony,
camcorders, digital cameras, DVD Garmin, Nintendo, Microsoft and
players, audio components, compact Yamaha
disc players, GPS devices, video game
equipment, speakers and portable
electronics (e.g. iPods)
Other Lawn and garden, furniture and Poulan, Husqvarna, Toro, Rally,
mattresses Weedeater, Ashley, Lane, Franklin,
Simmons and Serta
8
Purchasing. We purchase products from over 100 manufacturers and
distributors. Our agreements with these manufacturers and distributors typically
cover a one or two year time period, are renewable at the option of the parties
and are terminable upon 30 days written notice by either party. Similar to other
specialty retailers, we purchase a significant portion of our total inventory
from a limited number of vendors. During fiscal 2008, 54.8% of our total
inventory purchases were from six vendors, including 13.1%, 13.0% and 9.1% of
our total inventory from Whirlpool, Samsung and Electrolux, respectively. The
loss of any one or more of these key vendors or our failure to establish and
maintain relationships with these and other vendors could have a material
adverse effect on our results of operations and financial condition. We have no
indication that any of our suppliers will discontinue selling us merchandise. We
have not experienced significant difficulty in maintaining adequate sources of
merchandise, and we generally expect that adequate sources of merchandise will
continue to exist for the types of products we sell.
Merchandising Strategy. We focus on providing a comprehensive selection
of high-quality merchandise to appeal to a broad range of potential customers.
Consistent with our good-better-best merchandising strategy, we offer a wide
range of product selections from entry-level models through high-end models. We
primarily sell brand name warranted merchandise. Our established relationships
with major appliance and electronic vendors and our affiliation with NATM, a
major buying group with $3.8 billion in purchases annually, give us purchasing
power that allows us to offer custom-featured appliances and electronics and
provides us a competitive selling advantage over other independent retailers. As
part of our merchandising strategy, we operate four clearance centers with two
in Houston, one in San Antonio and one in Dallas to help sell damaged, used or
discontinued merchandise.
Pricing. We emphasize competitive pricing on all of our products and
maintain a low price guarantee that is valid in all markets for 10 to 30 days
after the sale, depending on the product. At most of our stores, to print an
invoice that contains pricing other than the price maintained within our
computer system, sales personnel must call a special "hotline" number at the
corporate office for approval. Personnel staffing this hotline number are
familiar with competitor pricing and are authorized to make price adjustments to
fulfill our low price guarantee when a customer presents acceptable proof of the
competitor's lower price. This centralized function allows us to maintain
control of pricing and gross margins, and to store and retrieve pricing data of
our competitors.
Customer Service
We focus on customer service as a key component of our strategy. We
believe our next day delivery option is one of the keys to our success.
Additionally, we attempt to answer and resolve all customer complaints within 48
hours of receipt. We track customer complaints by individual salesperson,
delivery person and service technician. We send out over 38,000 customer
satisfaction survey cards each month covering all deliveries and service calls.
Based upon a response rate from our customers of approximately 15%, we
consistently report an average customer satisfaction level of approximately 91%.
9
Store Operations
Stores. At the end of fiscal 2008 we operated 69 retail and clearance
stores located in Texas, Louisiana and Oklahoma. The following table illustrates
our markets, the number of freestanding and strip mall stores in each market and
the calendar year in which we opened our first store in each market:
Number of Stores
------------------ First
Stand Strip Store
Market Alone Mall Opened
------------------------------------------------- --------- --------- ---------
Houston.......................................... 6 16 1983
San Antonio/Austin............................... 6 9 1994
Golden Triangle (Beaumont, Port Arthur and
Orange, Texas and Lake Charles, Louisiana)...... 1 4 1937
Baton Rouge/Lafayette............................ 1 4 1975
Corpus Christi................................... 1 0 2002
Dallas/Fort Worth................................ 1 16 2003
South Texas...................................... 0 3 2004
Oklahoma......................................... 0 1 2008
--------- ---------
Total 16 53
========= =========
Our stores have an average selling space of approximately 22,000 square
feet, plus a rear storage area averaging approximately 5,500 square feet for
fast-moving or smaller products that customers prefer to carry out rather than
wait for in-home delivery. Four of our stores are clearance centers for
discontinued product models and damaged merchandise, returns and repossessed
product located in our San Antonio, Houston and Dallas markets and contain
48,800 square feet of combined selling space. All stores are open from 10:00
a.m. to 9:30 p.m. Monday through Friday, from 9:00 a.m. to 9:30 p.m. on
Saturday, and from 11:00 a.m. to 7:00 p.m. on Sunday. We also offer extended
store hours during the holiday selling season.
Approximately 77% of our stores are located in strip shopping centers and
regional malls, with the balance being stand-alone buildings in "power centers"
of big box consumer retail stores. All of our locations have parking available
immediately adjacent to the store's front entrance. Our storefronts have a
distinctive front that guides the customer to the entrance of the store. Inside
the store, a large colorful tile track circles the interior floor of the store.
One side of the track leads the customer to major appliances, while the other
side of the track leads the customer to a large display of television and
projection television products. The inside of the track contains various home
office and consumer electronic products such as computers, laptops, printers,
DVD players, camcorders, digital cameras, MP3 players, video game equipment and
GPS devices. Mattresses, furniture and lawn and garden equipment displays occupy
the rear of the sales floor. To reach the cashier's desk at the center of the
track area, our customers must walk past our products. We believe this increases
sales to customers who have purchased products from us on credit in the past and
who return to our stores to make their monthly credit payments.
We have updated many of our stores in the last three years. We expect to
continue to update our stores as needed to address each store's specific needs.
All of our updated stores, as well as our new stores, include modern interior
selling spaces featuring attractive signage and display areas specifically
designed for each major product type. Our prototype store for future expansion
has from 20,000 to 25,000 square feet of retail selling space, which
approximates the average size of our existing stores and a rear storage area of
between 5,000 and 7,000 square feet. Our investment to update our stores has
averaged approximately $105,000 per store over the past three years, and as a
result of the updating, we expect to increase same store sales at those stores.
Over the last three years, we have invested approximately $5.1 million updating,
refurbishing or relocating our existing stores.
Site Selection. Our stores are typically located adjacent to freeways or
major travel arteries and in the vicinity of major retail shopping areas. We
prefer to locate our stores in areas where our prominent storefront will be the
anchor of the shopping center or readily visible from major thoroughfares. We
also attempt to locate our stores in the vicinity of major home appliance and
electronics superstores. We have typically entered major metropolitan markets
where we can potentially support at least 10 to 12 stores. We believe this
number of stores allows us to optimize advertising and distribution costs. We
have and may continue to elect to experiment with opening lower numbers of new
stores in smaller communities where customer demand for products and services
outweighs any extra cost. Other factors we consider when evaluating potential
markets include the distance from our distribution centers, our existing store
locations and store locations of our competitors and population, demographics
and growth potential of the market.
10
Store Economics. We lease 64 of our 69 current store locations, with an
average monthly rent of $20,000. Our average per store investment for the 12 new
leased stores we have opened in the last two years was approximately $1.6
million, including leasehold improvements, fixtures and equipment and inventory
(net of accounts payable). Our total investment for the location that was built
in the last two years totaled approximately $6.8 million, including land,
buildings, fixtures and equipment and inventory (net of accounts payable). For
these new stores, excluding the clearance center, the net sales per store have
averaged $0.7 million per month.
Our new stores have typically been profitable on an operating basis
within their first three to six months of operation and, on average have
returned our net cash investment in 20 months or less. We consider a new store
to be successful if it achieves $8 million to $9 million in sales volume and 2%
to 5% in operating margins before other ancillary revenues and allocations of
overhead and advertising in the first full year of operation. We expect
successful stores that have matured, which generally occurs after two to three
years of operations, to generate annual sales of approximately $12 million to
$15 million and 5% to 9% in operating margins before other ancillary revenues
and overhead and allocations. However, depending on the credit and insurance
penetration of an individual store, we believe that a store that does not
achieve these levels of sales can still contribute significantly to our pretax
margin.
Personnel and Compensation. We staff a typical store with a store
manager, an assistant manager, an average of 20 sales personnel and other
support staff including cashiers and/or porters based on store size and
location. Managers have an average tenure with us exceeding five years and
typically have prior sales floor experience. In addition to store managers, we
have four district managers that generally oversee from seven to ten stores in
each market. Our district managers generally have six to twenty years of sales
experience and report to our senior vice president of sales, who has over twenty
years of sales experience.
We compensate the majority of our sales associates on a straight
commission arrangement, while we generally compensate store managers on a salary
basis plus incentives and cashiers at an hourly rate. In some instances, store
managers receive earned commissions plus base salary. We believe that because
our store compensation plans are tied to sales, they generally provide us an
advantage in attracting and retaining highly motivated employees.
Training. New sales personnel must complete an intensive classroom
training program conducted in each of our markets. We then require them to spend
an additional week riding in delivery and service trucks to gain an
understanding of how we serve our customers after the sale is made. Installation
and delivery staff and service personnel receive training through an on-the-job
program in which individuals are assigned to an experienced installation and
delivery or service employee as helpers prior to working alone. In addition, our
employees benefit from on-site training conducted by many of our vendors.
We attempt to identify store manager candidates early in their careers
with us and place them in a defined program of training. They generally first
attend our in-house training program, which provides guidance and direction for
the development of managerial and supervisory skills. They then attend a Dale
Carnegie certified management course that helps solidify their management
knowledge and builds upon their internal training. After completion of these
training programs, manager candidates work as assistant managers for six to
twelve months and are then allowed to manage one of our smaller stores, where
they are supervised closely by the store's district manager. We give new
managers an opportunity to operate larger stores as they become more proficient
in their management skills. Each store manager attends mandatory training
sessions on a monthly basis and also attends bi-weekly sales training meetings
where participants receive and discuss new product information.
Marketing
We design our marketing and advertising programs to increase our brand
name recognition, educate consumers about our products and services and generate
customer traffic in order to increase sales. We conduct our advertising programs
primarily through newspapers, radio and television stations and direct marketing
through direct mail, telephone and our website. Our promotional programs include
the use of discounts, rebates, product bundling and no-interest financing plans.
11
Our website, www.conns.com, provides customers the ability to purchase
our products on-line, offers information about our selection of products and
provides useful information to the consumer on pricing, features and benefits
for each product, in addition to required corporate governance information. Our
website also allows the customers residing in the markets in which we operate
retail locations to apply and be considered for credit. The website currently
averages approximately 11,000 visits per day from potential and existing
customers and during fiscal 2008, was the source of credit applications. The
website is linked to a call center, allowing us to better assist customers with
their credit and product needs.
Distribution and Inventory Management
We typically locate our stores in close proximity of our five regional
distribution centers located in Houston, San Antonio, Dallas and Beaumont, Texas
and Lafayette, Louisiana and smaller cross-dock facilities in Austin and
Harlingen, Texas and Oklahoma City, Oklahoma. This enables us to deliver
products to our customers quickly, reduces inventory requirements at the
individual stores and facilitates regionalized inventory and accounting
controls.
In our retail stores we maintain an inventory of fast-moving items and
products that the customer is likely to carry out of the store. Our
sophisticated Distribution Inventory Sales computer system and the use of
scanning technology in our distribution centers allow us to determine, on a
real-time basis, the exact location of any product we sell. If we do not have a
product at the desired retail store at the time of sale, we can provide it
through our distribution system on a next day basis.
We maintain a fleet of tractors and trailers that allow us to move
products from market to market and from distribution centers to stores to meet
customer needs. Our fleet of home delivery vehicles enables our highly-trained
delivery and installation specialists to quickly complete the sales process,
enhancing customer service. We receive a delivery fee based on the products sold
and the services needed to complete the delivery. Additionally, we are able to
complete deliveries to our customers on the day after the sale for approximately
93% of our customers who have scheduled delivery during that timeframe.
Finance Operations
General. We sell our products for cash or for payment through major
credit cards, in addition to offering our customers several financing
alternatives through our proprietary credit programs. In the last three fiscal
years, we financed, on average, approximately 59% of our retail sales through
one of our two credit programs. We offer our customers a choice of installment
payment plans and revolving credit plans through our primary credit portfolio.
We also offer an installment program through our secondary credit portfolio to a
limited number of customers who do not qualify for credit under our primary
credit portfolio. Additionally, the most credit worthy customers in our primary
credit portfolio may be eligible for no-interest financing plans. The following
table shows our product and service maintenance agreements sales, net of returns
and allowances, by method of payment for the periods indicated.
Year Ended January 31,
-----------------------------------------------------------------
2006 2007 2008
--------------------- --------------------- ---------------------
Amount % Amount % Amount %
---------- ---------- ---------- ---------- ---------- ----------
Cash and other credit cards.. $ 254,047 42.3% $ 274,533 42.0% $ 267,931 37.8%
Primary credit portfolio:
Installment............... 263,667 43.9 262,653 40.1 340,274 48.1
Revolving................. 30,697 5.1 43,225 6.6 34,025 4.8
Secondary credit portfolio... 52,049 8.7 74,115 11.3 65,765 9.3
---------- ---------- ---------- ---------- ---------- ----------
Total..................... $ 600,460 100.0% $ 654,526 100.0% $ 707,995 100.0%
========== ========== ========== ========== ========== ==========
Credit Approval. Our credit programs are managed by our centralized
credit underwriting department staff, independent of sales personnel. As part of
our centralized credit approval process, we have developed a proprietary
standardized scoring model that provides preliminary credit decisions, including
down payment amounts and credit terms, based on both customer and product risk.
The weighted average origination credit score of the receivables included in the
sold portfolio was 611 at January 31, 2008, excluding bankruptcy accounts and
accounts that had no credit score. While we automatically approve some credit
applications from customers, approximately 92% of our credit decisions are based
on evaluation of the customer's creditworthiness by a qualified credit grader.
As of January 31, 2008, we employed over 450 full-time and part-time employees
who focus on credit approval, collections and credit customer service. Employees
in these operational areas are trained to follow our strict methodology in
approving credit, collecting our accounts, and charging off any uncollectible
accounts based on pre-determined aging criteria, depending on their area of
responsibility.
12
A significant part of our ability to control delinquency and net
charge-off is based on the level of down payments that we require and the
purchase money security interest that we obtain in the product financed, which
reduce our credit risk and increase our customers' ability and willingness to
meet their future obligations. We require the customer to purchase or provide
proof of credit property insurance coverage to offset potential losses relating
to theft or damage of the product financed.
Installment accounts are paid over a specified period of time with set
monthly payments. Revolving accounts provide customers with a specified amount
which the customer may borrow, repay and re-borrow so long as the credit limit
is not exceeded. Most of our installment accounts provide for payment over 12 to
36 months, with the average account in the primary credit portfolio remaining
outstanding for approximately 12 to 14 months. Our revolving accounts remain
outstanding approximately 13 to 15 months. During fiscal 2008, approximately 12%
of the applications approved under the primary program were approved
automatically through our computer system based on the customer's credit
history. The remaining applications, of both new and repeat customers, are sent
to an experienced in-house credit grader.
We created our secondary credit portfolio program to meet the needs of
those customers who do not qualify for credit under our primary program,
typically due to past credit problems or lack of credit history. If we cannot
approve a customer's application for credit under our primary portfolio, we
automatically send the application to the credit staff of our secondary
portfolio for further consideration, using stricter underwriting criteria. The
additional requirements include verification of employment and recent work
history, reference checks and higher required down payment levels. We offer only
the installment program to those customers that qualify under these stricter
underwriting criteria. An experienced, in-house credit grader administers the
credit approval process for all applications received under our secondary
portfolio program. Most of the installment accounts approved under this program
provide for repayment over 12 to 36 months, with the average account was
remaining outstanding for approximately 18 to 20 months.
The following tables present, for comparison purposes, information
regarding our two credit portfolios.
Primary Portfolio (1)
--------------------------------
Year Ended January 31,
--------------------------------
2006 2007 2008
---------- ---------- ----------
(total outstanding balance
in thousands)
Total outstanding balance (period end).........$ 421,649 $ 435,607 $ 511,586
Average outstanding customer balance...........$ 1,284 $ 1,250 $ 1,287
Number of active accounts (period end)......... 328,402 348,593 397,606
Total applications processed (2)............... 684,674 778,784 823,627
Percent of retail sales financed............... 49.0% 46.7% 52.9%
Total applications approved.................... 52.8% 45.8% 48.6%
Average down payment........................... 7.6% 10.6% 7.4%
Average interest spread (3).................... 12.0% 11.0% 12.9%
13
Secondary Portfolio
--------------------------------
Year Ended January 31,
--------------------------------
2006 2007 2008
---------- ---------- ----------
(total outstanding balance
in thousands)
Total outstanding balance (period end).........$ 98,072 $ 133,944 $ 143,281
Average outstanding customer balance...........$ 1,128 $ 1,212 $ 1,264
Number of active accounts (period end)......... 86,936 110,472 113,316
Total applications processed (2)............... 314,698 404,543 400,592
Percent of retail sales financed............... 8.7% 11.3% 9.3%
Total applications approved.................... 34.1% 32.1% 29.8%
Average down payment........................... 26.4% 25.1% 24.4%
Average interest spread (3).................... 14.1% 13.5% 14.0%
Combined Portfolio (1)
--------------------------------
Year Ended January 31,
--------------------------------
2006 2007 2008
---------- ---------- ----------
(total outstanding balance
in thousands)
Total outstanding balance (period end).........$ 519,721 $ 569,551 $ 654,867
Average outstanding customer balance...........$ 1,251 $ 1,241 $1,282
Number of active accounts (period end)......... 415,338 459,065 510,922
Total applications processed (2)............... 999,372 1,183,327 1,224,219
Percent of retail sales financed............... 57.7% 58.0% 62.2%
Total applications approved.................... 44.3% 41.7% 45.3%
Average down payment........................... 10.9% 13.7% 9.9%
Average interest spread (3).................... 12.4% 11.5% 13.2%
(1) The Primary Portfolio consists of owned and sold receivables.
(2) Unapproved credit applications in the primary portfolio are automatically
referred to the secondary portfolio.
(3) Difference between the average interest rate yield on the portfolio and
the average cost of funds under the securitization program plus the
allocated interest related to funds required to finance the credit
enhancement portion of the portfolio. Also reflects the loss of interest
income resulting from interest free promotional programs.
Credit Quality. We enter into securitization transactions to sell our
retail receivables to a qualifying special purpose entity or QSPE, which we
formed for this purpose. After the sale, we continue to service these
receivables under a contract with the QSPE. We closely monitor these credit
portfolios to identify delinquent accounts early and dedicate resources to
contacting customers concerning past due accounts. We believe that our local
presence, ability to work with customers and flexible financing alternatives
contribute to the historically low net charge-off rates on these portfolios. In
addition, our customers have the opportunity to make their monthly payments in
our stores, and approximately 56% of our active credit accounts did so at some
time during the last 12 months. We believe that these factors help us maintain a
relationship with the customer that keeps losses low while encouraging repeat
purchases.
Our collection activities involve a combination of efforts that take
place in our corporate office and San Antonio collection centers, and outside
collection efforts that involve a visit by one of our credit counselors to the
customer's home. We maintain a predictive dialer system and letter campaign that
helps us contact between 25,000 and 30,000 delinquent customers daily. We also
maintain an experienced skip-trace department that utilizes current technology
to locate customers who have moved and left no forwarding address. Our outside
collectors provide on-site contact with the customer to assist in the collection
process or, if needed, to actually repossess the product in the event of
non-payment. Repossessions are made when it is clear that the customer is
unwilling to establish a reasonable payment program. Our legal department
represents us in bankruptcy proceedings and filing of delinquency judgment
claims and helps handle any legal issues associated with the collection process.
Generally, we deem an account to be uncollectible and charge it off if
the account is 120 days or more past due and we have not received a payment in
the last seven months. Over the last 36 months, we have recovered approximately
12% of charged-off amounts through our collection activities. The income that we
realize from our interest in securitized receivables depends on a number of
factors, including expected credit losses. Therefore, it is to our advantage to
maintain a low delinquency rate and loss ratio on these credit portfolios.
14
Our accounting and credit staff consistently monitor trends in
charge-offs by examining the various characteristics of the charge-offs,
including store of origination, product type, customer credit information, down
payment amounts and other identifying information. We track our charge-offs both
gross, before recoveries, and net, after recoveries. We periodically adjust our
credit granting, collection and charge-off policies based on this information.
The following tables reflects the performance of our two credit
portfolios, net of unearned interest.
Primary Portfolio (1) Secondary Portfolio
-------------------------------- --------------------------------
Year Ended January 31, Year Ended January 31,
-------------------------------- --------------------------------
2006 2007 2008 2006 2007 2008
---------- ---------- ---------- ---------- ---------- ----------
(dollars in thousands) (dollars in thousands)
Total outstanding balance (period end)........$ 421,649 $ 435,607 $ 511,586 $ 98,072 $ 133,944 $ 143,281
Average total outstanding balance.............$ 387,464 $ 417,747 $ 465,429 $ 83,461 $ 116,749 $ 141,202
Account balances over 60 days old (period
end).........................................$ 26,029 $ 26,024 $ 31,558 $ 9,508 $ 11,638 $ 18,220
Percent of balances over 60 days old to
total outstanding (period end) (2)........... 6.2% 6.0% 6.2% 9.7% 8.7% 12.7%
Bad debt write-offs (net of recoveries).......$ 9,852 $ 13,507 $ 12,429 $ 1,915 $ 3,896 $ 4,989
Percent of write-offs (net) to average
outstanding (3).............................. 2.5% 3.2% 2.7% 2.2% 3.3% 3.5%
Combined Portfolio (1)
--------------------------------
Year Ended January 31,
--------------------------------
2006 2007 2008
---------- ---------- ----------
(dollars in thousands)
Total outstanding balance (period end)........$ 519,721 $ 569,551 $ 654,867
Average total outstanding balance.............$ 470,925 $ 534,496 $ 606,628
Account balances over 60 days old (period
end).........................................$ 35,537 $ 37,662 $ 49,778
Percent of balances over 60 days old to
total outstanding (period end) (2)........... 6.8% 6.6% 7.6%
Bad debt write-offs (net of recoveries).......$ 11,767 $ 17,403 $ 17,418
Percent of write-offs (net) to average
outstanding (3).............................. 2.5% 3.3% 2.9%
------------------------------------
(1) The Primary Portfolio consists of owned and sold receivables.
(2) At January 31, 2006, the percent of balances over 60 days old was
elevated due to the impact of Hurricanes Katrina and Rita. See additional
discussion in Management's Discussion and Analysis of Financial Condition
and Results of Operations.
(3) The fiscal year ended January 31, 2007, was impacted by the disruption to
our credit collection operations caused by Hurricane Rita.
The following table presents information regarding the growth of our
combined credit portfolios, including unearned interest.
Year Ended January 31,
-----------------------------------
2006 2007 2008
----------- ----------- -----------
(dollars in thousands)
Beginning balance...........................$ 514,204 $ 620,736 $ 675,253
New receivables financed.................... 495,553 511,158 615,606
Revolving finance charges................... 3,858 3,892 3,838
Returns on account.......................... (5,397) (5,465) (5,474)
Collections on account...................... (375,342) (437,665) (491,487)
Accounts charged off........................ (14,392) (19,538) (19,622)
Recoveries of charge-offs................... 2,252 2,135 2,204
----------- ----------- -----------
Ending balance.............................. 620,736 675,253 780,318
Less unearned interest at end of period..... (101,015) (105,702) (125,451)
----------- ----------- -----------
Total portfolio, net........................$ 519,721 $ 569,551 $ 654,867
=========== =========== ===========
Product Support Services
Credit Insurance. Acting as agents for unaffiliated insurance companies,
we sell credit life, credit disability, credit involuntary unemployment and
credit property insurance at all of our stores. These products cover payment of
the customer's credit account in the event of the customer's death, disability
or involuntary unemployment or if the financed property is lost or damaged. We
receive sales commissions from the unaffiliated insurance company at the time we
sell the coverage, and we recognize retrospective commissions, which are
additional commissions paid by the insurance carrier if insurance claims are
less than earned premiums.
15
We require proof of property insurance on all installment credit
purchases, although we do not require that customers purchase this insurance
from us. During fiscal 2008, approximately 75.2% of our credit customers
purchased one or more of the credit insurance products we offer, and
approximately 18.9% purchased all of the insurance products we offer. Commission
revenues from the sale of credit insurance contracts represented approximately
2.4%, 2.4% and 2.6% of total revenues for fiscal years 2006, 2007 and 2008,
respectively.
Warranty Service. We provide service for all of the products we sell and
only for the products we sell. Customers purchased service maintenance
agreements on products representing approximately 49.4% of our total retail
sales for fiscal 2008. These agreements broaden and extend the period of covered
manufacturer warranty service for up to five years from the date of purchase,
depending on the product, and cover certain items during the manufacturer's
warranty period. These agreements are sold at the time the product is purchased.
Customers may finance the cost of the agreements along with the purchase price
of the associated product. We contact the customer prior to the expiration of
the service maintenance period to provide them the opportunity to renew the
period of warranty coverage.
We have contracts with unaffiliated third party insurers that issue the
service maintenance agreements to cover the costs of repairs performed by our
service department under these agreements. The initial service contract is
between the customer and the independent insurance company, but we are the
insurance company's first choice to provide service when it is needed. We
receive a commission on the sale of the contract, and we bill the insurance
company for the cost of the service work that we perform. Commissions earned on
the sales of these third party contracts are recognized in revenues at the time
of the sale. We are the obligor under renewal contracts sold after the primary
warranty and third party service maintenance agreements expire. Under renewal
contracts we recognize revenues received, and direct selling expenses incurred,
over the life of the contracts, and expense the cost of the service work
performed as products are repaired.
Of the 16,000 to 23,000 repairs that we perform each month, approximately
32.6% are covered under these service maintenance agreements, approximately
35.3% are covered by manufacturer warranties and the remainder are "walk-in"
repairs from our customers. Revenues from the sale of service maintenance
agreements represented approximately 4.9%, 4.5%, and 5.0% of net sales during
fiscal years 2006, 2007 and 2008, respectively.
Management Information Systems
We have a fully integrated management information system that tracks, on
a real-time basis, point-of-sale information, inventory receipt and
distribution, merchandise movement and financial information. The management
information system also includes a local area network that connects all
corporate users to e-mail, scheduling and various servers. All of our facilities
are linked by a wide-area network that provides communication for in-house
credit authorization and real-time capture of sales and merchandise movement at
the store level. In our distribution centers, we use wireless terminals to
assist in receiving, stock put-away, stock movement, order filling, cycle
counting and inventory management. At our stores, we currently use desktop
terminals to provide sales, and inventory receiving, transferring and
maintenance capabilities.
Our integrated management information system also includes extensive
functionality for management of the complete credit portfolio life cycle as well
as functionality for the management of product service. The credit system
continues from our in-house credit authorization through account set up and
tracking, credit portfolio condition, collections, credit employee productivity
metrics, skip-tracing, and bankruptcy, fraud and legal account management. The
service system provides for service order processing, warranty claims
processing, parts inventory management, technician scheduling and dispatch,
technician performance metrics and customer satisfaction measurement. The sales,
credit and service systems share a common customer and product sold database.
Our point of sale system uses an IBM Series i5 hardware system that runs
on the i5OS operating system. This system enables us to use a variety of readily
available applications in conjunction with software that supports the system.
All of our current business application software, except our website,
accounting, human resources and credit legal systems, has been developed
in-house by our management information system employees. We believe our
management information systems efficiently support our current operations and
provide a foundation for future growth.
16
We employ Nortel telephone switches and state of the art Avaya predictive
dialers, as well as a redundant data network and cable plant, to improve the
efficiency of our collection and overall corporate communication efforts.
As part of our ongoing system availability protection and disaster
recovery planning, we have implemented a secondary IBM Series i5 system. We
installed and implemented the back-up IBM Series i5 system in our corporate
offices to provide the ability to switch production processing from the primary
system to the secondary system within thirty minutes should the primary system
become disabled or unreachable. The two machines are kept synchronized utilizing
third party software. This backup system provides "high availability" of the
production processing environment. The primary IBM Series i5 system is
geographically removed from our corporate office for purposes of disaster
recovery and security. Our disaster recovery plan worked as designed during our
evacuation from our corporate headquarters in Beaumont, Texas, due to Hurricane
Rita in September 2005. While we were displaced, our store, distribution and
service operations that were not impacted by the hurricane continued to have
normal system availability and functionality.
Competition
According to Twice, total industry manufacturer sales of home appliances
and consumer electronics products in the United States, including imports, to
the top 100 dealers were estimated to be $24.0 billion and $113.1 billion,
respectively, in 2006. The retail home appliance market is large and
concentrated among a few major suppliers. Sears has historically been the leader
in the retail home appliance market, with a market share among the top 100
retailers of approximately 39% in 2005 and 37% in 2006. The consumer electronics
market is highly fragmented. We estimate that the two largest consumer
electronics superstore chains accounted for approximately 32% of the total
electronics sales attributable to the 100 largest retailers in 2006. However,
new entrants in both industries have been successful in gaining market share by
offering similar product selections at lower prices.
As reported by Twice, based upon revenue in 2006, we were the 9th largest
retailer of home appliances and the 37th largest retailer of consumer
electronics. Our competitors include national mass merchants such as Sears and
Wal-Mart, specialized national retailers such as Circuit City and Best Buy, home
improvement stores such as Lowe's and Home Depot, and locally-owned regional or
independent retail specialty stores. The availability and convenience of the
Internet is increasing as a competitive factor in our industry.
We compete primarily based on enhanced customer service through our
unique sales force training and product knowledge, next day delivery
capabilities, proprietary in-house credit program, guaranteed low prices and
product repair service.
Regulation
The extension of credit to consumers is a highly regulated area of our
business. Numerous federal and state laws impose disclosure and other
requirements on the origination, servicing and enforcement of credit accounts.
These laws include, but are not limited to, the Federal Truth in Lending Act,
Equal Credit Opportunity Act and Federal Trade Commission Act. State laws impose
limitations on the maximum amount of finance charges that we can charge and also
impose other restrictions on consumer creditors, such as us, including
restrictions on collection and enforcement. We routinely review our contracts
and procedures to ensure compliance with applicable consumer credit laws.
Failure on our part to comply with applicable laws could expose us to
substantial penalties and claims for damages and, in certain circumstances, may
require us to refund finance charges already paid and to forego finance charges
not yet paid under non-complying contracts. We believe that we are in
substantial compliance with all applicable federal and state consumer credit and
collection laws.
Our sale of credit life, credit disability, credit involuntary
unemployment and credit property insurance products is also highly regulated.
State laws currently impose disclosure obligations with respect to our sales of
credit and other insurance products similar to those required by the Federal
Truth in Lending Act, impose restrictions on the amount of premiums that we may
charge and require licensing of certain of our employees and operating entities.
We believe we are in substantial compliance with all applicable laws and
regulations relating to our credit insurance business.
17
Employees
As of January 31, 2008, we had approximately 2,800 full-time employees
and 100 part-time employees, of which approximately 1,300 were sales personnel.
We offer a comprehensive benefits package including health, life, short and long
term disability, and dental insurance coverage as well as a 401(k) plan,
employee stock purchase plan, paid vacation and holiday pay. None of our
employees are covered by collective bargaining agreements and we believe our
employee relations are good. Conn's has formal dispute resolution plan that
requires mandatory arbitration for employment related issues. The plan covers
all applicants and current employees, and covers former employees who left
Conn's on or after March 1, 2006.
Tradenames and Trademarks
We have registered the trademarks "Conn's" and our logos.
Available Information
We are subject to reporting requirements of the Securities Exchange Act
of 1934, or the Exchange Act, and its rules and regulations. The Exchange Act
requires us to file reports, proxy and other information statements and other
information with the Securities and Exchange Commission (SEC). Copies of these
reports, proxy statements and other information can be inspected and copied at
the SEC Public Reference Room, 450 Fifth Street, N.W., Washington, D.C. 20549.
You may obtain information on the operation of the Public Reference Room by
calling the SEC at 1-800-SEC-0330. You may also obtain these materials
electronically by accessing the SEC's home page on the internet at www.sec.gov.
Our board has adopted a code of business conduct and ethics for our
employees, a code of ethics for our chief executive officer and senior financial
professionals and a code of business conduct and ethics for our board of
directors. A copy of these codes are published on our website at www.conns.com
under "Investor Relations." We intend to make all required disclosures
concerning any amendments to, waivers from, these codes on our website. In
addition, we make available, free of charge on our internet website, our Annual
Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form
8-K, and amendments to these reports filed or furnished pursuant to Section
13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we
electronically file this material with, or furnish it to, the SEC. You may
review these documents, under the heading "Conn's Investor Relations," by
accessing our website at www.conns.com. Also, reports and other information
concerning us are available for inspection and copying at NASDAQ Capital
Markets.
ITEM 1A. RISK FACTORS.
An investment in our common stock involves risks and uncertainties. You
should consider carefully the following information about these risks and
uncertainties before buying shares of our common stock. The occurrence of any of
the risks described below could adversely affect our business, financial
condition or results of operations. In that case, the trading price of our stock
could decline, and you could lose all or part of the value of your investment.
OUR SUCCESS DEPENDS ON OUR ABILITY TO OPEN AND OPERATE PROFITABLY NEW STORES IN
EXISTING, ADJACENT AND NEW GEOGRAPHIC MARKETS.
We plan to continue our expansion by opening an additional seven to 10
new stores in fiscal 2009. We have not yet selected sites for all of the stores
that we plan to open within the next fiscal year. We may not be able to open all
of these stores, and any new stores that we open may not be profitable or meet
our goals. Any of these circumstances could have a material adverse effect on
our financial results.
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There are a number of factors that could affect our ability to open and
operate new stores consistent with our business plan, including:
o competition in existing, adjacent and new markets;
o competitive conditions, consumer tastes and discretionary spending
patterns in adjacent and new markets that are different from those
in our existing markets;
o a lack of consumer demand for our products or financing programs
at levels that can support new store growth;
o inability to make customer financing programs available that allow
consumer to purchase products at levels that can support new store
growth;
o limitations created by covenants and conditions under our credit
facilities and our asset-backed securitization program;
o the availability of additional financial resources;
o the substantial outlay of financial resources required to open new
stores and the possibility that we may recognize little or no
related benefit;
o an inability or unwillingness of vendors to supply product on a
timely basis at competitive prices;
o the failure to open enough stores in new markets to achieve a
sufficient market presence;
o the inability to identify suitable sites and to negotiate
acceptable leases for these sites;
o unfamiliarity with local real estate markets and demographics in
adjacent and new markets;
o problems in adapting our distribution and other operational and
management systems to an expanded network of stores;
o difficulties associated with the hiring, training and retention of
additional skilled personnel, including store managers; and
o higher costs for print, radio and television advertising.
These factors may also affect the ability of any newly opened stores to
achieve sales and profitability levels comparable with our existing stores or to
become profitable at all.
IF WE ARE UNABLE TO MANAGE OUR GROWING BUSINESS, OUR REVENUES MAY NOT INCREASE
AS ANTICIPATED, OUR COST OF OPERATIONS MAY RISE AND OUR PROFITABILITY MAY
DECLINE.
We face many business risks associated with growing companies, including
the risk that our management, financial controls and information systems will be
inadequate to support our planned expansion. Our growth plans will require
management to expend significant time and effort and additional resources to
ensure the continuing adequacy of our financial controls, operating procedures,
information systems, product purchasing, warehousing and distribution systems
and employee training programs. We cannot predict whether we will be able to
manage effectively these increased demands or respond on a timely basis to the
changing demands that our planned expansion will impose on our management,
financial controls and information systems. If we fail to manage successfully
the challenges our growth poses, do not continue to improve these systems and
controls or encounter unexpected difficulties during our expansion, our
business, financial condition, operating results or cash flows could be
materially adversely affected.
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THE INABILITY TO OBTAIN FUNDING FOR OUR CREDIT OPERATIONS THROUGH SECURITIZATION
FACILITIES OR OTHER SOURCES MAY ADVERSELY AFFECT OUR BUSINESS AND EXPANSION
PLANS.
We finance most of our customer receivables through asset-backed
securitization facilities. The trust arrangement governing these facilities
currently provides for three separate series of asset-backed notes that allowed
us, as of January 31, 2008, to borrow up to $640 million to finance customer
receivables. Under each note series, we transfer customer receivables to a
qualifying special purpose entity we formed for this purpose, in exchange for
cash, subordinated securities and the right to receive cash flows equal to the
interest rate spread between the transferred receivables and the notes issued to
third parties. This qualifying special purpose entity, in turn, issues notes
collateralized by these receivables that entitle the holders of the notes to
participate in certain cash flows from these receivables. The 2002 Series A
program is a $450 million variable funding note, of which $278.0 million was
drawn as of January 31, 2008. The 2002 Series A program consists of a $250
million 364-day tranche that is up for renewal in July 2008, and a $200 million
tranche that matures in August 2011. If the $250 million 364-day commitment is
not renewed in July 2008, the qualifying special purpose entity would be
required to use the proceeds from collections on the receivables portfolio to
pay off the portion of the 2002 Series A note that is greater than $200 million.
If that were to occur, and if we are not able to complete the issuance of an
additional series of medium-term notes, we would be required to fund new
receivables generated using our existing cash flows, borrowings on our credit
facilities and may be required to obtain new sources of financing to continue
funding our credit operations. The 2002 Series B program consists of $40.0
million in private bond placements that began scheduled principal payments in
October 2006. The 2006 Series A program consists of $150 million in private bond
placements that will require scheduled principal payments beginning in September
2010.
Our ability to raise additional capital through further securitization
transactions, and to do so on economically favorable terms, depends in large
part on factors that are beyond our control.
These factors include:
o conditions in the securities and finance markets generally;
o conditions in the markets for securitized instruments;
o the credit quality and performance of our customer receivables;
o our ability to obtain financial support for required credit
enhancement;
o our ability to adequately service our financial instruments;
o the absence of any material downgrading or withdrawal of ratings
given to our securities previously issued in securitizations; and
o prevailing interest rates.
Our ability to finance customer receivables under our current
asset-backed securitization facilities depends on our continued compliance with
covenants relating to our business and our customer receivables. If these
programs reach their capacity or otherwise become unavailable, and we are unable
to arrange substitute securitization facilities or other sources of financing,
we may have to limit the amount of credit that we make available through our
customer finance programs. This may adversely affect revenues and results of
operations. Further, our inability to obtain funding through securitization
facilities or other sources may adversely affect the profitability of
outstanding accounts under our credit programs if existing customers fail to
repay outstanding credit due to our refusal to grant additional credit. Since
our cost of funds under our bank credit facility is expected to be greater than
our cost of funds under our current securitization facility, increased reliance
on our bank credit facility may adversely affect our net income.
We also have a revolving credit facility of $50 million that can be used
for working capital purposes, including funding credit portfolio growth. The
credit facility has an accordion feature that allows further expansion of the
facility to $90 million, under certain conditions. This facility has a maturity
date of November 1, 2010, and provides a sublimit of $5 million for standby
letters of credit.
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AN INCREASE IN INTEREST RATES MAY ADVERSELY AFFECT OUR PROFITABILITY.
The interest rates on our bank credit facility and the 2002 Series A
program under our asset-backed securitization facility fluctuate up or down
based upon the LIBOR rate, the prime rate of our administrative agent or the
federal funds rate in the case of the bank credit facility and the commercial
paper rate in the case of the 2002 Series A program. Additionally, the level of
interest rates in the market in general will impact the interest rate on
medium-term notes issued under our asset-backed securitization facility. To the
extent that such rates increase, the fair value of our interests in securitized
assets will decline and our interest expense could increase, which may result in
a decrease in our profitability.
WE HAVE SIGNIFICANT FUTURE CAPITAL NEEDS WHICH WE MAY BE UNABLE TO FUND, AND WE
MAY NEED ADDITIONAL FUNDING SOONER THAN CURRENTLY ANTICIPATED.
We will need substantial capital to finance our expansion plans,
including funds for capital expenditures, pre-opening costs and initial
operating losses related to new store openings. We may not be able to obtain
additional financing on acceptable terms. If adequate funds are not available,
we will have to curtail projected growth, which could materially adversely
affect our business, financial condition, operating results or cash flows.
We estimate that capital expenditures during fiscal 2009 will be
approximately $20 million to $25 million and that capital expenditures during
future years may exceed this amount. We expect that cash provided by operating
activities, available borrowings under our credit facility, and access to the
unfunded portion of our asset-backed securitization program will be sufficient
to fund our operations, store expansion and updating activities and capital
expenditure programs for at least 12 months. However, this may not be the case.
We may be required to seek additional capital earlier than anticipated if future
cash flows from operations fail to meet our expectations and costs or capital
expenditures related to new store openings exceed anticipated amounts.
A DECREASE IN OUR CREDIT SALES OR A DECLINE IN CREDIT QUALITY COULD LEAD TO A
DECREASE IN OUR PRODUCT SALES AND PROFITABILITY.
In the last three fiscal years, we financed, on average, approximately
59% of our retail sales through our internal credit programs. Our ability to
provide credit as a financing alternative for our customers depends on many
factors, including the quality of our accounts receivable portfolio. Payments on
some of our credit accounts become delinquent from time to time, and some
accounts end up in default, due to several factors, such as general and local
economic conditions, including the impact of rising interest rates on sub-prime
mortgage borrowers. As we expand into new markets, we will obtain new credit
accounts that may present a higher risk than our existing credit accounts since
new credit customers do not have an established credit history with us. A
general decline in the quality of our accounts receivable portfolio could lead
to a reduction of available credit provided through our finance operations. As a
result, we might sell fewer products, which could adversely affect our earnings.
Further, because approximately 56% of our credit customers make their credit
account payments in our stores, any decrease in credit sales could reduce
traffic in our stores and lower our revenues. A decline in the credit quality of
our credit accounts could also cause an increase in our credit losses, which
could result in a decrease in our securitization income or increase the
provision for bad debts on our statement of operations and result in an adverse
effect on our earnings. A decline in credit quality could also lead to stricter
underwriting criteria which might have a negative impact on sales.
A DOWNTURN IN THE ECONOMY MAY AFFECT CONSUMER PURCHASES OF DISCRETIONARY ITEMS,
WHICH COULD REDUCE OUR NET SALES.
A portion of our sales represent discretionary spending by our customers.
Many factors affect spending, including regional or world events, war,
conditions in financial markets, general business conditions, interest rates,
inflation, energy and gasoline prices, consumer debt levels, the availability of
consumer credit, taxation, unemployment trends and other matters that influence
consumer confidence and spending. Our customers' purchases of discretionary
items, including our products, could decline during periods when disposable
income is lower or periods of actual or perceived unfavorable economic
conditions. If this occurs, our net sales and profitability could decline.
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WE FACE SIGNIFICANT COMPETITION FROM NATIONAL, REGIONAL AND LOCAL RETAILERS OF
HOME APPLIANCES AND CONSUMER ELECTRONICS.
The retail market for consumer electronics is highly fragmented and
intensely competitive and the market for home appliances is concentrated among a
few major dealers. We currently compete against a diverse group of retailers,
including national mass merchants such as Sears, Wal-Mart, Target, Sam's Club
and Costco, specialized national retailers such as Circuit City and Best Buy,
home improvement stores such as Lowe's and Home Depot, and locally-owned
regional or independent retail specialty stores that sell home appliances and
consumer electronics similar, and often identical, to those we sell. We also
compete with retailers that market products through store catalogs and the
Internet. In addition, there are few barriers to entry into our current and
contemplated markets, and new competitors may enter our current or future
markets at any time.
We may not be able to compete successfully against existing and future
competitors. Some of our competitors have financial resources that are
substantially greater than ours and may be able to purchase inventory at lower
costs and better sustain economic downturns. Our competitors may respond more
quickly to new or emerging technologies and may have greater resources to devote
to promotion and sale of products and services. If two or more competitors
consolidate their businesses or enter into strategic partnerships, they may be
able to compete more effectively against us.
Our existing competitors or new entrants into our industry may use a
number of different strategies to compete against us, including:
o expansion by our existing competitors or entry by new competitors
into markets where we currently operate;
o the decreased size of flat-panel televisions allowing new entrants
to display and sell the product;
o lower pricing;
o aggressive advertising and marketing;
o extension of credit to customers on terms more favorable than we
offer;
o larger store size, which may result in greater operational
efficiencies, or innovative store formats; and
o adoption of improved retail sales methods.
Competition from any of these sources could cause us to lose market
share, revenues and customers, increase expenditures or reduce prices, any of
which could have a material adverse effect on our results of operations.
IF NEW PRODUCTS ARE NOT INTRODUCED OR CONSUMERS DO NOT ACCEPT NEW PRODUCTS, OUR
SALES MAY DECLINE.
Our ability to maintain and increase revenues depends to a large extent
on the periodic introduction and availability of new products and technologies.
We believe that the introduction and continued growth in consumer acceptance of
new products, such as digital video recorders and digital, high-definition
televisions, will have a significant impact on our ability to increase revenues.
These products are subject to significant technological changes and pricing
limitations and are subject to the actions and cooperation of third parties,
such as movie distributors and television and radio broadcasters, all of which
could affect the success of these and other new consumer electronics
technologies. It is possible that new products will never achieve widespread
consumer acceptance.
IF WE FAIL TO ANTICIPATE CHANGES IN CONSUMER PREFERENCES, OUR SALES MAY DECLINE.
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Our products must appeal to a broad range of consumers whose preferences
cannot be predicted with certainty and are subject to change. Our success
depends upon our ability to anticipate and respond in a timely manner to trends
in consumer preferences relating to home appliances and consumer electronics. If
we fail to identify and respond to these changes, our sales of these products
may decline. In addition, we often make commitments to purchase products from
our vendors up to six months in advance of proposed delivery dates. Significant
deviation from the projected demand for products that we sell may have a
material adverse effect on our results of operations and financial condition,
either from lost sales or lower margins due to the need to reduce prices to
dispose of excess inventory.
A DISRUPTION IN OUR RELATIONSHIPS WITH, OR IN THE OPERATIONS OF, ANY OF OUR KEY
SUPPLIERS COULD CAUSE OUR SALES TO DECLINE.
The success of our business and growth strategies depends to a
significant degree on our relationships with our suppliers, particularly our
brand name suppliers such as General Electric, Whirlpool, Frigidaire, Maytag,
LG, Mitsubishi, Samsung, Sony, Toshiba, Hitachi, Serta, Simmons, Ashley, Lane,
Hewlett Packard, Compaq, Poulan, Husqvarna and Toro. We do not have long term
supply agreements or exclusive arrangements with the majority of our vendors. We
typically order our inventory through the issuance of individual purchase orders
to vendors. We also rely on our suppliers for cooperative advertising support.
We may be subject to rationing by suppliers with respect to a number of limited
distribution items. In addition, we rely heavily on a relatively small number of
suppliers. Our top six suppliers represented 54.8% of our purchases for fiscal
2008, and the top two suppliers represented approximately 26.1% of our total
purchases. The loss of any one or more of these key vendors or our failure to
establish and maintain relationships with these and other vendors could have a
material adverse effect on our results of operations and financial condition.
Our ability to enter new markets successfully depends, to a significant
extent, on the willingness and ability of our vendors to supply merchandise to
additional warehouses or stores. If vendors are unwilling or unable to supply
some or all of their products to us at acceptable prices in one or more markets,
our results of operations and financial condition could be materially adversely
affected.
Furthermore, we rely on credit from vendors to purchase our products. As
of January 31, 2008, we had $30.4 million in accounts payable and $81.5 million
in merchandise inventories. A substantial change in credit terms from vendors or
vendors' willingness to extend credit to us would reduce our ability to obtain
the merchandise that we sell, which could have a material adverse effect on our
sales and results of operations.
Our vendors also supply us with marketing funds and volume rebates. If
our vendors fail to continue these incentives it could have a material adverse
effect on our sales and results of operations.
YOU SHOULD NOT RELY ON OUR COMPARABLE STORE SALES AS AN INDICATION OF OUR FUTURE
RESULTS OF OPERATIONS BECAUSE THEY FLUCTUATE SIGNIFICANTLY.
Our historical same store sales growth figures have fluctuated
significantly from quarter to quarter. For example, same store sales growth for
each of the quarters of fiscal 2008 were -0.3%, 5.0%, 6.8%, and 1.9%,
respectively. A number of factors have historically affected, and will continue
to affect, our comparable store sales results, including:
o changes in competition;
o general economic conditions;
o new product introductions;
o consumer trends;
o changes in our merchandise mix;
o changes in the relative sales price points of our major product
categories;
o ability to offer credit programs attractive to our customers;
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o the impact of our new stores on our existing stores, including
potential decreases in existing stores' sales as a result of
opening new stores;
o weather conditions in our markets;
o timing of promotional events;
o timing, location and participants of major sporting events; and
o our ability to execute our business strategy effectively.
Changes in our quarterly and annual comparable store sales results could
cause the price of our common stock to fluctuate significantly.
BECAUSE WE EXPERIENCE SEASONAL FLUCTUATIONS IN OUR SALES, OUR QUARTERLY RESULTS
WILL FLUCTUATE, WHICH COULD ADVERSELY AFFECT OUR COMMON STOCK PRICE.
We experience seasonal fluctuations in our net sales and operating
results. In fiscal 2008, we generated 27.4% of our net sales and 33.0% of our
net income in the fiscal quarter ended January 31 (which included the holiday
selling season). We also incur significant additional expenses during this
fiscal quarter due to higher purchase volumes and increased staffing. If we
miscalculate the demand for our products generally or for our product mix during
the fiscal quarter ending January 31, our net sales could decline, resulting in
excess inventory or increased sales discounts to sell excess inventory, which
could harm our financial performance. A shortfall in expected net sales,
combined with our significant additional expenses during this fiscal quarter,
could cause a significant decline in our operating results. This could adversely
affect our common stock price.
OUR BUSINESS COULD BE ADVERSELY AFFECTED BY CHANGES IN CONSUMER PROTECTION LAWS
AND REGULATIONS.
Federal and state consumer protection laws and regulations, such as the
Fair Credit Reporting Act, limit the manner in which we may offer and extend
credit. Since we finance a substantial portion of our sales, any adverse change
in the regulation of consumer credit could adversely affect our total revenues
and gross margins. For example, new laws or regulations could limit the amount
of interest or fees that may be charged on consumer credit accounts or restrict
our ability to collect on account balances, which would have a material adverse
effect on our earnings. During 2005, new bankruptcy laws went into effect that
impacted our customers' ability to file for bankruptcy. Historically, we had
been relatively effective in pursuing our position as a secured creditor of
bankrupt borrowers and obtaining payments on the related accounts and contracts.
However, at this time we cannot be certain what long term impact these changes
will have on our delinquency or loss experience. Compliance with existing and
future laws or regulations could require us to make material expenditures, in
particular personnel training costs, or otherwise adversely affect our business
or financial results. Failure to comply with these laws or regulations, even if
inadvertent, could result in negative publicity, fines or additional licensing
expenses, any of which could have an adverse effect on our results of operations
and stock price.
PENDING LITIGATION RELATING TO THE SALE OF CREDIT INSURANCE AND THE SALE OF
SERVICE MAINTENANCE AGREEMENTS IN THE RETAIL INDUSTRY COULD ADVERSELY AFFECT OUR
BUSINESS.
We understand that states' attorneys general and private plaintiffs have
filed lawsuits against other retailers relating to improper practices conducted
in connection with the sale of credit insurance in several jurisdictions around
the country. We offer credit insurance in all of our stores and require the
customer to purchase property insurance from us or from a third party provider,
at their election, in connection with sales of merchandise on installment
credit; therefore, similar litigation could be brought against us. While we
believe we are in full compliance with applicable laws and regulations, if we
are found liable in any future lawsuit regarding credit insurance or service
maintenance agreements, we could be required to pay substantial damages or incur
substantial costs as part of an out-of-court settlement, either of which could
have a material adverse effect on our results of operations and stock price. An
adverse judgment or any negative publicity associated with our service
maintenance agreements or any potential credit insurance litigation could also
affect our reputation, which could have a negative impact on sales.
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IF WE LOSE KEY MANAGEMENT OR ARE UNABLE TO ATTRACT AND RETAIN THE QUALIFIED
SALES AND CREDIT GRANTING AND COLLECTION PERSONNEL REQUIRED FOR OUR BUSINESS,
OUR OPERATING RESULTS COULD SUFFER.
Our future success depends to a significant degree on the skills,
experience and continued service of our key executives or the identification of
suitable successors for them. If we lose the services of any of these
individuals, or if one or more of them or other key personnel decide to join a
competitor or otherwise compete directly or indirectly with us, and we are
unable to identify a suitable successor, our business and operations could be
harmed, and we could have difficulty in implementing our strategy. In addition,
as our business grows, we will need to locate, hire and retain additional
qualified sales personnel in a timely manner and develop, train and manage an
increasing number of management level sales associates and other employees.
Additionally, if we are unable to attract and retain qualified credit granting
and collection personnel, our ability to perform quality underwriting of new
credit transactions or maintain workloads for our collections personnel at a
manageable level, our operations could be adversely impacted and result in
higher delinquency and net charge-offs on our credit portfolio. Competition for
qualified employees could require us to pay higher wages to attract a sufficient
number of employees, and increases in the federal minimum wage or other employee
benefits costs could increase our operating expenses. If we are unable to
attract and retain personnel as needed in the future, our net sales growth and
operating results could suffer.
BECAUSE OUR STORES ARE LOCATED IN TEXAS, LOUISIANA AND OKLAHOMA, WE ARE SUBJECT
TO REGIONAL RISKS.
Our 69 stores are located exclusively in Texas, Louisiana and Oklahoma.
This subjects us to regional risks, such as the economy, weather conditions,
hurricanes and other natural disasters. If the region suffered an economic
downturn or other adverse regional event, there could be an adverse impact on
our net sales and profitability and our ability to implement our planned
expansion program. Several of our competitors operate stores across the United
States and thus are not as vulnerable to the risks of operating in one region.
OUR INFORMATION TECHNOLOGY INFRASTRUCTURE IS VULNERABLE TO DAMAGE THAT COULD
HARM OUR BUSINESS.
Our ability to operate our business from day to day, in particular our
ability to manage our credit operations and inventory levels, largely depends on
the efficient operation of our computer hardware and software systems. We use
management information systems to track inventory information at the store
level, communicate customer information, aggregate daily sales information and
manage our credit portfolio. These systems and our operations are subject to
damage or interruption from:
o power loss, computer systems failures and Internet,
telecommunications or data network failures;
o operator negligence or improper operation by, or supervision of,
employees;
o physical and electronic loss of data or security breaches,
misappropriation and similar events;
o computer viruses;
o intentional acts of vandalism and similar events; and
o hurricanes, fires, floods and other natural disasters.
The software that we have developed to use in our daily operations may
contain undetected errors that could cause our network to fail or our expenses
to increase. Any failure due to any of these causes, if it is not supported by
our disaster recovery plan, could cause an interruption in our operations and
result in reduced net sales and profitability.
IF WE ARE UNABLE TO MAINTAIN OUR INSURANCE LICENSES IN THE STATES WE OPERATE OUR
OPERATING RESULTS COULD SUFFER.
We derive a significant portion of our revenues and operating income
from the sale of various insurance products to our customers. These products
include credit insurance, service maintenance agreements and product replacement
policies. If for any reason we were unable to maintain our insurance licenses in
the states we operate our operating results could suffer.
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IF WE ARE UNABLE TO MAINTAIN OUR CURRENT INSURANCE COVERAGE FOR OUR SERVICE
MAINTENANCE AGREEMENTS, OUR CUSTOMERS COULD INCUR ADDITIONAL COSTS AND OUR
REPAIR EXPENSES COULD INCREASE, WHICH COULD ADVERSELY AFFECT OUR FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
There are a limited number of insurance carriers that provide coverage
for our service maintenance agreements. If insurance becomes unavailable from
our current carriers for any reason, we may be unable to provide replacement
coverage on the same terms, if at all. Even if we are able to obtain replacement
coverage, higher premiums could have an adverse impact on our profitability if
we are unable to pass along the increased cost of such coverage to our
customers. Inability to obtain insurance coverage for our service maintenance
agreements could cause fluctuations in our repair expenses and greater
volatility of earnings.
IF WE ARE UNABLE TO MAINTAIN GROUP CREDIT INSURANCE POLICIES FROM INSURANCE
CARRIERS, WHICH ALLOW US TO OFFER THEIR CREDIT INSURANCE PRODUCTS TO OUR
CUSTOMERS PURCHASING ON CREDIT, OUR REVENUES COULD BE REDUCED AND BAD DEBTS
MIGHT INCREASE.
There are a limited number of insurance carriers that provide credit
insurance coverage for sale to our customers. If credit insurance becomes
unavailable for any reason we may be unable to offer replacement coverage on the
same terms, if at all. Even if we are able to obtain replacement coverage, it
may be at higher rates or reduced coverage, which could affect the customer
acceptance of these products, reduce our revenues or increase our credit losses.
CHANGES IN PREMIUM AND COMMISSION RATES ALLOWED BY REGULATORS ON OUR CREDIT
INSURANCE AND SERVICE MAINTENANCE AGREEMENTS AS ALLOWED BY THE LAWS AND
REGULATIONS IN THE STATES IN WHICH WE OPERATE COULD AFFECT OUR REVENUES.
We derive a significant portion of our revenues and operating income from
the sale of various insurance products to our customers. These products include
credit insurance and service maintenance agreements. If the rate we are allowed
to charge on those products declines, our operating results could suffer.
CHANGES IN TRADE REGULATIONS, CURRENCY FLUCTUATIONS AND OTHER FACTORS BEYOND OUR
CONTROL COULD AFFECT OUR BUSINESS.
A significant portion of our inventory is manufactured overseas and in
Mexico. Changes in trade regulations, currency fluctuations or other factors
beyond our control may increase the cost of items we purchase or create
shortages of these items, which in turn could have a material adverse effect on
our results of operations and financial condition. Conversely, significant
reductions in the cost of these items in U.S. dollars may cause a significant
reduction in the retail prices of those products, resulting in a material
adverse effect on our sales, margins or competitive position. In addition,
commissions earned on both our credit insurance and service maintenance
agreement products could be adversely affected by changes in statutory premium
rates, commission rates, adverse claims experience and other factors.
WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, WHICH COULD IMPAIR
OUR NAME AND REPUTATION.
We believe that our success and ability to compete depends in part on
consumer identification of the name "Conn's." We have registered the trademarks
"Conn's" and our logo. We intend to protect vigorously our trademark against
infringement or misappropriation by others. A third party, however, could
attempt to misappropriate our intellectual property in the future. The
enforcement of our proprietary rights through litigation could result in
substantial costs to us that could have a material adverse effect on our
financial condition or results of operations.
FAILURE TO PROTECT THE SECURITY OF OUR CUSTOMER'S INFORMATION COULD EXPOSE US TO
LITIGATION, JUDGMENTS FOR DAMAGES AND UNDERMINE THE TRUST PLACED WITH US BY OUR
CUSTOMERS.
We capture, transmit, handle and store sensitive information, which
involves certain inherent security risks. Such risks include, among other
things, the interception of by persons outside the Company or by our own
employees. While we believe we have taken appropriate steps to protect
confidential information, there can be no assurance that we can prevent the
compromise of our customers' data or other confidential information. If such a
breach should occur at Conn's, it could have a severe negative impact on our
business and results of operations.
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ANY CHANGES IN THE TAX LAWS OF THE STATES IN WHICH WE OPERATE COULD AFFECT OUR
STATE TAX LIABILITIES. ADDITIONALLY, BEGINNING OPERATIONS IN NEW STATES COULD
ALSO AFFECT OUR STATE TAX LIABILITIES.
As we experienced in fiscal year 2007 with the change in the Texas tax
law, legislation could be introduced at any time that changes our state tax
liabilities in a way that has an adverse impact on our results of operations.
The Texas margin tax is expected to increase our effective rate from
approximately 35.3%, before its introduction, to between 36.5% and 37.5% in the
future. Our recent commencement of operations in Oklahoma and the potential to
enter new states in the future could adversely affect our results of operations,
dependent upon the tax laws in place in those states.
A FURTHER RISE IN OIL AND GASOLINE PRICES COULD AFFECT OUR CUSTOMERS'
DETERMINATION TO DRIVE TO OUR STORES, AND CAUSE US TO RAISE OUR DELIVERY
CHARGES.
A further significant increase in oil and gasoline prices could adversely
affect our customers' shopping decisions and patterns. We rely heavily on our
internal distribution system and our next day delivery policy to satisfy our
customers' needs and desires, and any such significant increases could result in
increased distribution charges. Such increases may not significantly affect our
competitors.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
ITEM 2. PROPERTIES.
The following summarizes the geographic location of our stores, warehouse
and distribution centers and corporate facilities by major market area:
Leases
With
Options
Total Expiring
No. of Leased Square Storage Beyond 10
Geographic Location Locations Facilities Feet Square Feet Years
---------------------------- ----------- ----------- ----------- ----------- -----------
Golden Triangle District (1). 5 5 157,129 30,456 5
Louisiana District........... 5 5 148,628 38,394 5
Houston District............. 22 19 538,342 89,235 14
San Antonio/Austin District.. 15 15 458,637 87,849 14
Corpus Christi............... 1 1 61,864 18,960 1
South Texas.................. 3 3 91,697 15,484 3
Oklahoma District............ 1 1 31,385 6,385 1
Dallas District.............. 17 15 492,193 86,809 15
----------- ----------- ----------- ----------- -----------
Store Totals.............. 69 64 1,979,875 373,572 58
Warehouse/Distribution
Centers..................... 7 4 721,453 721,453 1
Service Centers.............. 5 3 191,932 133,636 1
Corporate Offices............ 1 1 106,783 25,000 1
----------- ----------- ----------- ----------- -----------
Total..................... 82 72 3,000,043 1,253,661 61
=========== =========== =========== =========== ===========
-----------
(1) Includes one store in Lake Charles, Louisiana.
27
ITEM 3. LEGAL PROCEEDINGS.
We are involved in routine litigation incidental to our business from
time to time. We do not expect the outcome of any of this routine litigation to
have a material effect on our financial condition or results of operation.
However, the results of their proceedings cannot be predicted with certainty,
and changes in facts and circumstances could impact our estimate of reserves for
litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There were no matters submitted to a vote of security holders during the
fourth quarter of fiscal 2008.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, AND RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES.
WHAT IS THE PRINCIPAL MARKET FOR OUR COMMON STOCK?
The principal market for our common stock is the NASDAQ Global Select
Market. Our common stock is listed on the NASDAQ Global Select Market under the
symbol "CONN." Information regarding the high and low sales prices for our
common stock for each quarterly period within the two most recent fiscal years
as reported on NASDAQ is summarized as follows:
High Low
--------- ---------
Quarter ended April 30, 2006.................. $ 44.99 $ 31.81
Quarter ended July 31, 2006................... $ 35.52 $ 24.02
Quarter ended October 31, 2006................ $ 26.75 $ 17.61
Quarter ended January 31, 2007................ $ 25.33 $ 21.00
Quarter ended April 30, 2007.................. $ 28.27 $ 22.66
Quarter ended July 31, 2007................... $ 32.19 $ 24.35
Quarter ended October 31, 2007................ $ 28.54 $ 19.60
Quarter ended January 31, 2008................ $ 25.87 $ 14.05
HOW MANY COMMON STOCKHOLDERS DO WE HAVE?
As of March 14, 2008, we had approximately 51 common stockholders of
record and an estimated 7,500 beneficial owners of our common stock.
DID WE DECLARE ANY CASH DIVIDENDS IN FISCAL 2007 OR FISCAL 2008?
No cash dividends were paid in fiscal 2007 or 2008. We do not anticipate
paying dividends in the foreseeable future. Any future payment of dividends will
be at the discretion of the Board of Directors and will depend upon our results
of operations, financial condition, cash requirements and other factors deemed
relevant by the Board of Directors, including the terms of our indebtedness.
Provisions in agreements governing our long-term indebtedness restrict the
amount of dividends that we may pay to our stockholders. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources."
HAS THE COMPANY HAD ANY SALES OF UNREGISTERED SECURITIES DURING THE LAST YEAR?
The Company has had no sales of unregistered securities during fiscal
2008.
28
HAS THE COMPANY PURCHASED ANY OF ITS SECURITIES DURING THE PAST QUARTER?
On August 25, 2006, we announced that our Board of Directors had
authorized a common stock repurchase program, permitting us to purchase, from
time to time, in the open market and in privately negotiated transactions, up to
an aggregate of $50.0 million of our common stock, dependent on market
conditions and the price of the stock. During the quarter ended January 31,
2008, we effected the following repurchases of our common stock:
Total # of Shares Approximate
Purchased as Dollar Value of
Total # of Average Part of Publicly Shares That May
shares Price Paid Announced Yet Be Purchased
Period purchased per share Programs Under the Programs
------ ---------- ---------- ----------------- -------------------
November 1 - November 30, 2007...... - $ - - $ 25,498,150
December 1 - December 31, 2007...... 443,600 $ 19.64 443,600 $ 16,784,118
January 1 - January 31, 2008........ 238,420 $ 15.93 238,420 $ 12,985,016
---------- -----------------
Total............................... 682,020 682,020
========== =================
29
ITEM 6. SELECTED FINANCIAL DATA.
Year Ended January 31, (A)
-----------------------------------------------------------
2004 2005 2006 2007 2008
----------- ----------- ----------- ----------- -----------
(dollars and shares in thousands, except per share amounts)
(B)
Statement of Operations:
Total revenues.................................. $498,378 $565,821 $701,148 $760,657 $824,128
Operating expense:
Cost of goods sold, including warehousing
and occupancy cost............................. 300,935 339,887 427,843 473,064 517,166
Selling, general and administrative expense..... 152,234 173,349 208,259 224,979 245,317
Provision for bad debts......................... 2,504 2,589 1,133 1,476 1,908
----------- ----------- ----------- ----------- -----------
Total operating expense......................... 455,673 515,825 637,235 699,519 764,391
----------- ----------- ----------- ----------- -----------
Operating income................................ 42,705 49,996 63,913 61,138 59,737
Interest (income) expense, net and minority
interest....................................... 4,577 2,477 400 (676) (515)
Other (income) expense.......................... (175) 126 69 (772) (943)
----------- ----------- ----------- ----------- -----------
Earnings before income taxes.................... 38,303 47,393 63,444 62,586 61,195
Provision for income taxes...................... 13,260 16,706 22,341 22,275 21,509
----------- ----------- ----------- ----------- -----------
Net income...................................... 25,043 30,687 41,103 40,311 39,686
Less preferred stock dividends (1).............. (1,954) - - - -
----------- ----------- ----------- ----------- -----------
Net income available for common stockholders.... $23,089 $30,687 $41,103 $40,311 $39,686
=========== =========== =========== =========== ===========
Earnings per common share:
Basic...................................... $1.30 $1.32 $1.76 $1.70 $1.71
Diluted.................................... $1.26 $1.30 $1.71 $1.66 $1.68
Average common shares outstanding:
Basic...................................... 17,726 23,192 23,412 23,663 23,193
Diluted.................................... 18,257 23,646 24,088 24,289 23,673
Other Financial Data:
Stores open at end of period.................... 45 50 56 62 69
Same store sales growth (2)..................... 2.6% 3.6% 16.9% 3.6% 3.2%
Inventory turns (3)............................. 6.5 6.0 6.6 6.1 6.4
Gross margin percentage (4)..................... 39.6% 39.9% 39.0% 37.8% 37.2%
Operating margin (5)............................ 8.6% 8.8% 9.1% 8.0% 7.2%
Return on average equity (6).................... 20.9% 16.1% 17.7% 14.7% 13.3%
Capital expenditures............................ $9,401 $19,619 $18,490 $18,425 $18,955
Balance Sheet Data:
Working capital................................. $121,154 $156,006 $190,073 $220,740 $236,763
Total assets.................................... 240,081 276,716 355,617 389,947 382,852
Total debt...................................... 14,512 10,532 136 198 119
Total stockholders' equity...................... 171,911 208,734 255,861 292,528 304,418
--------------------------------
(1) Dividends declared and paid related to 2004.
(2) Same store sales growth is calculated by comparing the reported sales by
store for all stores that were open throughout a period to reported sales
by store for all stores that were open throughout the prior period. Sales
from closed stores have been removed from each period. Sales from
relocated stores have been included in each period because each such
store was relocated within the same general geographic market. Sales from
expanded stores have been included in each period.
(3) Inventory turns are defined as the cost of goods sold, excluding
warehousing and occupancy cost, divided by the average product inventory
balance, excluding consigned goods.
(4) Gross margin percentage is defined as total revenues less cost of goods
and parts sold, including warehousing and occupancy cost, divided by
total revenues.
(5) Operating margin is defined as operating income divided by total
revenues.
(6) Return on average equity is calculated as current period net income
divided by the average of the beginning and ending equity.
(A) In order to present our results on a basis that is more comparable with
others in our industry, we have reclassified advertising expenditures
that were previously included in costs of goods sold to selling, general
and administrative expense.
(B) Fiscal 2008 was impacted by a non-cash fair value adjustment of $4.8
million which reduced the fair value of our interests in securitized
assets.
30
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Forward-Looking Statements
This report contains forward-looking statements. We sometimes use words
such as "believe," "may," "will," "estimate," "continue," "anticipate,"
"intend," "expect," "project" and similar expressions, as they relate to us, our
management and our industry, to identify forward-looking statements.
Forward-looking statements relate to our expectations, beliefs, plans,
strategies, prospects, future performance, anticipated trends and other future
events. We have based our forward-looking statements largely on our current
expectations and projections about future events and financial trends affecting
our business. Actual results may differ materially. Some of the risks,
uncertainties and assumptions about us that may cause actual results to differ
from these forward-looking statements include, but are not limited to:
o the success of our growth strategy and plans regarding opening new
stores and entering adjacent and new markets, including our plans
to continue expanding into the Dallas/Fort Worth Metroplex, South
Texas and Oklahoma;
o our ability to open and profitably operate new stores in existing,
adjacent and new geographic markets;
o our intention to update or expand existing stores;
o our ability to obtain capital for required capital expenditures
and costs related to the opening of new stores or to update or
expand existing stores;
o our cash flows from operations, borrowings from our revolving line
of credit and proceeds from securitizations to fund our
operations, capital expenditures, debt repayment and expansion;
o the ability of the QSPE to obtain additional funding for the
purpose of purchasing our receivables, including limitations on
the ability of the QSPE to obtain financing through its commercial
paper-based funding sources;
o the effect of rising interest rates that could increase our cost
of borrowing or reduce securitization income; the
o the effect of rising interest rates on sub-prime mortgage
borrowers that could impair our customers' ability to make
payments on outstanding credit accounts;
o our inability to make customer financing programs available that
allow consumers to purchase products at levels that can support
our growth;
o the potential for deterioration in the delinquency status of the
sold or owned credit portfolios or higher than historical net
charge-offs in the portfolios could adversely impact earnings;
o the long-term effect of the change in bankruptcy laws could effect
net charge-offs in the credit portfolio which could adversely
impact earnings;
o technological and market developments, growth trends and projected
sales in the home appliance and consumer electronics industry,
including with respect to digital products like DVD players, HDTV,
GPS devices, home networking devices and other new products, and
our ability to capitalize on such growth;
o the potential for price erosion or lower unit sales points that
could result in declines in revenues;
o higher oil and gas prices could adversely affect our customers'
shopping decisions and patterns, as well as the cost of our
delivery and service operations and our cost of products, if
vendors pass on their additional fuel costs through increased
pricing for products;
31
o the ability to attract and retain qualified personnel;
o both the short-term and long-term impact of adverse weather
conditions (e.g. hurricanes) that could result in volatility in
our revenues and increased expenses and casualty losses;
o changes in laws and regulations and/or interest, premium and
commission rates allowed by regulators on our credit, credit
insurance and service maintenance agreements as allowed by those
laws and regulations;
o our relationships with key suppliers;
o the adequacy of our distribution and information systems and
management experience to support our expansion plans;
o changes in the assumptions used in the valuation of our interests
in securitized assets at fair value;
o the accuracy of our expectations regarding competition and our
competitive advantages;
o the potential for market share erosion that could result in
reduced revenues;
o the accuracy of our expectations regarding the similarity or
dissimilarity of our existing markets as compared to new markets
we enter; and
o the outcome of litigation affecting our business.
Additional important factors that could cause our actual results to
differ materially from our expectations are discussed under "Risk Factors" in
this Form 10-K. In light of these risks, uncertainties and assumptions, the
forward-looking events and circumstances discussed in this report might not
happen.
The forward-looking statements in this report reflect our views and
assumptions only as of the date of this report. We undertake no obligation to
update publicly or revise any forward-looking statements, whether as a result of
new information, future events or otherwise, except as required by law.
All forward-looking statements attributable to us, or to persons acting
on our behalf, are expressly qualified in their entirety by these cautionary
statements.
General
We intend the following discussion and analysis to provide you with a
better understanding of our financial condition and performance in the indicated
periods, including an analysis of those key factors that contributed to our
financial condition and performance and that are, or are expected to be, the key
drivers of our business.
Through our 69 retail stores, we provide products and services to our
customers in seven primary market areas, including Houston, San Antonio/Austin,
Dallas/Fort Worth, southern Louisiana, Southeast and South Texas and Oklahoma.
Products and services offered through retail sales outlets include home
appliances, consumer electronics, home office equipment, lawn and garden
products, mattresses, furniture, service maintenance agreements, customer credit
programs, including installment and revolving credit account programs, and
various credit insurance products. These activities are supported through our
extensive service, warehouse and distribution system. Our stores bear the
"Conn's" name, after our founder's family, and deliver the same products and
services to our customers. All of our stores follow the same procedures and
methods in managing their operations. The Company's management evaluates
performance and allocates resources based on the operating results of the retail
stores and considers the credit programs, service contracts and distribution
system to be an integral part of the Company's retail operations.
32
On February 1, 2007, we were required to adopt Statement of Financial
Accounting Standard (SFAS) No. 155, Accounting for Certain Hybrid Financial
Instruments. Among other things, this statement established a requirement to
evaluate interests in securitized financial assets to identify interests that
are freestanding derivatives or that are hybrid financial instruments that
contain an embedded derivative requiring bifurcation. Additionally, we had the
option to choose to early adopt the provisions of SFAS No. 159, The Fair Value
Option for Financial Assets and Financial Liabilities. We elected to early adopt
SFAS No. 159 because we believe it provides a more easily understood
presentation for financial statement users. This election resulted in us
including all changes in the fair value of our Interests in securitized assets
in current earnings, in Finance charges and other, beginning February 1, 2007.
Previously, most changes in the fair value of our Interests in securitized
assets were recorded in Other comprehensive income, which was included in
Stockholders' equity. SFAS Nos. 155 and 159 do not allow for retrospective
application of these changes in accounting principle, as such, no adjustments
have been made to the amounts disclosed in the financial statements for periods
ending prior to February 1, 2007. Additionally, effective February 1, 2007, we
adopted SFAS No. 157, Fair Value Measurements, which established a framework for
measuring fair value, based on the assumptions we believe market participants
would use to value assets or liabilities to be exchanged. Changes in the
assumptions over time, including varying credit portfolio performance, market
interest rate changes, market participant risk premiums required, or a shift in
the mix of funding sources, could result in significant volatility in the fair
value of the Interest in securitized assets, and thus our earnings.
During the fiscal year ended January 31, 2008, risk premiums required by
market participants on many investments increased significantly as a result of
disruption in the asset-backed securities markets due to increased losses and
delinquencies in sub-prime real estate mortgages. Though we do not anticipate
any significant variation from the current earnings and cash flow performance of
our securitized credit portfolio, we increased the risk premium included in the
discount rate assumption used in the determination of the fair value of our
interests in securitized assets to reflect the higher estimated risk premium we
believe a market participant would require if purchasing the asset. Based on a
review of the changes in market risk premiums during the fiscal year ended
January 31, 2008, and discussions with our investment bankers and financial
advisors, we estimated that a market participant would require an approximately
500 basis point increase in the required discount rate risk premium. As a
result, we increased the weighted average discount rate assumption from 14.6% at
January 31, 2007, to 16.5% at January 31, 2008, after reflecting a 280 basis
point decrease in the risk-free interest rate included in the discount rate
assumption. We have also included an expected market participant-based
assumption related to the estimated cost of a bond issuance contemplated by the
QSPE, and an increase in the credit loss rate on the credit portfolio we
estimate a market participant would use in determining the fair value of our
interests in securitized assets. The increase in the discount rate has the
effect of deferring income to future periods, but not permanently reducing
securitization income or our earnings. If a market participant were to require a
risk premium that is 100 basis points higher than we estimated in the fair value
calculation, the fair value of our interests in securitized assets would be
decreased by an additional $1.7 million. 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 and Finance charges and other would have been reduced by $6.7
million as of January 31, 2008. If the assumption used for estimating credit
losses was increased by 0.5%, the impact to Finance charges and other would have
been a reduction in revenues and pretax income of $2.3 million. As of the date
of the filing of this Annual Report on Form 10-K, we understand that risk
premiums and borrowing costs have continued to increase since January 31, 2008,
and could result in a significant adjustment to the fair value of our interests
in securitized assets in future periods.
We were also required to adopt the provisions of SFAS No. 156, Accounting
for Servicing of Financial Assets, effective on February 1, 2007. As a result of
the adoption of this pronouncement, along with the requirements of SFAS No. 157,
we recorded a $1.1 million servicing liability on the balance sheet in Deferred
revenues and allowances. Any changes in the fair value of the liability are
recorded in the period of change in the statement of operations in Finance
charges and other. As with the other changes discussed above, no adjustments
have been made to the financial statements for periods ending prior to February
1, 2007.
33
Presented below is a diagram setting forth our five cornerstones which
represent, in our view, the five components of our sales goal - strong
merchandising systems, flexible credit options for our customers, an extensive
warehousing and distribution system, a service system to support our customers
needs during and beyond the product warranty periods, and our uniquely,
well-trained employees in each area. Each of these systems combine to create a
"nuts and bolts" support system for our customers needs and desires. Each of
these systems is discussed at length in the Business section of this report.
BUSINESS
CORNERSTONES:
---------------------
Merchandising
Credit
Distribution Drive > Sales
Service
Training
We, of course, derive a large part of our revenue from our product sales.
However, unlike many of our competitors, we provide in-house credit options for
our customers' product purchases. In the last three years, we have financed, on
average, approximately 59% of our retail sales through these programs. In turn,
we finance (convert to cash) substantially all of our customer receivables from
these credit options through an asset-backed securitization facility. See
"Business - Finance Operations" for a detailed discussion of our in-house credit
programs. As part of our asset-backed securitization facility, we have created a
qualifying special purpose entity, which we refer to as the QSPE or the issuer,
to purchase customer receivables from us and to issue medium-term and variable
funding notes serviced by the receivables to finance its acquisition of the
receivables. We transfer our receivables, consisting of retail installment and
revolving account receivables extended to our customers, to the issuer in
exchange for cash and subordinated securities.
While our warehouse and distribution system does not directly generate
revenues, other than the fees paid by our customers for delivery and
installation of the products to their homes, it is our extra, "value-added"
program that our existing customers have come to rely on, and our new customers
are hopefully sufficiently impressed with to become repeat customers. We derive
revenues from our repair services on the products we sell. Additionally, acting
as an agent for unaffiliated companies, we sell credit insurance to protect our
customers from credit losses due to death, disability, involuntary unemployment
and damage to the products they have purchased; to the extent they do not
already have it.
Executive Overview
This overview is intended to provide an executive level overview of our
operations for our fiscal year ended January 31, 2008. A detailed explanation of
the changes in our operations for the fiscal year ended January 31, 2008, as
compared to the prior year is included beginning under Results of Operations.
Following are significant financial items in managements view:
o Our revenues for the fiscal year ended January 31, 2008, increased
by 8.3 percent, or $63.5 million, from fiscal year 2007, to $824.1
million due primarily to product sales growth which drove higher
service maintenance agreement commissions and finance charge and
other revenues. Our same store sales growth rate for the fiscal
year ended January 31, 2008, was 3.2%, versus 3.6% for fiscal
2007.
34
o The addition of stores in our existing Dallas/Fort Worth, Houston,
San Antonio and South Texas markets and our first store in
Oklahoma had a positive impact on our revenues. We achieved
approximately $35.0 million of increases in product sales and
service maintenance agreement (SMA) commissions for the year ended
January 31, 2008, from the opening of thirteen new stores in these
markets since February 2006. Our plans provide for the opening of
seven to ten additional stores, primarily in existing markets, and
expand our presence in Oklahoma, during fiscal 2009 as we focus on
opportunities in markets in which we have existing infrastructure.
o Deferred interest and "same as cash" plans continue to be an
important part of our sales promotion plans and are utilized to
provide a wide variety of financing to enable us to appeal to a
broader customer base. For the fiscal year ended January 31, 2008,
$193.4 million, or 28.8%, of our product sales were financed by
deferred interest and "same as cash" plans. This volume of
promotional credit as a percent of product sales is consistent
with our use of this type of credit product before the hurricanes
in late 2005. For the comparable period in the prior year, product
sales financed by deferred interest and "same as cash" sales were
$152.3 million, or 24.4%. Our promotional credit programs (same as
cash and deferred interest programs), which require monthly
payments, are reserved for our highest credit quality customers,
thereby reducing the overall risk in the portfolio, and are used
primarily to finance sales of our highest margin products. We
expect to continue to offer extended term promotional credit in
the future.
o Our gross margin was 37.2% for fiscal 2008, a decrease from 37.8%
in fiscal 2007, primarily as a result of a $4.8 million reduction
in the fair value of our interest in securitized assets and
reduced gross margin realized on product sales from 25.3% in the
year ended January 31, 2007, to 24.2% in fiscal year 2008.
Excluding the decrease in the fair value of our interest in
securitized assets we would have achieved a 37.6% gross margin.
o Our operating margin decreased to 7.2% in fiscal 2008, from 8.0%
in fiscal 2007, primarily as a result of the $4.8 million decrease
in the fair value of our interest in securitized assets. Excluding
the decrease in the fair value of our interest in securitized
assets, we would have achieved a 7.8% operating margin. In fiscal
year 2008, SG&A expense as a percent of revenues increased to
29.8% from 29.6% when compared to the prior year, primarily from
increases in payroll and payroll related expenses.
o Cash flows used in operations was $5.6 million during fiscal 2008
due primarily to increased investment in credit portfolio growth
and increased investment in inventory due to the timing of
receipts of inventory.
o Our pretax income for fiscal 2008 decreased by 2.2% or
approximately $1.4 million, from fiscal 2007 to $61.2 million in
fiscal 2008. The decrease was driven by $4.8 million non-cash
reduction in the fair value of our interest in securitized assets.
Operational Changes and Outlook
We have implemented, continued increased focus on, or modified several
initiatives in fiscal 2008 that we believe will positively impact our future
operating results, including:
o Increased promotion of flat panel technology in our stores as the
price point becomes more affordable for our customers; and
o Increased emphasis on the sale of small electronics, including
video game equipment and GPS devices; and
o Increased emphasis on the sales of furniture, and additional
product lines added to this category; and
o A thorough review of our staffing and cost structure to ensure we
are effectively leveraging the infrastructure in place and that it
is sufficient to support our growth plans.
35
While the hurricanes that hit the Gulf Coast on August and September of
2005 impacted our customer's ability to pay on their accounts, its biggest
impact was the disruption to our credit collection operations, including payment
processing delays caused by disruption in the mail service. The credit
collection operations were negatively affected by the loss of personnel, as some
employees did not return to work, and by the increase in the number of
delinquent accounts, resulting in increased workloads for the personnel that
returned to work. To address the staffing issues caused by the disruption we saw
after Hurricane Rita that hit the Gulf Coast during September of 2005, we
intensified our recruiting efforts to attract individuals to our Beaumont, Texas
collection center. Further, during 2008, we opened a second collection center in
San Antonio, Texas and closed our collection center in Dallas, Texas. We
identified and have been successful in recruiting highly qualified, bi-lingual
credit collectors in the San Antonio market that we were not able to recruit in
sufficient numbers in Dallas. Additionally, non-storm factors that may be
negatively affecting delinquencies and charge-offs include the impact of the
bankruptcy law change in October 2005 and other economic factors on our
customers, including the impact of rising interest rates on sub-prime mortgages.
In addition to opening the San Antonio collection center, we have reorganized
the management team over our credit operations to achieve a flatter organization
to put key managers closer to the customer. As a result of the changes made, we
have been successful in reducing delinquencies and expect to maintain net credit
losses around 3%.
On May 18, 2006, the Governor of Texas signed a tax bill that modifies
the existing franchise tax, with the most significant change being the
replacement of the existing base with a tax based on margin. Taxable margin is
generally defined as total federal tax revenues minus the greater of (a) cost of
goods sold or (b) compensation. The tax rate to be paid by retailers and
wholesalers is 0.5% on taxable margin. This will result in an increase in taxes
paid by us, as franchise taxes paid totaled less than $50,000 per year for the
years prior to fiscal 2007. During June 2007, we completed a reorganization to
simplify our legal entity structure by merging certain of our Texas limited
partnerships into their corporate partners. The reorganization also resulted in
the one-time elimination of the Texas margin tax owed by those partnerships,
representing virtually all of the margin tax owed by us. Accordingly, we
reversed approximately $0.9 million of accrued Texas margin tax as of June 2007,
net of federal income tax. We began accruing the margin tax for the entities
that acquired the operations through the mergers in July 2007. Going forward, we
expect our effective tax rate on Income before income taxes to increase to
between 36.5% and 37.5%, from the 35.3% we experienced prior to the initiation
of the new tax.
During the year, we opened one new store in the Houston market, three in
the Dallas/Fort Worth market, one in San Antonio, Texas, one in Brownsville,
Texas and one in Oklahoma City, Oklahoma. The Dallas/Fort Worth market continues
to perform at the mid-point of our range of expectations and we believe we have
significant upside potential in that market through growth in the existing
stores and our intention to continue to expand the number of stores in that
market. We have several other locations in Texas, Louisiana and Oklahoma that we
believe are promising and are in various stages of development for opening in
fiscal year 2009. We also continue to look at other markets, including
neighboring states for opportunities.
The consumer electronics industry depends on new products to drive same
store sales increases. Typically, these new products, such as LCD, plasma and
DLP televisions, DVD players, digital cameras, GPS devices and MP3 players are
introduced at relatively high price points that are then gradually reduced as
the product becomes more mainstream. To sustain positive same store sales
growth, unit sales must increase at a rate greater than the decline in product
prices. The affordability of the product helps drive the unit sales growth.
However, as a result of relatively short product life cycles in the consumer
electronics industry, which limit the amount of time available for sales volume
to increase, combined with rapid price erosion in the industry, retailers are
challenged to maintain overall gross margin levels and positive same store
sales. This has historically been our experience, and we continue to adjust our
marketing strategies to address this challenge through the introduction of new
product categories and new products within our existing categories.
Application of Critical Accounting Policies
In applying the accounting policies that we use to prepare our
consolidated financial statements, we necessarily make accounting estimates that
affect our reported amounts of assets, liabilities, revenues and expenses. Some
of these accounting estimates require us to make assumptions about matters that
are highly uncertain at the time we make the accounting estimates. We base these
assumptions and the resulting estimates on authoritative pronouncements,
historical information and other factors that we believe to be reasonable under
the circumstances, and we evaluate these assumptions and estimates on an ongoing
basis. We could reasonably use different accounting estimates, and changes in
our accounting estimates could occur from period to period, with the result in
each case being a material change in the financial statement presentation of our
financial condition or results of operations. We refer to accounting estimates
of this type as critical accounting estimates. We believe that the critical
accounting estimates discussed below are among those most important to an
understanding of our consolidated financial statements as of January 31, 2008.
36
Transfers of Financial Assets. We transfer customer receivables to a 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 amended by SFAS No. 155, Accounting for Certain Hybrid Financial Instruments.
As we transfer the accounts we record an asset representing our interest in the
cash flows of the QSPE, 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, plus our retained interest in the transferred receivables,
discounted using a return that would be expected by a third-party investor. We
recognize the 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.
On February 1, 2007, we were required to adopt SFAS No. 155, Accounting
for Certain Hybrid Financial Instruments. Among other things, this statement
establishes a requirement to evaluate interests in securitized financial assets
to identify interests that are freestanding derivatives or that are hybrid
financial instruments that contain an embedded derivative requiring bifurcation.
Additionally, we had the option to choose to early adopt the provisions of SFAS
No. 159, The Fair Value Option for Financial Assets and Financial Liabilities.
Essentially, we had to decide between bifurcation of the embedded derivative and
the fair value option in determining how we would account for our Interests in
securitized assets. We elected to early adopt SFAS No. 159 because we believe it
provides a more easily understood presentation for financial statement users.
Historically, we had valued and reported our interests in securitized assets at
fair value, though most changes in the fair value were recorded in Other
comprehensive income. The fair value option simplifies the treatment of changes
in the fair value of the asset, by reflecting all changes in the fair value of
our Interests in securitized assets in current earnings, in Finance charges and
other, beginning February 1, 2007. SFAS Nos. 155 and 159 do not allow for
retrospective application of these changes in accounting principle and, as such,
no adjustments have been made to the amounts disclosed in the financial
statements for periods ending prior to February 1, 2007. However, the balance in
Other comprehensive income, as of January 31, 2007, of $6.3 million, which
represented unrecognized gains on the fair value of the Interests in securitized
assets, was included in a cumulative-effect adjustment that was recorded in
Retained earnings, effective February 1, 2007.
Because of our adoption of SFAS No. 159, effective February 1, 2007, we
were required to adopt the provisions of SFAS No. 157, Fair Value Measurements.
This statement establishes a framework for measuring fair value and defines fair
value as "the price that would be received to sell an asset or paid to transfer
a liability in an orderly transaction between market participants at the
measurement date." We estimate the fair value of our Interests in securitized
assets using a discounted cash flow model with most of the inputs used being
unobservable inputs. The primary unobservable inputs, which are derived
principally from our historical experience, with input from our investment
bankers and financial advisors, include the estimated portfolio yield, credit
loss rate, discount rate, payment rate and delinquency rate and reflect our
judgments about the assumptions market participants would use in determining
fair value. In determining the cost of borrowings, we use current actual
borrowing rates, and adjusts them, as appropriate, using interest rate futures
data from market sources to project interest rates over time. Changes in the
assumptions over time, including varying credit portfolio performance, market
interest rate changes, market participant risk premiums required, or a shift in
the mix of funding sources, could result in significant volatility in the fair
value of the Interest in securitized assets, and thus our earnings.
Additionally, as a result of our adoption of SFAS No. 159, The Fair Value
Option for Financial Assets and Financial Liabilities, effective February 1,
2007, we record all changes in the fair value of our Interests in securitized
assets in current earnings, in Finance charges and other. Previously, most
changes in the fair value of our Interests in securitized assets were recorded
in Other comprehensive income. Effective February 1, 2007, we adopted SFAS No.
157, Fair Value Measurements, which established a framework for measuring fair
value, based on the assumptions a company believes market participants would use
to value assets or liabilities to be exchanged. The gain or loss recognized on
the sales of the receivables 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, based on our
expectations of the assumptions that a market participant would use.
37
We were required to adopt the provisions of SFAS No. 156, Accounting for
Servicing of Financial Assets, effective on February 1, 2007. As a result of the
adoption of this pronouncement we recorded a servicing liability on the balance
sheet in Deferred revenues and allowances and any changes in the fair value of
the liability are recorded in the period of change in the statement of
operations in Finance charges and other. We estimate the fair value of our
servicing liability using the portfolio performance and discount rate
assumptions discussed above, and an estimate of the servicing fee a market
participant would require to service the portfolio.
The use of different estimates or assumptions in the valuation of our
Interest in securitized assets or servicing liability could produce different
financial results. Additionally, changes in the assumptions over time, including
varying credit portfolio performance, market interest rate changes or risk
premiums required, or a shift in the mix of funding sources, could result in
significant volatility in the fair value of the Interests in securitized assets,
and thus our earnings. During the fiscal year ended January 31, 2008, risk
premiums required by market participants on many investments increased
significantly as a result of disruption in the asset-backed securities markets
due to increased losses and delinquencies in sub-prime mortgages. Though we do
not anticipate any significant variation from the current earnings and cash flow
performance of our securitized credit portfolio, we increased the risk premium
included in the discount rate assumption used in the determination of the fair
value of our interests in securitized assets to reflect the higher expected risk
premiums included in investment returns we believe a market participant would
require if purchasing our interests. Based on a review of the changes in market
risk premiums during the fiscal year ended January 31, 2008, and discussions
with our investment bankers and financial advisors, we estimated that a market
participant would require an approximately 500 basis point increase in the
required risk premium. As a result, the Company increased the weighted average
discount rate assumption from 14.6% at January 31, 2007, to 16.5% at January 31,
2008, after reflecting a 280 basis point decrease in the risk-free interest rate
included in the discount rate assumption. We have also included an expected
market participant-based assumption related to the estimated cost of a bond
issuance contemplated by the QSPE, and an increase in the credit loss rate on
the credit portfolio we estimate a market participant would use in determining
the fair value of our interests in securitized assets. The increase in the
discount rate has the effect of deferring income to future periods, but not
permanently reducing securitization income or our earnings. If a market
participant were to require a risk premium that is 100 basis points higher than
we estimated in the fair value calculation, the fair value of our interests in
securitized assets would be decreased by an additional $1.7 million. 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 and Finance charges and other
would have been reduced by $6.7 million as of January 31, 2008. If the
assumption used for estimating credit losses was increased by 0.5%, the impact
to Finance charges and other would have been a reduction in revenues and pretax
income of $2.3 million.
Revenue Recognition. Revenues from the sale of retail products are
recognized at the time the product is delivered to the customer. Such revenues
are recognized net of any adjustments for sales incentive offers such as
discounts, coupons, rebates, or other free products or services. We sell service
maintenance agreements and credit insurance contracts on behalf of unrelated
third parties. For contracts where the third parties are the obligor on the
contract, commissions are recognized in revenues at the time of sale, and in the
case of retrospective commissions, at the time that they are earned. When we
sell service maintenance agreements in which we are deemed to be the obligor on
the contract at the time of sale, revenue is recognized ratably, on a
straight-line basis, over the term of the service maintenance agreement. These
direct obligor service maintenance agreements are renewal contracts that provide
our customers protection against product repair costs arising after the
expiration of the manufacturer's warranty and the third party obligor contracts
and typically range from 12 months to 36 months. These agreements are separate
units of accounting under Emerging Issues Task Force No. 00-21, Revenue
Arrangements with Multiple Deliverables. The amounts of service maintenance
agreement revenue deferred at January 31, 2007 and 2008 were $3.6 million and
$5.4 million, respectively, and are included in Deferred revenue in the
accompanying balance sheets. The amounts of service maintenance agreement
revenue recognized for the fiscal years ended January 31, 2006, 2007 and 2008
were $5.0 million, $4.7 million and $5.7 million, respectively.
38
Vendor Allowances. We receive funds from vendors for price protection,
product rebates (earned upon purchase or sale of product), 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 product sales, the
allowances, credits or payments are recorded as a reduction of cost of goods
sold; if the programs are related to promotion or marketing of the product, the
allowances, credits, or payments are recorded as a reduction of advertising
expense in the period in which the expense is incurred. We received $25.3
million, $27.2 million and $36.1 million in vendor allowances during the fiscal
year ended January 31, 2006, 2007 and 2008, respectively, of which $5.8 million,
$7.2 million and $6.6 million, respectively, represented advertising assistance
allowances.
Share-Based Compensation. In December 2004, SFAS No. 123R, Share-Based
Payment, was issued. Under the requirements of this statement we measure the
cost of employee services received in exchange for an award of equity
instruments, typically stock options, based on the grant-date fair value of the
award, and record that cost over the period during which the employee is
required to provide service in exchange for the award. The grant-date fair value
is based on our best estimate of key assumptions, including expected time period
over which the options will remain outstanding and expected stock price
volatility at the date of grant. Additionally, we must estimate expected
forfeitures for each stock option grant and adjust the recorded compensation
expense accordingly. The use of different estimates could produce different
financial results. See Notes 1 and 8 to our financial statements for additional
information.
Accounting for Leases. The accounting for leases is governed primarily by
SFAS No. 13, Accounting for Leases. As required by the standard, we analyze each
lease, at its inception and any subsequent renewal, to determine whether it
should be accounted for as an operating lease or a capital lease. Additionally,
monthly lease expense for each operating lease is calculated as the average of
all payments required under the minimum lease term, including rent escalations.
Generally, the minimum lease term begins with the date we take possession of the
property and ends on the last day of the minimum lease term, and includes all
rent holidays, but excludes renewal terms that are at our option. Any tenant
improvement allowances received are deferred and amortized into income as a
reduction of lease expense on a straight line basis over the minimum lease term.
The amortization of leasehold improvements is computed on a straight line basis
over the shorter of the remaining lease term or the estimated useful life of the
improvements. For transactions that qualify for treatment as a sale-leaseback,
any gain or loss is deferred and amortized as rent expense on a straight-line
basis over the minimum lease term. Any deferred gain would be included in
Deferred gain on sale of property and any deferred loss would be included in
Other assets on the consolidated balance sheets.
39
Results of Operations
The following table sets forth certain statement of operations
information as a percentage of total revenues for the periods indicated.
Year ended January 31, (A)
----------------------------------
2006 2007 2008
---------- ---------- ----------
Revenues:
Product sales......................................... 81.3 % 82.0 % 81.5 %
Service maintenance agreement commissions (net)....... 4.3 4.0 4.4
Service revenues...................................... 2.9 3.0 2.8
---------- ---------- ----------
Total net sales.................................... 88.5 89.0 88.7
Finance charges and other............................. 11.5 11.0 11.3
---------- ---------- ----------
Total revenues..................................... 100.0 100.0 100.0
Cost and expenses:
Cost of goods sold, including warehousing and
occupancy costs...................................... 60.3 61.3 61.7
Cost of parts sold, including warehousing and
occupancy costs...................................... 0.7 0.9 1.0
Selling, general and administrative expense........... 29.7 29.6 29.8
Provision for bad debts............................... 0.2 0.2 0.3
---------- ---------- ----------
Total costs and expenses.............................. 90.9 92.0 92.8
---------- ---------- ----------
Operating income........................................ 9.1 8.0 7.2
Interest (income) expense............................... 0.1 (0.1) (0.1)
Other (income) expense.................................. 0.0 (0.1) (0.1)
---------- ---------- ----------
Earnings before income taxes............................ 9.0 8.2 7.4
Provision for income taxes.............................. 3.1 2.9 2.6
---------- ---------- ----------
Net income.............................................. 5.9 % 5.3 % 4.8 %
========== ========== ==========
(A) - In order to present our results on a basis that is more comparable with
others in our industry, we have reclassified advertising expenditures that were
previously included in costs of goods sold to selling, general and
administrative expense.
The table above identifies several changes in our operations for the
periods presented, including changes in revenue and expense categories expressed
as a percentage of revenues. These changes are discussed in the Executive
Overview, and in more detail in the discussion of operating results beginning in
the analysis below.
Same store sales growth is calculated by comparing the reported sales by
store for all stores that were open throughout a period to reported sales by
store for all stores that were open throughout the prior year period. Sales from
closed stores have been removed from each period. Sales from relocated stores
have been included in each period because each store was relocated within the
same general geographic market. Sales from expanded stores have been included in
each period.
The presentation of our gross margins may not be comparable to other
retailers since we include the cost of our in-home delivery service as part of
selling, general and administrative expense. Similarly, we include the cost of
merchandising our products, including amounts related to purchasing the product
in selling, general and administrative expense. It is our understanding that
other retailers may include such costs as part of cost of goods sold.
40
The following table presents certain operations information in dollars
and percentage changes from year to year:
Refer to the above Analysis of Consolidated Statements of Operations in
condensed form while reading the operations review on a year by year basis.
Analysis of Consolidated Statements of Operations
(in thousands except percentages)
2007 vs. 2006 2008 vs. 2007
Year Ended January 31, (A) Incr/(Decr) Incr/(Decr)
------------------------------------------------- -------------------
2006 2007 2008 Amount Pct Amount Pct
--------- --------- --------- -------- ------- -------- ------
Revenues
Product sales $569,877 $623,959 $671,571 $54,082 9.5% $47,612 7.6 %
Service maintenance agreement
commissions (net) 30,583 30,567 36,424 (16) (0.1) 5,857 19.2
Service revenues 20,278 22,411 22,997 2,133 10.5 586 2.6
--------- --------- --------- -------- --------
Total net sales 620,738 676,937 730,992 56,199 9.1 54,055 8.0
Finance charges and other 80,410 83,720 93,136 3,310 4.1 9,416 11.2
--------- --------- --------- -------- --------
Total revenues 701,148 760,657 824,128 59,509 8.5 63,471 8.3
Cost and expenses
Cost of goods and parts sold 427,843 473,064 517,166 45,221 10.6 44,102 9.3
--------- --------- --------- -------- --------
Gross Profit 273,305 287,593 306,962 14,288 5.2 19,369 6.7
Gross Margin 39.0% 37.8% 37.2%
Selling, general and
administrative expense 208,259 224,979 245,317 16,720 8.0 20,338 9.0
Provision for bad debts 1,133 1,476 1,908 343 30.3 432 29.3
--------- --------- --------- -------- --------
Operating income 63,913 61,138 59,737 (2,775) (4.3) (1,401) (2.3)
Operating Margin 9.1% 8.0% 7.2%
Interest (income) expense 400 (676) (515) (1,076) (269.0) 161 (23.8)
Other (income) expense 69 (772) (943) (841) (1218.8) (171) 22.2
--------- --------- --------- -------- --------
Pretax Income 63,444 62,586 61,195 (858) (1.4) (1,391) (2.2)
Provision for income taxes 22,341 22,275 21,509 (66) (0.3) (766) (3.4)
--------- --------- --------- -------- --------
Net income available
for common stockholders $41,103 $40,311 $39,686 ($792) (1.9)% ($625) (1.6)%
========= ========= ========= ======== ========
(A) - In order to present our results on a basis that is more comparable
with others in our industry, we have reclassified advertising expenditures that
were previously included in costs of goods sold to selling, general and
administrative expense.
Year Ended January 31, 2007 Compared to the Year Ended January 31, 2008
---------------------------------------------------------------------------- ------------- ------------- ------------------
Change
(Dollars in Millions) 2008 2007 $ %
---------------------------------------------------------------------------- ------------- ------------- -------- ---------
Net sales $731.0 $676.9 54.1 8.0
---------------------------------------------------------------------------- ------------- ------------- -------- ---------
Finance charges and other 93.1 83.7 9.4 11.2
---------------------------------------------------------------------------- ------------- ------------- -------- ---------
Revenues 824.1 760.6 63.5 8.3
---------------------------------------------------------------------------- ------------- ------------- -------- ---------
The $54.1 million increase in net sales was made up of the following:
o a $20.4 million increase resulted from a same store sales increase
of 3.2%.
o a $35.0 million increase generated by thirteen retail locations that
were not open for twelve consecutive months in each period,
o a $1.9 million decrease resulted from an increase in discounts on
promotional credit sales, and
41
o a $0.6 million increase resulted from an increase in service
revenues.
The components of the $54.1 million increase in net sales were a $47.6
million increase in product sales and an $6.5 million net increase in service
maintenance agreement commissions and service revenues. The $47.6 million
increase in product sales resulted from the following:
o approximately $4.6 million was attributable to increases in unit
sales, due primarily to increased consumer electronics (especially
flat-panel televisions) and furniture sales, partially offset by a
decline in appliance and track sales, and
o approximately $43.0 million was attributable to an overall increase
in the average unit price. The increase was driven primarily by a
change in the mix of product sales, as consumer electronics, which
has the highest average price, became a larger share of our total
product sales and was partially offset by the $1.9 million increase
in discounts on extended-term promotional credit 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.
Classification of sales has been adjusted from previous filings to ensure
comparability between the categories.
Year Ended January 31,
-----------------------------------------------
2007 2008 Percent
--------------------- -------------------------
Category Amount Percent Amount Percent Increase
----------- --------- ----------- ------------- -----------
Home appliances $230,963 34.1% $223,967 30.6% (3.0)%(1)
Consumer electronics 214,271 31.7 244,040 33.4 13.9 (2)
Track 94,395 13.9 102,031 14.0 8.1 (3)
Delivery 11,380 1.7 12,524 1.7 10.1 (4)
Lawn and garden 16,741 2.5 20,914 2.9 24.9 (5)
Bedding 17,721 2.6 16,424 2.3 (7.3) (6)
Furniture 33,357 4.9 46,373 6.3 39.0 (7)
Other 5,131 0.8 5,298 0.7 3.3
----------- --------- ----------- ----------
Total product sales 623,959 92.2 671,571 91.9 7.6
Service maintenance agreement
commissions 30,567 4.5 36,424 5.0 19.2 (8)
Service revenues 22,411 3.3 22,997 3.1 2.6 (9)
----------- --------- ----------- -------------
Total net sales $676,937 100.0% $730,992 100.0% 8.0%
=========== ========= =========== =============
(1) While the industry is down nationally, we expect to outperform the
national trend and are taking steps to improve our performance relative to
merchandising, advertising and promotion of this category. Additionally, we
experienced higher than normal demand for these products in the prior year due
to consumers replacing appliances after Hurricanes Katrina and Rita, especially
during the first three months of the period.
(2) This increase is due to increased unit volume in the area of
flat-panel televisions, partially offset by a decline in the sale of tube and
projection televisions.
(3) The increase in track sales (consisting largely of computers,
computer peripherals, video game equipment, portable electronics and small
appliances) is driven primarily by increased laptop computer and video game
equipment sales and was partially offset by reduced sales of portable
electronics, including camcorders, digital cameras and portable CRT televisions.
(4) This increase was due to an increase in the delivery fee charged to
our customers, as the total number of deliveries declined slightly as compared
to the prior year.
(5) This category benefited from a high level of rainfall in the current
year and an increase in sales of higher priced lawn and garden equipment, such
as zero turn radius mowers and tractors.
(6) This decrease is due to the impact of our change in strategy as we
move to a multi-vendor relationship.
(7) This increase is due to the increased emphasis on the sales of
furniture, primarily sofas, recliners and entertainment centers, and new
products added to this category.
(8) This increase is due to the increase in product sales, increased
sales penetration and decreased SMA cancellations as credit charge-offs declined
as compared to the prior year period.
(9) This increase is driven by increased units in operation as we
continue to grow product sales and an increase in the cost of parts used to
repair higher-priced technology (flat-panel televisions, etc.).
42
Finance charges and other increased due primarily to an increase in
securitization income of $7.4 million, or 11.9% and an increase in insurance
commissions of $2.9 million, and a decrease in other items of $0.9 million. The
securitization income, which grew due to growth in the portfolio and lower net
credit losses on receivables transferred to the QSPE, was negatively impacted by
a non-cash, decrease in the fair value of our Interests in securitized assets.
The non-cash fair value adjustment of $4.8 million was recorded primarily as a
result of the recent turmoil in the financial markets. We increased the risk
premium included in the discount rate assumption in the determination of the
fair value of our interests in securitized assets based on our estimate of the
risk premium we believe a market participant would require if they purchased our
Interests in securitized assets. Additionally, we increased the loss rate and
borrowing cost assumptions we believe a market participant would use in
determining the fair value of our interest in securitized assets (See Note 2 to
the financial statements for additional information). The securitization income
comparison was impacted by a $1.5 million impairment charge recorded in the
prior year for higher projected credit losses due to the impact in the prior
year of Hurricane Rita on our credit collection operations and increased
bankruptcy filings due to the new bankruptcy laws that took effect in October
2005. Our net credit loss rate of 2.9% for the year ended January 31, 2008, was
in-line with our expected long-term net loss rate of between 2.5% and 3.0%.
Insurance commissions increased primarily due to increased sales and reduced
insurance cancellations as credit charge-offs declined from the prior year
period.
---------------------------------------------------------------- -------------------- ------------------ ------------------
Change
(Dollars in Millions) 2008 2007 $ %
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
Cost of goods sold $508.8 $466.3 42.5 9.1
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
As a percent of net product sales 75.8% 74.7%
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
Cost of products sold increased from 74.7% of net product sales in the
2007 period to 75.8% in the 2008 period due to pricing pressures in retailing in
general, and especially on flat-panel TV's.
---------------------------------------------------------------- -------------------- ------------------ ------------------
Change
(Dollars in Millions) 2008 2007 $ %
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
Cost of service parts sold $8.4 $6.8 1.6 23.5
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
As a percent of service revenues 36.4% 30.4%
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
This increase was due primarily to a 22.8% increase in parts sales, which
grew faster than labor sales.
---------------------------------------------------------------- -------------------- ------------------ ------------------
Change
(Dollars in Millions) 2008 2007 $ %
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
Selling, general and administrative expense $245.3 $225.0 20.3 9.0
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
As a percent of total revenues 29.8% 29.6%
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
The increase in expense as a percentage of total revenues resulted
primarily from increased payroll and payroll related expenses, as a percent of
revenues.
---------------------------------------------------------------- -------------------- ------------------ ------------------
Change
(Dollars in Millions) 2008 2007 $ %
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
Provision for bad debts $1.9 $1.5 0.4 29.3
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
As a percent of total revenues .23% .19%
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
The provision for bad debts on non-credit portfolio receivables and
credit portfolio receivables retained by us and not eligible to be transferred
to the QSPE increased primarily as a result of provision adjustments due to
increased net credit losses. Additionally, the provision for bad debts in the
year ended January 31, 2007, benefited from a $0.1 million reserve adjustment
related to the special reserves recorded as a result of the hurricanes in 2005.
See the notes to the financial statements for information regarding the
performance of the credit portfolio.
43
---------------------------------------------------------------- -------------------- ------------------ ------------------
Change
(Dollars in Millions) 2008 2007 $ %
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
Interest income, net $(515) $(676) (161) 23.8
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
The net decrease in interest income was a result of a decrease in
interest income from invested funds due to lower balances of invested cash and
lower interest rates earned on amounts invested.
---------------------------------------------------------------- -------------------- ------------------ ------------------
Change
(Dollars in Millions) 2008 2007 $ %
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
Other income $(943) $(772) 171 22.2
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
Both periods included gains recognized on the sales of company assets.
Additionally, during the year ended January 31, 2008, there were gains realized,
but not recognized, on transactions qualifying for sale-leaseback accounting
that have been deferred and will be amortized as a reduction of rent expense on
a straight-line basis over the minimum lease terms.
---------------------------------------------------------------- -------------------- ------------------ ------------------
Change
(Dollars in Millions) 2008 2007 $ %
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
Provision for income taxes $21.5 $22.3 (0.8) (3.4)
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
This decrease in taxes was impacted primarily by the 1.4% decrease in
pretax income. Additionally, the effective tax rate declined from 35.6% for the
year ended January 31, 2007, to 35.1% for the year ended January 31, 2008. The
decrease in the effective tax rate is attributable to the reversal of previously
accrued Texas margin tax as a result of the legal entity reorganization
completed during the three months ended July 31, 2007. In July 2007, we began
accruing margin tax for the entities that acquired the operations through the
mergers completed during the quarter.
Year Ended January 31, 2006 Compared to the Year Ended January 31, 2007
--------------------------------------------------------------------------- -------------- ------------- ------------------
Change
(Dollars in Millions) 2007 2006 $ %
--------------------------------------------------------------------------- -------------- ------------- -------- ---------
Net sales $676.9 $620.7 56.2 9.1
--------------------------------------------------------------------------- -------------- ------------- -------- ---------
Finance charges and other 83.7 80.4 3.3 4.1
--------------------------------------------------------------------------- -------------- ------------- -------- ---------
Revenues 760.6 701.1 59.5 8.5
--------------------------------------------------------------------------- -------------- ------------- -------- ---------
The $56.2 million increase in net sales was made up of the following:
o a $21.1 million increase resulted from a same store sales increase
of 3.6%. The fiscal 2007 growth rate was impacted as a result of
being compared to the very strong, hurricane-impacted prior year
sales, which resulted in a same store sales growth rate of 16.9%
achieved in the year ended January 31, 2006.
o a $35.2 million increase generated by twelve retail locations that
were not open for twelve consecutive months in each period,
o a $2.2 million decrease resulted from an increase in discounts on
promotional credit sales, and
o a $2.1 million increase resulted from an increase in service
revenues.
44
The components of the $56.2 million increase in net sales were a $54.1
million increase in product sales and an $2.1 million net increase in service
maintenance agreement commissions and service revenues. The $54.1 million
increase in product sales resulted from the following:
o approximately $34.1 million was attributable to increases in unit
sales, due primarily to increased appliances, consumer electronics
(especially LCD, plasma and DLP televisions) and furniture sales,
partially offset by a decline in track sales, and
o approximately $20.0 million was attributable to increases in unit
price points. The price point impact was driven primarily by
consumers selecting higher priced appliance products, including
high-efficiency washers and dryers and stainless steel kitchen
appliances and increased delivery fees, partially offset by a
decline in consumer electronics as prices for new technology erode
and the $2.2 million increase in discounts on extended-term
promotional credit 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.
Classification of sales has been adjusted from previous filings to ensure
comparability between the categories.
Year Ended January 31,
-----------------------------------------------
2006 2007
--------------------- ------------------------- Percent
Category Amount Percent Amount Percent Increase
----------- --------- ----------- ------------- -----------
Home appliances $223,294 36.0% $230,963 34.1% 3.4%(1)
Consumer electronics 186,663 30.1 214,271 31.7 14.8 (2)
Track 99,184 16.0 94,395 13.9 (4.8)(3)
Delivery 9,931 1.6 11,380 1.7 14.6 (2)
Lawn and garden 17,567 2.8 16,741 2.5 (4.7)(4)
Bedding 13,120 2.1 17,721 2.6 35.1 (5)
Furniture 15,320 2.4 33,357 4.9 117.7 (5)
Other 4,798 0.8 5,131 0.8 6.9 (2)
----------- --------- ----------- -------------
Total product sales 569,877 91.8 623,959 92.2 9.5
Service maintenance agreement
commissions 30,583 4.9 30,567 4.5 (0.1)(6)
Service revenues 20,278 3.3 22,411 3.3 10.5 (7)
----------- --------- ----------- -------------
Total net sales $620,738 100.0% $676,937 100.0% 9.1%
=========== ========= =========== =============
(1) Fiscal year 2006 appliance sales were benefited by strong customer
demand after Hurricanes Katrina and Rita in that year.
(2) These increases are consistent with overall increase in product
sales and improved unit prices.
(3) The decline in track sales (consisting largely of computers,
computer peripherals, portable electronics and small appliances)
is due primarily to reduced sales of computers and portable CRT
televisions.
(4) A slower late-summer selling season due to dry weather impacted
this category.
(5) This increase is due to the increased emphasis on the sales of
mattresses and furniture, primarily sofas, recliners and
entertainment centers, and new product lines added to the
furniture category.
(6) This decrease is due to increased SMA cancellations driven by
higher credit charge-offs and reduced sales penetration as we
introduced products (furniture and mattresses) that are not
SMA-eligible.
(7) This increase is driven by increased units in operation as we
continue to grow product sales and an increase in the prices of
parts used to repair higher-priced technology (flat-panel
televisions, etc.).
This increase in revenue resulted primarily from increases in
securitization income of $3.4 million, a $2.0 million decrease in service
maintenance agreement retrospective commissions and a net increase in insurance
commissions and other revenues of $1.9 million. Securitization income grew at a
slower pace than net sales because of higher credit losses experienced during
the year ended January 31, 2007, as a result of the disruption to our credit
operations caused by Hurricane Rita. As a result of the higher loss rate
experienced, we recorded an impairment charge of $1.5 million during the quarter
ended July 31, 2006, reducing the value of our interest in securitized assets.
The credit net charge-off rate has returned to historical levels and is expected
to approximate 3.0% during fiscal 2008. We recorded an impairment charge of $0.9
million during the quarter ended October 31, 2005, for anticipated credit losses
due to the impact of Hurricane Rita on our credit operations and an increase in
bankruptcy filings due to the new bankruptcy law that took effect in October
2005. Securitization income growth is attributable to higher product sales and
increases in our retained interest in assets transferred to the QSPE, due
45
primarily to increases in the transferred balances. Insurance commissions and
other revenue growth was driven by the increase in product sales The decline in
service maintenance agreement retrospective commissions was due to a change in
the commission structure that became effective during fiscal 2006. The change
resulted in us receiving a greater portion of the income at the time of the sale
of the service maintenance agreement, which is included in Total net sales, with
a corresponding decrease in the retrospective commissions received.
---------------------------------------------------------------- -------------------- ------------------ ------------------
Change
(Dollars in Millions) 2007 2006 $ %
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
Cost of Goods Sold $466.3 $422.5 43.8 10.4
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
As a percent of net product sales 74.7% 74.1%
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
Cost of products sold increased due to pricing pressures on flat-panel
TV's and the fact that the strong fiscal 2006 sales, after the hurricanes, were
achieved with very little discounting.
---------------------------------------------------------------- -------------------- ------------------ ------------------
Change
(Dollars in Millions) 2007 2006 $ %
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
Cost of Service Parts Sold $6.8 $5.3 1.5 27.8
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
As a percent of service revenue 30.4% 26.1%
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
Cost of service parts sold, including warehousing and occupancy cost,
increased due to a 34.8% increase in parts sales.
---------------------------------------------------------------- -------------------- ------------------ ------------------
Change
(Dollars in Millions) 2007 2006 $ %
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
Selling, General and Administrative Expense $225.0 $208.3 16.7 8.0
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
As a percent of total revenue 29.6% 29.7%
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
The decrease in expense as a percentage of total revenues resulted
primarily from decreased payroll and payroll related expenses and net
advertising expense, as a percent of revenues. Additionally, $0.9 million of
expenses, net of insurance proceeds, were incurred in the year ended January 31,
2006, due to Hurricane Rita.
---------------------------------------------------------------- -------------------- ------------------ ------------------
Change
(Dollars in Millions) 2007 2006 $ %
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
Provision for Bad Debts $1.5 $1.1 .4 30.3
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
As a percent of total revenue .19% .16%
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
The provision for bad debts on non-credit portfolio receivables and
credit portfolio receivables retained by the Company and not transferred to the
QSPE increased primarily as a result of provision adjustments due to increased
credit losses.
---------------------------------------------------------------- -------------------- ------------------ ------------------
Change
(Dollars in Millions) 2007 2006 $ %
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
Interest (Income) Expense, net $(676) $400 1,076 N/A
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
The net improvement in interest (income) expense was attributable to the
following factors:
o expiration in April 2005 of $20.0 million in our interest rate
hedges and the discontinuation of hedge accounting for derivatives
resulted in a net decrease in interest expense of approximately
$244,000; and
o increased interest income from invested funds of approximately
$539,000.
46
The remaining change of $317,000 resulted from lower average outstanding
debt balances and capitalization of interest on construction in progress.
---------------------------------------------------------------- -------------------- ------------------ ------------------
Change
(Dollars in Millions) 2007 2006 $ %
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
Other (Income) Expense, net $(772) $69 841 N/A
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
This change was primarily the result of a $0.7 million gain recognized on
the sale of a building and the related land.
---------------------------------------------------------------- -------------------- ------------------ ------------------
Change
(Dollars in Millions) 2007 2006 $ %
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
Provision for Income Taxes $22.3 $22.4 .1 0.3
---------------------------------------------------------------- -------------------- ------------------ -------- ---------
The decrease in the Provision for income taxes is attributable to lower
Income before income taxes, state tax refunds received during the period and
adjustments to reconcile final tax returns to previous estimates, partially
offset by additional tax expense from the new Texas margin tax. The impact of
the new Texas margin tax was partially offset by the one-time benefit of
deferred tax assets recorded as a result of the new tax. Our effective rate for
the year ended January 31, 2007 was 35.6%, as compared to 35.2% for the year
ended January 31, 2006, as impact of the Texas margin tax was partially offset
by the refunds and return adjustments.
Impact of Inflation
We do not believe that inflation has a material effect on our net sales
or results of operations. However, a continuing significant increase in oil and
gasoline prices could adversely affect our customers' shopping decisions and
patterns. We rely heavily on our internal distribution system and our next day
delivery policy to satisfy our customers' needs and desires, and any such
significant increases could result in increased distribution charges. Such
increases may not affect our competitors in the same manner as it affects us.
Seasonality and Quarterly Results of Operations
Our business is somewhat seasonal, with a higher portion of sales and
operating profit realized during the quarter that ends January 31, due primarily
to the holiday selling season. Over the four quarters of fiscal 2008, gross
margins were 34.8%, 33.8%, 32.6% and 32.8%. During the same period, operating
margins were 9.4%, 6.7%, 3.4% and 9.0%. A portion of the fluctuation in gross
margins and operating margins is due to planned infrastructure cost additions,
such as increased warehouse space and larger stores, additional personnel and
systems required to absorb the significant increase in revenues that we have
experienced over the last several years. We also recorded a reduction in the
fair value of our interests in securitized assets by $4.0 million in the quarter
ended October 31, 2007, which caused both the gross margin and operating margin
for that quarter to be reduced.
Additionally, quarterly results may fluctuate materially depending on
factors such as the following:
o timing of new product introductions, new store openings and store
relocations;
o sales contributed by new stores;
o increases or decreases in comparable store sales;
o adverse weather conditions;
o shifts in the timing of certain holidays or promotions; and
o changes in our merchandise mix.
Results for any quarter are not necessarily indicative of the results
that may be achieved for a full year.
47
The following tables sets forth certain unaudited quarterly statement of
operations information for the eight quarters ended January 31, 2008. The
unaudited quarterly information has been prepared on a consistent basis and
includes all normal recurring adjustments that management considers necessary
for a fair presentation of the information shown.
Fiscal Year 2007 (A)
------------------------------------------------
Quarter Ended
------------------------------------------------
Apr. 30 Jul. 31 Oct. 31 Jan. 31
----------- ----------- ----------- ------------
(dollars and shares in thousands, except per
share amounts)
Revenues
Product sales $158,509 $150,647 $139,594 $175,209
Service maintenance agreement commissions (net) 7,967 7,063 6,845 8,692
Service revenues 5,229 5,927 5,951 5,304
----------- ----------- ----------- ------------
Total net sales 171,705 163,637 152,390 189,205
Finance charges and other 20,483 18,567 21,303 23,367
----------- ----------- ----------- ------------
Total revenues 192,188 182,204 173,693 212,572
Percent of annual revenues 25.3% 24.0% 22.8% 27.9%
Cost and expenses
Cost of goods sold, including warehousing and
occupancy costs 118,552 112,760 104,124 130,843
Cost of service parts sold, including warehousing
and occupancy costs 1,565 1,389 1,834 1,997
Selling, general and administrative expense 53,841 55,421 56,204 59,513
Provision for bad debts 43 390 526 517
----------- ----------- ----------- ------------
Total cost and expenses 174,001 169,960 162,688 192,870
----------- ----------- ----------- ------------
Operating Income 18,187 12,244 11,005 19,702
Operating Profit as a % total revenues 9.5% 6.7% 6.3% 9.3%
Interest (income) expense (184) (187) (141) (164)
Other (income) expense (33) (721) (19) 1
----------- ----------- ----------- ------------
Income before income taxes 18,404 13,152 11,165 19,865
Provision for income taxes 6,455 4,608 4,011 7,201
----------- ----------- ----------- ------------
Net income $11,949 $8,544 $7,154 $12,664
=========== =========== =========== ============
Net income as a % of revenue 6.2% 4.7% 4.1% 6.0%
Outstanding shares:
Basic 23,596 23,676 23,698 23,680
Diluted 24,448 24,344 24,165 24,204
Earnings per share:
Basic $0.51 $0.36 $0.30 $0.53
Diluted $0.49 $0.35 $0.30 $0.52
(A) - In order to present our results on a basis that is more comparable with others in our industry, we
have reclassified advertising expenditures that were previously included in costs of goods sold to
selling, general and administrative expense.
48
Fiscal Year 2008 (A)
------------------------------------------------
Quarter Ended
------------------------------------------------
Apr. 30 Jul. 31 Oct. 31 Jan. 31
----------- ----------- ----------- ------------
(dollars and shares in thousands, except per
share amounts)
Revenues
Product sales $166,639 $163,793 $155,657 $185,482
Service maintenance agreement commissions (net) 9,281 9,071 8,336 9,736
Service revenues 5,445 6,137 6,059 5,356
----------- ----------- ----------- ------------
Total net sales 181,365 179,001 170,052 200,574
Finance charges and other 23,945 24,526 19,314 25,351
----------- ----------- ----------- ------------
Total revenues 205,310 203,527 189,366 225,925
Percent of annual revenues 24.9% 24.7% 23.0% 27.4%
Cost and expenses
Cost of goods sold, including warehousing and
occupancy costs 124,393 125,297 118,191 140,906
Cost of service parts sold, including warehousing
and occupancy costs 1,866 2,123 2,257 2,133
Selling, general and administrative expense 59,214 62,113 61,928 62,062
Provision for bad debts 560 348 582 418
----------- ----------- ----------- ------------
Total cost and expenses 186,033 189,881 182,958 205,519
----------- ----------- ----------- ------------
Operating Income 19,277 13,646 6,408 20,406
Operating Profit as a % total revenues 9.4% 6.7% 3.4% 9.0%
Interest (income) expense (240) (251) (110) 86
Other (income) expense (831) (55) (34) (23)
----------- ----------- ----------- ------------
Income before income taxes 20,348 13,952 6,552 20,343
Provision for income taxes 7,402 4,295 2,531 7,281
----------- ----------- ----------- ------------
Net income $12,946 $9,657 $4,021 $13,062
=========== =========== =========== ============
Net income as a % of revenue 6.3% 4.7% 2.1% 5.8%
Outstanding shares:
Basic 23,567 23,489 23,077 22,651
Diluted 24,121 24,058 23,550 22,976
Earnings per share:
Basic $0.55 $0.41 $0.17 $0.58
Diluted $0.54 $0.40 $0.17 $0.57
(A) - In order to present our results on a basis that is more comparable with others in our industry, we
have reclassified advertising expenditures that were previously included in costs of goods sold to
selling, general and administrative expense.
Liquidity and Capital Resources
We require capital to finance our growth as we add new stores and markets
to our operations, which in turn requires additional working capital for
increased receivables and inventory. We have historically financed our
operations through a combination of cash flow generated from operations and
external borrowings, including primarily bank debt, extended terms provided by
our vendors for inventory purchases, acquisition of inventory under consignment
arrangements and transfers of receivables to our asset-backed securitization
facilities. At January 31, 2008, we had a revolving lines of credit in the
amount of $58 million, under which we had no borrowings outstanding, but
utilized $2.4 million of availability to issue letters of credit. We expect that
our cash requirements for the foreseeable future, including those for our
capital expenditure requirements, will be met with our available lines of credit
and our $6.4 million of excess cash and cash equivalents, which were invested in
short-term, tax-free instruments, at January 31, 2008, together with cash
generated from operations. Our current plans are to grow our store base by
approximately 10% a year. We expect we will invest in inventory, real estate and
customer receivables to support the additional stores and same store sales
growth. Depending on market conditions we may, at times, enter into
sale-leaseback transactions to finance our real estate or seek alternative
financing sources for new store expansions and customer receivables growth,
including expansion of existing lines of credit, and accessing new debt or
equity markets.
On March 26, 2008, we executed an amendment to our bank credit facility,
to increase the commitment from $50 million to $100 million, to provide
additional liquidity, if needed, to support our growth plans. In addition to the
expanded commitment, the interest margin added to the applicable base rate was
increased by 25 basis points. This facility matures in November 2010. This
increase in the facility brings our total availability under revolving lines of
credit to $105.6 million at March 26, 2008.
In its regularly scheduled meeting on August 24, 2006, our Board of
Directors authorized the repurchase of up to $50 million of our common stock,
49
dependent on market conditions and the price of the stock. We expect to fund
these purchases with a combination of excess cash, cash flow from operations,
borrowings under our revolving credit facilities and proceeds from the sale of
owned properties. Through January 31, 2008, we had spent $37.1 million under
this authorization to acquire 1,723,205 shares of our common stock. Future stock
repurchases will be dependent upon the availability of sufficient capital and
liquidity to support our growth plans and the repurchase program.
The following is a comparison of our statement of cash flows for our
fiscal years 2007 and 2008:
During the year ended January 31, 2008, net cash provided by (used in)
operating activities decreased $34.5 million from $28.9 million provided by
operating activities in the year ended January 31, 2007, to $5.6 million used in
the January 31, 2008. Operating cash flows for both periods were negatively
impacted by higher than normal payments on accounts payable and accrued
expenses, as discussed below. The cash used in operations for the year ended
January 31, 2008, was driven primarily by payments on accounts payable, which
was driven by the timing of receipts of inventory and increased investment in
accounts receivable. Our increased investment in accounts receivable was due
primarily to increased balances in the sold portfolio and a lower funding rate
as a percentage of the sold portfolio. The lower funding rate is primarily the
result of the QSPE's pay down of its 2002 Series B bond issuance. We expect the
funding rate to improve once the pay down is completed, which is scheduled for
completion in May, 2008. The cash provided by operations for the year ended
January 31, 2007, resulted primarily from net income plus depreciation plus the
benefit of the QSPE completing its medium-term bond issuance in August 2006. The
completion of the bond issuance resulted in an increase in the funding rate,
providing additional cash to be advanced to us on receivables transferred.
Offsetting the cash provided was cash used primarily due to increased investment
in inventory and the timing of payments of accounts payable and federal income
and employment taxes, which had been extended due to the impact of hurricanes in
the prior fiscal year. Those extended terms ended and deadlines were reached in
the quarter ended April 30, 2006, and we were required to satisfy those
obligations, negatively impacting our operating cash flows by approximately
$18.9 million.
As noted above, we offer promotional credit programs to certain customers
that provide for "same as cash" or deferred interest interest-free periods of
varying terms, generally three, six, or 12 months; in fiscal year 2005 we
increased these terms to include 18, 24 and 36 months. The various "same as
cash" promotional accounts and deferred interest program accounts are eligible
for securitization up to the limits provided for in our securitization
agreements. This limit is currently 30.0% of eligible securitized receivables.
If we exceed this 30.0% limit, we would be required to use some of our other
capital resources to carry the unfunded balances of the receivables for the
promotional period. The percentage of eligible securitized receivables
represented by promotional receivables was 20.0% as of January 31, 2007, and at
January 31, 2008, the percentage was 23.0% The weighted average promotional
period was 13.1 months and 15.1 months for promotional receivables outstanding
as of January 31, 2007 and 2008, respectively. The weighted average remaining
term on those same promotional receivables was 9.8 months and 10.7 months as of
January 31, 2007 and 2008, respectively. While overall these promotional
receivables have a much shorter weighted average term than non-promotional
receivables for the customers that take advantage of the promotional terms, we
receive less income on these receivables, resulting in a reduction of the net
interest margin used in the calculation of the gain on the sale of receivables.
Net cash used in investing activities was $16.1 million and $10.0 million
in fiscal year 2007 and fiscal year 2008, respectively. Cash used for purchases
of property and equipment was approximately $18.4 million in fiscal year 2007
and $19.0 fiscal year 2008. The cash expended for property and equipment was
used primarily for construction of new stores and the reformatting of existing
stores to better support our current product mix. We estimate that capital
expenditures for the 2009 fiscal year will approximate $20 million to $25
million.
We lease 64 of our 69 stores, and our plans for future store locations
include primarily leases, but does not exclude store ownership. Our capital
expenditures for future store projects should primarily be for our tenant
improvements to the property leased (including any new distribution centers and
warehouses), the cost of which is approximately $1.6 million per store, and for
our existing store remodels, in the range of $105,000 per store remodel,
50
depending on store size. In the event we purchase existing properties, our
capital expenditures will depend on the particular property and whether it is
improved when purchased. We are continuously reviewing new relationship and
funding sources and alternatives for new stores, which may include
"sale-leaseback" or direct "purchase-lease" programs, as well as other funding
sources for our purchase and construction of those projects. If we are
successful in these relationship developments, our direct cash needs should
include only our capital expenditures for tenant improvements to leased
properties and our remodel programs for existing stores, but could include full
ownership if it meets our cash investment strategy.
Net cash used in financing activities increased $28.6 million from $1.3
million for the year ended January 31, 2007, to $29.9 million for the year ended
January 31, 2008. This change resulted primarily from the use of $33.3 million
for the purchase of our common stock in fiscal year 2008.
We entered into our existing bank credit facility on October 31, 2005.
The agreement provides a line of credit to $50 million, with an accordion
feature to allow further expansion of the facility to $90 million, under certain
conditions. The credit facility has a maturity date of November 1, 2010.
Additionally, the facility provides sublimits of $8 million for a swingline line
of credit for faster advances on borrowing requests, and $5 million for standby
letters of credit. Loans under our revolving credit facility may, at our option,
bear interest at either the alternate base rate, which is the greater of the
administrative agent's prime rate or the federal funds rate, or the LIBOR rate
for the applicable interest period, in each case plus an applicable interest
margin. The interest margin is between 0.00% and 0.50% for base rate loans and
between 0.75% and 1.75% for LIBOR alternative rate loans. The interest margin
will vary depending on our debt coverage ratio. Additionally we pay commitment
fees for the undrawn portion of our revolving credit facility. At January 31,
2008, based on the LIBOR rate, the interest rate on the revolving facility was
4.15%.
Effective August 28, 2006, we entered into an amendment to our $50
million revolving credit facility with the existing lenders. The amendment
increases our restricted payment capacity, which includes payments for
repurchases of capital stock, from $25 million to $50 million. There were no
other modifications of the Credit Agreement.
A summary of the significant financial covenants that govern our bank
credit facility compared to our actual compliance status at January 31, 2008, is
presented below:
Required
Minimum/
Actual Maximum
--------------- ---------------
Debt service coverage ratio must exceed required minimum 4.09 to 1.00 2.00 to 1.00
Total adjusted leverage ratio must be lower than required maximum 1.65 to 1.00 3.00 to 1.00
Adjusted consolidated net worth must exceed required minimum $301.2 million $214.8 million
Charge-off ratio must be lower than required maximum 0.03 to 1.00 0.06 to 1.00
Extension ratio must be lower than required maximum 0.03 to 1.00 0.05 to 1.00
30-day delinquency ratio must be lower than required maximum 0.10 to 1.00 0.13 to 1.00
Note: All terms in the above table are defined by the bank credit facility
and may or may not agree directly to the financial statement captions in
this document.
Events of default under the credit facility include, subject to grace
periods and notice provisions in certain circumstances, non-payment of
principal, interest or fees; violation of covenants; material inaccuracy of any
representation or warranty; default under or acceleration of certain other
indebtedness; bankruptcy and insolvency events; certain judgments and other
liabilities; certain environmental claims; and a change of control. If an event
of default occurs, the lenders under the credit facility are entitled to take
various actions, including accelerating amounts due under the credit facility
and requiring that all such amounts be immediately paid in full. Our obligations
under the credit facility are secured by all of our and our subsidiaries'
assets, excluding customer receivables owned by the QSPE and certain inventory
subject to vendor floor plan arrangements.
51
The following table reflects outstanding commitments for borrowings and
letters of credit, and the amounts utilized under those commitments, as of
January 31, 2008:
Commitment Expires in Fiscal Year Ending January 31, Balance at Available at
------------------------------------------------------------ January 31, January 31,
2009 2010 2011 2012 2013 Thereafter Total 2008 2008
------------------------------------------------------------ ---------- ----------
(in thousands)
Revolving Bank
Facility (1) $50,000 $50,000 $2,442 $47,558
Unsecured Line of
Credit 8,000 8,000 - 8,000
Inventory Financing
(2) 40,000 40,000 14,766 25,234
Letters of Credit 25,000 25,000 847 24,153
------------------------------------------------------------ ---------- ----------
Total $73,000 $50,000 $- $- $- $- $123,000 $18,055 $104,945
============================================================ ========== ==========
(1) Includes letter of credit sublimit. There was $2.4 million of
letters of credit issued at January 31, 2008.
(2) Included in accounts payable on the consolidated balance sheet as of
January 31, 2008.
Since we extend credit in connection with a large portion of our retail,
service maintenance and credit insurance sales, we created a QSPE in 2002 to
purchase customer receivables from us and to issue medium-term and variable
funding notes secured by the receivables to third parties to finance its
purchase of these receivables. We transfer receivables, consisting of retail
installment and revolving accounts receivables extended to our customers, to the
issuer in exchange for cash, subordinated securities and the right to receive
the interest spread between the assets held by the QSPE and the notes issued to
third parties and our servicing fees. The subordinated securities issued to us
accrue interest based on prime rates and are subordinate to these third party
notes.
Both the bank credit facility and the asset-backed securitization program
are significant factors relative to our ongoing liquidity and our ability to
meet the cash needs associated with the growth of our business. Our inability to
use either of these programs because of a failure to comply with their covenants
would adversely affect our continued growth. Funding of current and future
receivables under the asset-backed securitization program can be adversely
affected if we exceed certain predetermined levels of re-aged receivables,
write-offs, bankruptcies or other ineligible receivable amounts. If the funding
under the asset-backed securitization program were reduced or terminated, we
would have to draw down our bank credit facility more quickly than we have
estimated.
A summary of the total receivables managed under the credit portfolio,
including quantitative information about delinquencies, net credit losses and
components of securitized assets, is presented in Note 3 to our consolidated
financial statements.
Based on current operating plans, we believe that cash provided by
operating activities, available borrowings under our credit facility, access to
the unfunded portion of the variable funding portion of our asset- backed
securitization program and our current cash and cash equivalents will be
sufficient to fund our operations, store expansion and updating activities and
capital expenditure programs for at least the next 12 months. However, there are
several factors that could decrease cash provided by operating activities,
including:
o reduced demand or margins for our products;
o more stringent vendor terms on our inventory purchases;
o loss of ability to acquire inventory on consignment;
o increases in product cost that we may not be able to pass on to our
customers;
o reductions in product pricing due to competitor promotional
activities;
o changes in inventory requirements based on longer delivery times of
the manufacturers or other requirements which would negatively
impact our delivery and distribution capabilities;
o increases in the retained portion of our receivables portfolio under
our current QSPE's asset-backed securitization program as a result
of changes in performance or types of receivables transferred
(promotional versus non-promotional), or as a result of a change in
the mix of funding sources available to the QSPE, requiring higher
collateral levels;
52
o inability to renew or expand our capacity for financing our
receivables portfolio under existing or replacement QSPE
asset-backed securitization programs or a requirement that we retain
a higher percentage of the credit portfolio under such programs;
o increases in the program costs (interest and administrative fees
relative to our receivables portfolio) associated with the funding
of our receivables;
o increases in personnel costs required for us to stay competitive in
our markets; and
o the inability to get our current variable funding facility renewed.
If cash provided by operating activities during this period is less than
we expect or if we need additional financing for future growth, we may need to
increase our revolving credit facility or undertake additional equity or debt
offerings. We may not be able to obtain such financing on favorable terms, if at
all.
Off-Balance Sheet Financing Arrangements
Since we extend credit in connection with a large portion of our retail,
service maintenance and credit insurance sales, we have created a qualified
special purpose entity, which we refer to as the QSPE or the issuer, to purchase
customer receivables from us and to issue asset-backed and variable funding
notes to third parties to obtain cash for these purchases. We transfer
receivables with a weighted average life of 1.2 years, consisting of retail
installment contracts and revolving accounts extended to our customers, to the
issuer in exchange for cash and subordinated, unsecured promissory notes. To
finance its acquisition of these receivables, the issuer has issued the notes
and bonds described below to third parties. The unsecured promissory notes
issued to us are subordinate to these third party notes and bonds.
At January 31, 2008, the issuer has issued three series of notes: the
2002 Series A variable funding note with a total availability of $450.0 million,
three classes of 2002 Series B notes in the aggregate amount outstanding of
$40.0 million, of which $4.0 million was required to be placed in a restricted
cash account for the benefit of the bondholders, and three classes of 2006
Series A bonds with an aggregate amount outstanding of $150.0 million, of which
$6.0 million was required to be placed in a restricted cash account for the
benefit of the bondholders. The 2002 Series A variable funding note is composed
of a $250 million 364-day tranche, and a $200 million tranche that matures in
2011. The 364-day commitment was recently renewed and increased, in the amount
of $150 million, by the note holders until July 31, 2008. The $150 million
increase in the commitment will stay in place until the first to occur of: (i)
the QSPE completes a medium-term bond issuance, or (ii) the note is not renewed
by the note holders. At the time of the increase in the note, an additional bank
joined as the second note holder in the facility. The commercial paper
underlying the 2002 Series A variable funding note is rated A1/P1 by Standard
and Poors and Moody's, respectively. These ratings represent the highest rating
(highest quality) of each rating agency's three short-term investment grade
ratings, except that Standard and Poors could add a "+" which would convert the
highest quality rating to an extremely strong rating. The 2002 Series B notes
consist of: Class A notes in the amount $24.0 million, rated Aaa by Moody's
representing the highest rating (highest quality) of the four long term
investment grade ratings provided by this organization; Class B notes in the
amount $11.6 million, rated A2 by Moody's representing the middle of the third
rating (upper medium quality) of the four long term investment grade ratings
provided by this organization; and Class C notes in the amount of $4.4 million,
rated Baa2/BBB by Moody's and Fitch, respectively. The 2006 Series A notes
consist of: Class A notes in the amount $90.0 million, rated Aaa by Moody's
representing the highest rating (highest quality) of the four long term
investment grade ratings provided by this organization; Class B notes in the
amount $43.3 million, rated A2 by Moody's representing the middle of the third
rating (upper medium quality) of the four long term investment grade ratings
provided by this organization; and Class C notes in the amount of $16.7 million,
rated Baa2 by Moody's. The Baa2/BBB ratings represent the lowest of the four
investment grades (medium quality) provided by these organizations. The ratings
disclosed are not recommendations to buy, sell or hold securities. These ratings
may be changed or withdrawn at any time without notice, and each of the ratings
should be evaluated independently of any other rating. We are not aware of a
rating by any other rating organization and are not aware of any changes in
these ratings. Private institutional investors, primarily insurance companies,
purchased the 2002 Series B notes and 2006 Series A notes. The issuer used the
proceeds of these issuances to purchase eligible accounts receivable from us and
to fund the required restricted cash accounts for credit enhancement of the
notes. If the net portfolio yield, as defined by agreements, falls below 5.0%,
53
then the issuer may be required to fund additions to the cash reserves in the
restricted cash accounts. At January 31,2008, the net portfolio yield was in
compliance with this requirement.
We are entitled to a monthly servicing fee, so long as we act as
servicer, in an amount equal to .25% multiplied by the average aggregate
principal amount of receivables plus the amount of average aggregate defaulted
receivables. The issuer records revenues equal to the interest charged to the
customer on the receivables less losses, the cost of funds, the program
administration fees paid in connection with the 2002 Series A, 2002 Series B, or
2006 Series A note holders, the servicing fee and additional earnings to the
extent they are available.
After the September 10, 2007, amendment, the 2002 Series A variable
funding note now permits the issuer to borrow funds up to $450 million to
purchase receivables from us, thereby functioning as a "basket" to accumulate
receivables. As issuer borrowings under the 2002 Series A variable funding note
approach $450 million, the issuer is required to request an increase in the 2002
Series A amount or issue a new series of bonds and use the proceeds to pay down
the then outstanding balance of the 2002 Series A variable funding note, so that
the basket will once again become available to accumulate new receivables or
meet other obligations required under the transaction documents. As of January
31, 2008, borrowings under the 2002 Series A variable funding note were $278.0
million.
Recent turmoil in the financial markets, especially with respect to
asset-backed securities, has resulted in reduced liquidity available for
issuances of these securities and rising costs for issuers. As a result, the
issuer has delayed the marketing of an additional series of fixed rate bonds. It
is currently anticipated that the issuer will attempt to complete a transaction
in the second or third quarter of the fiscal year ending January 31, 2009, but
no assurance can be given that a transaction can be completed on terms favorable
to it.. The proceeds of a new issuance would provide the issuer additional
capacity for the purchase of our receivables. If the issuer is unable to
complete the new bond issuance or renew or increase the total availability under
the 2002 Series A variable funding note, then, after its current funding sources
are exhausted, we may have to fund growth in the receivables portfolio until the
issuer can obtain additional funding. If necessary, in addition to available
cash balances, cash flow from operations and borrowing capacity under our
revolving facilities, additional cash to fund our growth and increase
receivables balances could be obtained by:
o reducing capital expenditures for new store openings,
o taking advantage of longer payment terms and financing available for
inventory purchases,
o utilizing other sources for providing financing to our customers,
o negotiating to expand the capacity available under existing credit
facilities, and
o accessing new debt or equity markets.
At January 31, 2008, we had $6.4 million of excess cash and $55.6 million
of availability under our revolving credit facilities, among other liquidity
sources, to provide funding, if needed, to fund receivable portfolio growth. As
such, we believe we have sufficient sources of liquidity to fund our operations,
including credit portfolio growth, for at least the next 12 months.
The Series A variable funding note bears interest at the commercial paper
rate plus an applicable margin, in most instances of 0.8%. The 2002 Series B
notes have fixed rates of 4.469%, 5.769% and 8.180% for the Class A, B and C
notes, respectively. The 2006 Series A notes have fixed rates of 5.507%, 5.854%
and 6.814% for the Class A, B and C notes, respectively. In addition, there is
an annual administrative fee and a non-use fee associated with the unused
portion of the committed facility.
While we are not directly liable to the lenders under the asset-backed
securitization facility, any shortfall in the cash necessary to repay the note
and bond holders and our subordinated notes would first reduce the amount paid
to us under the subordinated notes. As such, we bear the risk of losses incurred
by the issuer, to the extent of our retained interest, before the issuer's
third-party lenders are exposed to losses. If the issuer is unable to repay the
2002 Series A note, 2002 Series B bonds and 2006 Series A bonds due to its
inability to collect the transferred customer accounts and the issuer could not
pay the subordinated notes it has issued to us in partial payment for
transferred customer accounts, the 2002 Series B and 2006 Series A bond holders
could claim the balance in its $10.0 million restricted cash account. We are
also contingently liable under a $20.0 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.
54
The issuer is subject to certain affirmative and negative covenants
contained in the transaction documents governing the 2002 Series A variable
funding note and the 2002 Series B and 2006 Series A bonds, including covenants
that restrict, subject to specified exceptions: the incurrence of additional
indebtedness and other obligations and the granting of additional liens;
mergers, acquisitions, investments and disposition of assets; and the use of
proceeds of the program. The issuer also makes covenants relating to compliance
with certain laws, payment of taxes, maintenance of its separate legal entity,
preservation of its existence, protection of collateral and financial reporting.
In addition, the program requires the issuer to maintain a minimum net worth.
A summary of the significant financial covenants that govern the 2002
Series A variable funding note compared to actual compliance status at January
31, 2008, is presented below:
Required
Minimum/
As reported Maximum
------------------- -------------------
Issuer interest must exceed required minimum $78.5 million $75.8 million
Gross loss rate must be lower than required maximum 4.1% 10.0%
Net portfolio yield must exceed required minimum 8.7% 2.0%
Payment rate must exceed required minimum 7.0% 3.0%
Note: All terms in the above table are defined by the asset backed
credit facility and may or may not agree directly to the financial
statement captions in this document.
Events of default under the 2002 Series A variable funding note and the
2002 Series B and Series 2006 A bonds, subject to grace periods and notice
provisions in some circumstances, include, among others: failure of the issuer
to pay principal, interest or fees; violation by the issuer of any of its
covenants or agreements; inaccuracy of any representation or warranty made by
the issuer; certain servicer defaults; failure of the trustee to have a valid
and perfected first priority security interest in the collateral; default under
or acceleration of certain other indebtedness; bankruptcy and insolvency events;
failure to maintain certain loss ratios and portfolio yield; change of control
provisions and certain events pertaining to us. The issuer's obligations under
the program are secured by the receivables and proceeds.
Securitization Facilities
We finance most of our customer receivables through asset-backed
securitization facilities
----------------------------
| |
| 2002 Series A Note |
---->| $450 million Commitment |
| | $278 million Outstanding |
| | Credit Rating: P1/A2 |
| | Bank Commercial |
| | Paper Conduits |
| ----------------------------
|
-------------------------- -----------> -------------------------- | ----------------------------
| | | | | | 2002 Series B Bonds |
| | | Qualifying | | | $40 million |
| Retail | | Special Purpose |<---------->| Private Institutional |
| Sales | | Entity | | | Investors |
| Entity | | ("QSPE") | | | Class A: $24.0 mm (Aaa) |
| | | | | | Class B: $11.6 mm (A2) |
| | | | | | Class C: $4.4 mm (Baa2) |
-------------------------- <----------- -------------------------- | ----------------------------
|
1. Cash Proceeds | ----------------------------
2. Subordinated Securities | | 2006 Series A Bonds |
3. Right to Receive Cash Flows | | $150 million |
Equal to Interest Rate Spread |--->| Private Institutional |
| Investors |
| Class A: $90 mm (Aaa) |
| Class B: $43.3 mm (A2) |
| Class C: $16.7 mm (Baa2) |
----------------------------
55
Certain Transactions
Since 1996, we have leased a retail store location of approximately
19,150 square feet in Houston, Texas from Thomas J. Frank, Sr., our Chairman of
the Board and Chief Executive Officer. The lease provides for base monthly
rental payments of $17,235 plus escrows for taxes, insurance and common area
maintenance expenses of increasing monthly amounts based on expenditures by the
management company operating the shopping center of which this store is a part
through January 31, 2011. We also have an option to renew the lease for two
additional five-year terms. Mr. Frank received total payments under this lease
of $281,000 in fiscal 2006, 2007 and 2008, respectively. Based on market lease
rates for comparable retail space in the area, we believe that the terms of this
lease are no less favorable to us than we could have obtained in an arms' length
transaction at the date of the lease commencement.
We leased six store locations from Specialized Realty Development
Services, LP (SRDS), a real estate development company that was created prior to
our becoming publicly held and was owned by various members of management and
individual investors of Stephens Group, Inc., a significant shareholder of the
company. Based on independent appraisals that were performed on each project
that was completed, we believe that the terms of the leases were at least
comparable to those that could be obtained in an arms' length transaction. As
part of the ongoing operation of SRDS, we received management fees associated
with the administrative functions that were provided to SRDS of $6,500 for the
year ended January 31, 2006. As of January 31, 2005, we no longer leased any
properties from SRDS since it divested itself of the leased properties. As part
of the divestiture, SRDS reimbursed us $75,000 for costs related to lease
modifications.
We engage the services of Direct Marketing Solutions, Inc., or DMS, for a
substantial portion of our direct mail advertising. Direct Marketing Solutions,
Inc. is partially owned (less than 50%) by SF Holding Corp., members of the
Stephens family, Jon E. M. Jacoby, and Douglas H. Martin. SF Holding Corp. and
the members of the Stephens family are significant shareholders of the Company,
and Messrs. Jacoby and Martin are members of our Board of Directors. The fees we
paid to DMS during fiscal years ended 2006, 2007 and 2008 amounted to
approximately $2.1 million, $3.6 million and $2.5 million, respectively. Thomas
J. Frank, the Chief Executive Officer and Chairman of the Board of Directors
owned a small percentage (0.7%) at the end of fiscal year 2005, but divested his
interest during the first half of fiscal year 2006.
We engage the services of Stephens Inc. to act as our broker under our
stock repurchase program. Stephens Inc. is a shareholder of the Company, and
Doug Martin, an Executive Vice President of Stephens Inc., is a member of our
Board of Directors. During the years ended January 31, 2007 and 2008,
respectively, we incurred fees payable to Stephens Inc. of $5,040 and $46,644,
respectively, related to the purchase of 168,000 and 1,555,205 shares,
respectively of our common stock. Based on a review of competitive bids received
from various broker candidates, we believe the terms of this arrangement are no
less favorable than we could have obtained in an arms' length transaction.
56
Contractual Obligations
The following table presents a summary of our known contractual
obligations as of January 31, 2008, with respect to the specified categories,
classified by payments due per period.
Payments due by period
-------------------------------------------
Less Than 1 1-3 3-5 More Than
Total Year Years Years 5 Years
----------- --------------------- ---------- ----------
(in thousands)
Long term debt $119 $102 $10 $7 $-
Operating leases:
Real estate 145,463 17,769 34,420 29,792 63,482
Equipment 8,720 2,511 3,873 1,583 753
Purchase obligations (1) 1,998 1,515 483 - -
----------- ---------- ---------- ---------- ----------
Total contractual cash
obligations $156,300 $21,897 $38,786 $31,382 $64,235
=========== ========== ========== ========== ==========
---------------------
(1) Includes contracts for long-term communication services. Does not
include outstanding purchase orders for merchandise, services or
supplies which are ordered in the normal course of operations and which
generally are received and recorded within 30 days.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Interest rates under our bank credit facility are variable and are
determined, at our option, as the base rate, which is the greater of prime rate
or federal funds rate plus 0.50% plus the base rate margin, which ranges from
0.00% to 0.50%, or LIBOR plus the LIBOR margin, which ranges from 0.75% to
1.75%. 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 in
securitized assets. See Note 3 to the audited financial statements for
disclosures related to the sensitivity of the current fair value of the interest
in securitized assets to 10% and 20% adverse changes in the factors that affect
these assets, including interest rates. Since January 31, 2007, our interest
rate sensitivity has increased on our interest in securitized assets as the
variable rate portion of the QSPE's debt has increased from $120.0 million, or
29.2% of its debt, to $278.0 million or 59.4% of its total debt.
57
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Management's Report on Internal Control Over Financial Reporting..............59
Report of Independent Registered Public Accounting Firm on Internal Control
Over Financial Reporting......................................................60
Report of Independent Auditors................................................61
Consolidated Balance Sheets...................................................62
Consolidated Statements of Operations.........................................63
Consolidated Statements of Stockholders' Equity...............................64
Consolidated Statements of Cash Flows.........................................65
Notes to Consolidated Financial Statements....................................66
58
Management's Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rule 13a-15(f) or Rule
15(d)-15(f) under the Exchange Act. Our internal control over financial
reporting is designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Therefore, even those systems
determined to be effective can provide only reasonable assurance with respect to
financial statement preparation and presentation.
Our management (with the participation of our principal executive officer and
our principal financial officer) assessed the effectiveness of our internal
control over financial reporting as of January 31, 2008. In making this
assessment, management used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control -
Integrated Framework. Based on our assessment and those criteria, management
believes that, as of January 31, 2008, our internal control over financial
reporting is effective.
The effectiveness of our internal control over financial reporting as of January
31, 2008, has been audited by Ernst & Young LLP, an independent registered
public accounting firm, as stated in their report which is included elsewhere
herein.
Conn's, Inc.
Beaumont, Texas
March 27, 2008
/s/ Michael J. Poppe
-------------------------
Michael J. Poppe
Chief Financial Officer
/s/ Thomas J. Frank
-------------------------
Thomas J. Frank
Chief Executive Officer
59
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of Conn's, Inc.
We have audited Conn's Inc.'s internal control over financial reporting as of
January 31, 2008, based on criteria established in Internal Control--Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (the COSO criteria). Conn's, Inc.'s management is responsible for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting
included in the accompanying Management's Report Internal Control Over Financial
Reporting. Our responsibility is to express an opinion on the Company's internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, testing
and evaluating the design and operating effectiveness of internal control based
on the assessed risk, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, Conn's, Inc. maintained, in all material respects, effective
internal control over financial reporting as of January 31, 2008, based on the
COSO criteria.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
Conn's, Inc. as of January 31, 2008 and 2007, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended January 31, 2008 of Conn's, Inc. and our report
dated March 26, 2008 expressed an unqualified opinion thereon.
Ernst & Young LLP
Houston, Texas
March 26, 2008
60
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of Conn's, Inc.
We have audited the accompanying consolidated balance sheets of Conn's, Inc. as
of January 31, 2008 and 2007, and the related consolidated statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended January 31, 2008. Our audits also included the financial
statement schedule listed in the Index at Item 15(a). These financial statements
and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Conn's, Inc. at
January 31, 2008 and 2007, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended January 31, 2008,
in conformity with U.S. generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
As discussed in Note 1 to the consolidated financial statements, on February 1,
2006, the Company changed its method of accounting for share-based compensation.
As discussed in Note 2 to the consolidated financial statements, on February 1,
2007, the Company changed its method of accounting for interests in securitized
assets and its method of accounting for servicing liabilities.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), Conn's Inc.'s internal control over
financial reporting as of January 31, 2008, based on criteria established in
Internal Control -- Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report dated March 26, 2008,
expressed an unqualified opinion thereon.
Ernst & Young LLP
Houston, Texas
March 26, 2008
61
Conn's, Inc.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
January 31,
------------------------
Assets 2007 2008
----------- ------------
Current Assets
Cash and cash equivalents $56,570 $11,015
Accounts receivable, net of allowance for doubtful accounts of $821 and
$960, respectively 31,737 36,100
Interest in securitized assets 136,848 178,150
Inventories 87,098 81,495
Deferred income taxes 551 2,619
Prepaid expenses and other assets 4,958 4,449
----------- ------------
Total current assets 317,762 313,828
Non-current deferred income tax asset 2,920 -
Property and equipment
Land 9,102 8,011
Buildings 13,896 13,626
Equipment and fixtures 13,650 17,950
Transportation equipment 3,022 2,741
Leasehold improvements 66,761 74,120
----------- ------------
Subtotal 106,431 116,448
Less accumulated depreciation (46,991) (57,195)
----------- ------------
Total property and equipment, net 59,440 59,253
Goodwill, net 9,617 9,617
Other assets, net 208 154
----------- ------------
Total assets $389,947 $382,852
=========== ============
Liabilities and Stockholders' Equity
Current Liabilities
Current portion of long-term debt $110 $102
Accounts payable 51,028 28,179
Accrued compensation and related expenses 9,234 9,748
Accrued expenses 20,424 21,487
Income taxes payable 3,693 600
Deferred revenues and allowances 12,533 16,949
----------- ------------
Total current liabilities 97,022 77,065
Long-term debt 88 17
Non-current deferred tax liability - 131
Deferred gain on sale of property 309 1,221
Stockholders' equity
Preferred stock ($0.01 par value, 1,000,000 shares authorized; none issued
or outstanding) - -
Common stock ($0.01 par value, 40,000,000 shares authorized; 23,809,522 and
24,098,171 shares issued and outstanding at January 31, 2007 and 2008,
respectively) 238 241
Accumulated other comprehensive income 6,305 -
Additional paid in capital 93,365 99,514
Retained earnings 196,417 241,734
Treasury stock at cost (168,000 and 1,723,205 shares at January 31, 2007 and
2008, respectively) (3,797) (37,071)
----------- ------------
Total stockholders' equity 292,528 304,418
----------- ------------
Total liabilities and stockholders' equity $389,947 $382,852
=========== ============
See notes to consolidated financial statements.
62
Conn's, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except earnings per share)
Year Ended January 31,
-----------------------------
2006 2007 2008
-------- -------- ----------
Revenues
Product sales $569,877 $623,959 $671,571
Service maintenance agreement commissions (net) 30,583 30,567 36,424
Service revenues 20,278 22,411 22,997
-------- -------- ----------
Total net sales 620,738 676,937 730,992
Finance charges and other 80,410 83,720 93,136
-------- -------- ----------
Total revenues 701,148 760,657 824,128
Cost and expenses
Cost of goods sold, including warehousing and
occupancy costs 422,533 466,279 508,787
Cost of service parts sold, including warehousing
and occupancy cost 5,310 6,785 8,379
Selling, general and administrative expense 208,259 224,979 245,317
Provision for bad debts 1,133 1,476 1,908
-------- -------- ----------
Total cost and expenses 637,235 699,519 764,391
-------- -------- ----------
Operating income 63,913 61,138 59,737
Interest (income) expense 400 (676) (515)
Other (income) expense 69 (772) (943)
-------- -------- ----------
Income before income taxes 63,444 62,586 61,195
Provision for income taxes 22,341 22,275 21,509
-------- -------- ----------
Net Income $41,103 $40,311 $39,686
======== ======== ==========
Earnings per share
Basic $1.76 $1.70 $1.71
Diluted $1.71 $1.66 $1.68
Average common shares outstanding
Basic 23,412 23,663 23,193
Diluted 24,088 24,289 23,673
See notes to consolidated financial statements.
63
Conn's, Inc.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
Accum.
Other
Common Stock Compre- Treasury Stock
----------------------- hensive Paid in Retained ----------------------
Shares Amount Income Capital Earnings Shares Amount Total
----------- ----------- ------------- ----------- ---------- --------- ------------ ---------
Balance January 31, 2005 23,268 $ 233 $ 8,408 $ 85,090 $ 115,003 - $ - $208,734
Exercise of options
including tax benefit 293 3 2,579 2,582
Issuance of common stock under
Employee Stock Purchase Plan 11 192 192
Forfeiture of restricted shares -
Stock-based compensation 1,166 1,166
Comprehensive Income:
Net income 41,103 41,103
Reclassification adjustments
on derivative instruments
(net of tax of $ 86) 160 160
Adjustment of fair value of
securitized assets (net of
tax of $1,038), net of reclass-
ification adjustments of
$12,626 (net of tax of $6,828) 1,924 1,924
---------
Total comprehensive income 43,187
----------- ------------- ----------- ---------- --------- ------------ ---------
Balance January 31, 2006 23,572 236 10,492 89,027 156,106 - - 255,861
Exercise of options,
including tax benefit 226 2 2,370 2,372
Issuance of common stock under
Employee Stock Purchase Plan 12 245 245
Stock-based compensation 1,723 1,723
Purchase of treasury stock (168) (3,797) (3,797)
Comprehensive Income:
Net income 40,311 40,311
Adjustment of fair value of
securitized assets (net of
tax of $2,154), net of reclass-
ification adjustments of
$12,732 (net of tax of $7,100) (4,187) (4,187)
---------
Total comprehensive income 36,124
----------- ----------- ------------- ----------- ---------- --------- ------------ ---------
Balance January 31, 2007 23,810 238 6,305 93,365 196,417 (168) (3,797) 292,528
Cumulative effect of changes in
accounting principles (6,305) 5,631 (674)
Exercise of options,
including tax benefit 279 2 3,241 3,243
Issuance of common stock under
Employee Stock Purchase Plan 13 1 247 248
Stock-based compensation 2,661 2,661
Purchase of treasury stock (1,555) (33,274) (33,274)
Comprehensive Income:
Net income 39,686 39,686
----------- ------------- ----------- ---------- --------- ------------ ---------
Balance January 31, 2008 24,102 $ 241 $ - $ 99,514 $ 241,734 (1,723) $ (37,071) $304,418
=========== =========== ============= =========== ========== ========= ============ =========
See notes to consolidated financial statements.
64
Conn's, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended January 31,
------------------------------------
2006 2007 2008
----------- ----------- ------------
Cash flows from operating activities
Net income $41,103 $40,311 $39,686
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 11,271 12,520 12,441
Accretion, net (318) (461) (758)
Provision for bad debts 1,133 1,476 1,908
Stock-based compensation 1,166 1,723 2,661
Gains on interests in securitized assets (26,724) (23,874) (28,043)
Decrease in fair value of interests in securitized
assets - - 5,789
Provision for deferred income taxes (707) (1,080) (747)
Loss (gain) from sale of property and equipment 69 (772) (943)
Discounts on promotional credit 3,080 5,347 7,236
Losses from derivatives 69 - -
Change in operating assets and liabilities:
Accounts receivable 6,582 4,950 (32,549)
Inventory (11,641) (13,111) 5,603
Prepaid expenses and other assets (452) (954) 509
Accounts payable 13,812 10,108 (22,849)
Accrued expenses 15,751 (6,569) 1,577
Income taxes payable 8,833 (5,120) (987)
Deferred revenues and allowances 1,330 4,380 3,832
----------- ----------- ------------
Net cash provided by (used in) operating activities 64,357 28,874 (5,634)
----------- ----------- ------------
Cash flows from investing activities
Purchase of property and equipment (18,490) (18,425) (18,955)
Proceeds from sales of property 34 2,278 8,921
----------- ----------- ------------
Net cash used in investing activities (18,456) (16,147) (10,034)
----------- ----------- ------------
Cash flows from financing activities
Net proceeds from stock issued under employee
benefit plans, including tax benefit 2,640 2,407 3,188
Excess tax benefits from stock-based compensation 134 210 303
Purchase of treasury stock - (3,797) (33,274)
Borrowings under lines of credit 77,150 25,200 40,475
Payments on lines of credit (87,650) (25,200) (40,475)
Increase in debt issuance costs (130) - -
Borrowings on promissory notes 136 - -
Payment of promissory notes (32) (153) (104)
----------- ----------- ------------
Net cash used in financing activities (7,752) (1,333) (29,887)
----------- ----------- ------------
Net change in cash 38,149 11,394 (45,555)
Cash and cash equivalents
Beginning of the year 7,027 45,176 56,570
----------- ----------- ------------
End of the year $45,176 $56,570 $11,015
=========== =========== ============
Supplemental disclosure of cash flow information
Cash interest paid $635 $366 $435
Cash income taxes paid, net of refunds 13,179 28,262 22,935
Cash interest received from interests in securitized
assets 14,633 19,055 23,339
Cash proceeds from new securitizations 285,529 338,222 378,699
Cash flows from servicing fees 18,572 20,997 24,288
Supplemental disclosure of non-cash activity
Customer receivables exchanged for interests in
securitized assets 58,835 63,067 63,789
Amounts reinvested in interests in securitized assets (76,133) (61,880) (108,067)
Purchases of property and equipment with debt financing - 215 23
See notes to consolidated financial statements.
65
CONN'S , INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
January 31, 2008
1. Summary of Significant Accounting Policies
Principles of Consolidation. The consolidated financial statements
include the accounts of Conn's, Inc. and its subsidiaries, limited liability
companies and limited partnerships, all of which are wholly-owned (the
"Company"). All material intercompany transactions and balances have been
eliminated in consolidation.
The Company enters into securitization transactions to sell its retail
installment and revolving customer receivables and retains servicing
responsibilities and subordinated interests. 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, as amended by SFAS No. 155, Accounting
for Certain Hybrid Financial Instruments, because the Company has relinquished
control of the receivables. Additionally, the Company has transferred the
receivables to a qualifying special purpose entity (QSPE). Accordingly, neither
the transferred receivables nor the accounts of the QSPE are included in the
consolidated financial statements of the Company. The Company's retained
interest in the transferred receivables is valued under the requirements of SFAS
No. 159, The Fair Value Option for Financial Assets and Liabilities, and SFAS
No. 157, Fair Value Measurements.
Business Activities. The Company, through its retail stores, provides
products and services to its customer base in seven primary market areas,
including southern Louisiana, southeast Texas, Houston, South Texas, San
Antonio/Austin, Dallas/Fort Worth and Oklahoma. Products and services offered
through retail sales outlets include home appliances, consumer electronics, home
office equipment, lawn and garden products, mattresses, furniture, service
maintenance agreements, installment and revolving credit account programs, and
various credit insurance products. These activities are supported through an
extensive service, warehouse and distribution system. For the reasons discussed
below, the aggregation of operating companies represent one reportable segment
under SFAS No. 131, Disclosures About Segments of an Enterprise and Related
Information. Accordingly, the accompanying consolidated financial statements
reflect the operating results of the Company's single reportable segment. The
Company's retail stores bear the "Conn's" name, and deliver the same products
and services to a common customer group. The Company's customers generally are
individuals rather than commercial accounts. All of the retail stores follow the
same procedures and methods in managing their operations. The Company's
management evaluates performance and allocates resources based on the operating
results of the retail stores and considers the credit programs, service
contracts and distribution system to be an integral part of the Company's retail
operations.
Use of Estimates. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates. See the discussion under Note 2 regarding the change in assumptions
used in the Company's valuation of its Interests in securitized assets.
Vendor Programs. The Company receives funds from vendors for price
protection, product and volume rebates (earned upon purchase or sales of
product), marketing, training and promotional programs which are recorded as the
amounts are earned, as a reduction of the related product cost or advertising
expense, according to the nature of the program. The Company accrues rebates
based on the satisfaction of terms of the program even though funds may not be
received until the end of a quarter or year. If the programs are related to
product purchases, which would include price protection, and sales and volume
rebates, the allowances, credits, or payments are recorded as a reduction of
product cost and are reflected in cost of goods sold when the related product is
sold. If the programs are related to product sales, the allowances, credits or
payments are recorded as a reduction of cost of goods sold. If the programs
relate to marketing, training and promotions that are not for reimbursement of
specific incremental costs, the allowances, credits or payments are reflected as
a reduction of product cost. If the programs are related to promotion or
marketing of the product, the allowances, credits, or payments for reimbursement
of specific, incremental, identifiable, advertising-related costs incurred in
selling the vendors' products are recorded as a reduction of advertising expense
and are reflected in selling, general and administrative expenses in the period
66
in which the expense is incurred. Vendor rebates earned and recorded as a
reduction of product inventory cost totaled $19.5 million, $20.0 million and
$29.5 million for the years ended January 31, 2006, 2007 and 2008, respectively.
Earnings Per Share. In accordance with SFAS No. 128, Earnings per Share,
the Company calculates basic earnings per share by dividing net income by the
weighted average number of common shares outstanding. Diluted earnings per share
include the dilutive effects of any stock options granted, which is calculated
using the treasury-stock method. The following table sets forth the shares
outstanding for the earnings per share calculations (shares in thousands):
Year Ended January 31,
--------------------------------
2006 2007 2008
--------- --------- ------------
Common stock outstanding, beginning of period 23,268 23,571 23,642
Weighted average common stock issued in stock
option exercises 142 111 111
Weighted average common stock issued to employee
stock purchase plan 2 5 5
Less: Weighted average treasury shares purchased - (24) (565)
--------- --------- ------------
Shares used in computing basic earnings per share 23,412 23,663 23,193
Dilutive effect of stock options, net of assumed
repurchase of treasury stock 676 626 480
--------- --------- ------------
Shares used in computing diluted earnings per share 24,088 24,289 23,673
========= ========= ============
During the periods presented, options with an exercise price in excess of
the average market price of the Company's common stock are excluded from the
calculation of the dilutive effect of stock options for diluted earnings per
share calculations. The weighted average number of options not included in the
calculation of the dilutive effect of stock options was 0.1 million, 0.2
million, and 0.4 million for each of the years ended January 31, 2006, 2007, and
2008 respectively.
Cash and Cash Equivalents. The Company considers all highly liquid debt
instruments purchased with a maturity of three months or less to be cash
equivalents. Credit card deposits in-transit of $1.2 million and $1.3 million,
as of January 31, 2007 and 2008, respectively, are included in cash and cash
equivalents.
Inventories. Inventories consist of finished goods or parts and are
valued at the lower of cost (moving weighted average method) or market.
Property and Equipment. Property and equipment are recorded at cost.
Costs associated with major additions and betterments that increase the value or
extend the lives of assets are capitalized and depreciated. Normal repairs and
maintenance that do not materially improve or extend the lives of the respective
assets are charged to operating expenses as incurred. Depreciation, which
includes amortization of capitalized leases, is computed on the straight-line
method over the estimated useful lives of the assets, or in the case of
leasehold improvements, over the shorter of the estimated useful lives or the
remaining terms of the respective leases. The estimated lives used to compute
depreciation expense are summarized as follows:
Buildings...............................................................30 years
Equipment and fixtures...............................................3 - 5 years
Transportation equipment.................................................3 years
Leasehold improvements..............................................5 - 15 years
Property and equipment are evaluated for impairment at the retail store
level. The Company performs a periodic assessment of assets for impairment.
Additionally, an impairment evaluation is performed whenever events or changes
in circumstances indicate that the carrying amount of the assets might not be
recoverable. The most likely condition that would necessitate an assessment
would be an adverse change in historical and estimated future results of a
retail store's performance. For property and equipment to be held and used, the
67
Company recognizes an impairment loss if its carrying amount is not recoverable
through its undiscounted cash flows and measures the impairment loss based on
the difference between the carrying amount and fair value.
All gains and losses on sale of assets are included in Other (income)
expense in the consolidated statements of operations.
Year Ended January 31,
-------------------------------
(in thousands of dollars) 2006 2007 2008
---------------------------------- --------- --------- -----------
Gain (loss) on sale of assets (69) 772 943
During the year ended January 31, 2007, the Company completed a nonmonetary
transaction in an exchange of real estate assets. As required under Accounting
Principles Board No. 29, Accounting for Nonmonetary Transactions, a gain of $0.7
million was recorded in Other (income) expense. During the year ended January
31, 2008, the Company completed transactions involving certain real estate
assets that qualified for sales-leaseback treatment. As a result, a portion of
the gains resulting from the transactions are being deferred and amortized as a
reduction of rent expense on a straight-line basis over the minimum lease term.
The deferred gains of $1.3 million recorded during the year ended January 31,
2008, are included in Deferred gains on sales of property.
Receivable Sales and Interests in Securitized Receivables. The Company
enters into securitization transactions to sell customer retail installment and
revolving receivable accounts. In these transactions, the Company retains
interest-only strips and subordinated securities, all of which are retained
interests in the securitized receivables. Securitization income, which includes,
gains and losses on sales of receivables, changes in the fair value of interests
in securitized assets due to assumption changes, impairment on retained
interests, interest income from retained interests and servicing fees, is
included in Finance charges and other in the consolidated statement of
operations. Gains and losses from the sales of receivables are recorded at the
time of the transfer to the QSPE, based on the difference between the fair value
and the carrying amount at that time.
Receivables Not Sold. Certain receivables are not eligible for inclusion
in the securitization transactions and are therefore carried on the Company's
balance sheet in Accounts receivable. Such receivables are recorded net of an
allowance for doubtful accounts, which is calculated based on historical losses.
Typically, a receivable is considered delinquent if a payment has not been
received on the scheduled due date. Generally, an account that is delinquent
more than 120 days and for which no payment has been received in the past seven
months will be charged-off against the allowance and interest accrued subsequent
to the last payment will be reversed. Interest income is accrued using the Rule
of 78's method for installment contracts and the simple interest method for
revolving charge accounts. Typically, interest income is accrued until the
contract or account is paid off or charged-off. The Company has a secured
interest in the merchandise financed by these receivables and therefore has the
opportunity to recover a portion of the charged-off value. (See also Note 3.)
Goodwill. Goodwill represents the excess of purchase price over the fair
market value of net assets acquired. The Company performs an assessment annually
regarding the impairment of goodwill, or at any other time when impairment
indicators exist. In fiscal 2006, 2007 and 2008, the Company concluded that
goodwill was not impaired based on its annual impairment testing.
Income Taxes. The Company follows the liability method of accounting for
income taxes. Under this method, deferred tax assets and liabilities are
determined based on differences between financial reporting and tax bases of
assets and liabilities and are measured using the tax rates and laws that are
expected be in effect when the differences are expected to reverse.
Sales Taxes. The Company records and reports all sales taxes collected on
a net basis in the financial statements.
Revenue Recognition. Revenues from the sale of retail products are
recognized at the time the customer takes possession of the product. Such
revenues are recognized net of any adjustments for sales incentive offers such
as discounts, coupons, rebates or other free products or services. The Company
sells service maintenance agreements and credit insurance contracts on behalf of
unrelated third parties. For contracts where third parties are the obligor on
the contract, commissions are recognized in revenues at the time of sale, and in
the case of retrospective commissions, at the time that they are earned. The
68
Company records a receivable for earned but unremitted retrospective commissions
and reserves for future cancellations of service maintenance agreements and
credit insurance contracts estimated based on historical experience. When the
Company sells service maintenance agreements in which it is deemed to be the
obligor on the contract at the time of sale, revenue is recognized ratably, on a
straight-line basis, over the term of the service maintenance agreement. These
Company-obligor service maintenance agreements are renewal contracts which
provide our customers protection against product repair costs arising after the
expiration of the manufacturer's warranty and the third-party obligor contracts.
These agreements typically have terms ranging from 12 months to 36 months. These
agreements are separate units of accounting under EITF No. 00-21, Revenue
Arrangements with Multiple Deliverables and are valued based on the agreed upon
retail selling price. The amounts of service maintenance agreement revenue
deferred at January 31, 2007 and 2008 were $3.6 million and $5.4 million,
respectively, and are included in Deferred revenue and allowances in the
accompanying balance sheets. Under the renewal contracts, the Company defers and
amortizes its direct selling expenses over the contract term and records the
cost of the service work performed as products are repaired.
The classification of the amounts included as Finance charges and other
is summarized as follows (in thousands):
Year Ended January 31,
-------------------------------
2006 2007 2008
--------- --------- -----------
Securitization income:
Servicing fees received $18,572 $20,997 $24,288
Gains on sale of receivables, net 26,724 23,874 28,043
Change in fair value of securitized assets - - (5,789)
Impairment recorded on retained interests (1) (895) (1,495) -
Interest earned on retained interests 14,633 19,055 23,339
--------- --------- -----------
Total securitization income 59,034 62,431 69,881
Insurance commissions 16,672 18,394 21,278
Other 4,704 2,895 1,977
--------- --------- -----------
Finance charges and other $80,410 $83,720 $93,136
========= ========= ===========
(1) The impairment charge in the year ended January 31, 2006, was
due to higher expected credit losses as a result of changes in the
bankruptcy-filing laws and the disruption to our credit operations
as a result of Hurricane Rita, which hit the Gulf Coast in
September 2005. The impairment charge in the year ended January
31, 2007, was due to higher expected credit losses as a result of
the continued impact of the disruption to our credit operations as
a result of Hurricane Rita.
Sales on interest-free promotional credit programs are recognized at the
time the customer takes possession of the product, consistent with the above
stated policy. Considering the short-term nature of interest free programs for
terms less than one year, sales are recorded at full value and are not
discounted. Sales financed by longer-term (18-, 24- and 36-month) interest free
programs are recorded at their net present value in accordance with APB 21,
Interest on Receivables and Payables. The discount to net present value results
in a reduction in net sales, which totaled $3.1 million, $5.3 million and $7.2
million for the years ended January 31, 3006, 2007 and 2008, respectively.
Receivables arising out of the Company's interest-free programs are transferred
to the Company's QSPE, net of the discount, with other qualifying customer
receivables.
The Company classifies amounts billed to customers relating to shipping
and handling as revenues. Costs of $21.0 million, $21.4 million and $22.0
million associated with shipping and handling revenues are included in Selling,
general and administrative expense for the years ended January 31, 2006, 2007
and 2008, respectively.
Fair Value of Financial Instruments. The fair value of cash and cash
equivalents, receivables, and notes and accounts payable approximate their
carrying amounts because of the short maturity of these instruments. The fair
value of the Company's interests in securitized receivables is determined by
estimating the present value of future expected cash flows using management's
69
best estimates of the key assumptions, including credit losses, forward yield
curves and discount rates commensurate with the risks involved. See Notes 2 and
3. The carrying value of the Company's long-term debt approximates fair value
due to either the time to maturity or the existence of variable interest rates
that approximate current market rate.
Share-Based Compensation. On February 1, 2006, the Company adopted SFAS
No. 123R, Share-Based Payment, using the modified retrospective application
transition method. Under the modified retrospective application transition
method, all prior period financial statements have been adjusted to give effect
to the fair-value-based method of accounting for share-based compensation. The
adoption of the statement impacted the financial statements presented as
follows:
o For the fiscal year 2007, Income before income taxes and Net income
was reduced by $1.7 million and $1.4 million, respectively. Basic
earnings per share and Diluted earnings per share were reduced by
$.06. Cash flows from operating activities were reduced by and cash
flow from financing activities were increased by $0.2 million.
For stock option grants after our IPO in November 2003, the Company has
used the Black-Scholes model to determine fair value. Share-based compensation
expense is recorded, net of estimated forfeitures, on a straight-line basis over
the vesting period of the applicable grant. Prior to the IPO, the value of the
options issued was estimated using the minimum valuation option-pricing model.
Since the minimum valuation option-pricing model does not qualify as a fair
value pricing model under FAS 123R, the Company followed the intrinsic value
method of accounting for share-based compensation to employees for these grants,
as prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting
for Stock Issued to Employees, and related interpretations. The following table
presents the impact to earnings per share as if the Company had adopted the fair
value recognition provisions of SFAS No. 123 (dollars in thousands except per
share data):
Year Ended
January 31, 2006
----------------
Net income available for common stockholders as reported $41,103
Add: Stock-based compensation recorded, net of tax 963
Less: Stock-based compensation, net of tax,
for all awards (1,313)
------------
Pro forma net income $40,753
============
Earnings per share-as reported:
Basic $1.76
Diluted $1.71
Pro forma earnings per share:
Basic $1.74
Diluted $1.69
Self-insurance. The Company is self-insured for certain losses relating
to group health, workers' compensation, automobile, general and product
liability claims. The Company has stop loss coverage to limit the exposure
arising from these claims. Self-insurance losses for claims filed and claims
incurred, but not reported, are accrued based upon the Company's estimates of
the aggregate liability for claims incurred using development factors based on
historical experience.
Expense Classifications. The Company records Cost of goods sold as the
direct cost of products sold, any related in-bound freight costs, and receiving
costs, inspection costs, internal transfer costs, and other costs associated
with the operations of its distribution system. Advertising costs are expensed
as incurred. Advertising expense included in Selling, general and administrative
expense for the years ended January 31, 2006, 2007 and 2008, was:
70
Year Ended January 31,
---------------------------------
2006 2007 2008
---------- ---------- -----------
(in thousands)
Gross advertising expense $31,017 $33,680 $35,647
Less:
Vendor rebates (5,793) (7,188) (6,591)
---------- ---------- -----------
Net advertising expense in
Selling, general and adminstrative expense $25,224 $26,492 $29,056
========== ========== ===========
In addition, the Company records as Cost of service parts sold the direct
cost of parts used in its service operation and the related inbound freight
costs, purchasing and receiving costs, inspection costs, internal transfer
costs, and other costs associated with the parts distribution operation.
The costs associated with the Company's merchandising function, including
product purchasing, advertising, sales commissions, and all store occupancy
costs are included in Selling, general and administrative expense.
Reclassifications. Certain reclassifications have been made in the prior
years' financial statements to conform to the current year's presentation. In
order to present the Company's results on a basis that is more comparable with
others in its industry, the Company has reclassified advertising expenditures of
$25.5 million, $29.1 million and $30.8 million for the fiscal years ended
January 31, 2006, 2007, and 2008, respectively, that were previously included in
costs of goods sold to selling, general and administrative expense.
Accumulated Other Comprehensive Income. The balance of accumulated other
comprehensive income (net of tax) was comprised of $6.3 million of unrealized
gains on interests in securitized assets at January 31, 2007.
2. Adoption of New Accounting Pronouncements
On February 1, 2007, the Company was required to adopt SFAS No. 155,
Accounting for Certain Hybrid Financial Instruments. Among other things, this
statement established a requirement to evaluate interests in securitized
financial assets to identify interests that are freestanding derivatives or that
are hybrid financial instruments that contain an embedded derivative requiring
bifurcation. Additionally, the Company had the option to choose to early adopt
the provisions of SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities. Essentially, the Company had to decide between
bifurcation of the embedded derivative and the fair value option in determining
how it would account for its Interests in securitized assets. The Company
elected to early adopt SFAS No. 159 because it believes it provides a more
easily understood presentation for financial statement users. Historically, the
Company had valued and reported its interests in securitized assets at fair
value, though most changes in the fair value were recorded in Other
comprehensive income. The fair value option simplifies the treatment of changes
in the fair value of the asset, by reflecting all changes in the fair value of
its Interests in securitized assets in current earnings, in Finance charges and
other, beginning February 1, 2007. SFAS Nos. 155 and 159 do not allow for
retrospective application of these changes in accounting principle and, as such,
no adjustments have been made to the amounts disclosed in the financial
statements for periods ending prior to February 1, 2007. However, the balance in
Other comprehensive income, as of January 31, 2007, of $6.3 million, which
represented unrecognized gains on the fair value of the Interests in securitized
assets, was included in a cumulative-effect adjustment that was recorded in
Retained earnings, effective February 1, 2007.
Because of its adoption of SFAS No. 159, effective February 1, 2007, the
Company was required to adopt the provisions of SFAS No. 157, Fair Value
Measurements. This statement established a framework for measuring fair value
and defines fair value as "the price that would be received to sell an asset or
paid to transfer a liability in an orderly transaction between market
participants at the measurement date." The Company estimates the fair value of
its Interests in securitized assets using a discounted cash flow model with most
of the inputs used being unobservable inputs. The primary unobservable inputs,
which are derived principally from the Company's historical experience, with
input from its investment bankers and financial advisors, include the estimated
portfolio yield, credit loss rate, discount rate, payment rate and delinquency
rate and reflect the Company's judgments about the assumptions market
71
participants would use in determining fair value. In determining the cost of
borrowings, the Company uses current actual borrowing rates, and adjusts them,
as appropriate, using interest rate futures data from market sources to project
interest rates over time. Changes in the assumptions over time, including
varying credit portfolio performance, market interest rate changes, market
participant risk premiums required, or a shift in the mix of funding sources,
could result in significant volatility in the fair value of the Interest in
securitized assets, and thus the earnings of the Company.
For the fiscal year ended January 31, 2008, Finance charges and other
included non-cash decreases in the fair value our interests in securitized
assets of $4.7 million, reflecting primarily a higher risk premium added to the
discount rate assumption resulting from the volatility in the financial markets,
plus adjustments for other changes in the fair value assumptions, partially
offset by lower interest rates, including the risk-free interest rate (see
reconciliation of the balance of Interests in securitized assets below). The
change to fair value accounting, including the servicing liability, resulted in
a charge to pretax income of $4.8 million, a charge to net income of $3.1
million, and reduced basic and diluted earnings per share by $0.13, for the
fiscal year ended January 31, 2008. During the period ended January 31, 2008,
returns required by market participants on many investments increased
significantly as a result of disruption in the asset-backed securities markets
due to increased losses and delinquencies on sub-prime real estate mortgages.
Though the Company does not anticipate any significant variation from the
current earnings and cash flow performance of the securitized credit portfolio,
it increased the risk premium included in the discount rate assumption used in
the determination of the fair value of its interests in securitized assets to
reflect the higher estimated risk premium it believes a market participant would
require if purchasing the asset. Based on a review of the changes in market risk
premiums during the last six months of fiscal year ended January 31, 2008, and
discussions with its investment bankers and financial advisors, the Company
estimated that a market participant would require an approximately 500 basis
point increase in the required risk premium. As a result, the Company increased
the weighted average discount rate assumption from 14.6% at January 31, 2007, to
16.5% at January 31, 2008, after reflecting a 280 basis point decrease in the
risk-free interest rate included in the discount rate assumption. The Company
also included an expected market participant-based assumption related to the
estimated cost of a bond issuance contemplated by the QSPE and an increase in
the credit loss rate on the credit portfolio we estimate a market participant
would use in determining the fair value of our interest in securitized assets
The increase in the discount rate will have the effect of deferring
income to future periods, but not permanently reducing securitization income or
the earnings of the Company. The deferred earnings will be recognized in future
periods as interest income on the Interests in securitized assets as the actual
cash flows on the receivables are realized. If a market participant were to
require a return on investment that is 100 basis points higher than estimated in
the Company's calculation, the fair value of its interests in securitized assets
would be decreased by an additional $1.7 million. The Company will continue to
monitor financial market conditions and, each quarter, as it reassesses the
assumptions used may adjust its assumptions up or down, including the risk
premiums a market participant will use. As the financial markets, especially
with respect to asset-backed securities, have continued to experience a
high-level of volatility, the Company will likely be required to record
additional non-cash gains and losses in future periods, until such time as
financial market conditions stabilize and liquidity available for asset-backed
securities improves.
Effective February 1, 2007, the Company was required to adopt the
provisions SFAS No. 156, Accounting for Servicing of Financial Assets, an
Amendment of FASB Statement No. 140. This statement requires companies to
measure servicing assets or servicing liabilities at fair value at each
reporting date and report changes in fair value in earnings in the period the
changes occur, or amortize servicing assets or servicing liabilities in
proportion to and over the estimated net servicing income or loss and assess
servicing assets or servicing liabilities for impairment or increased obligation
based on the fair value at each reporting date. The Company receives a servicing
fee each month equal to 0.25% of the average outstanding sold portfolio balance,
plus late fees and other customer fees collected. Servicing fees collected
during the fiscal years ended January 31, 2006, 2007 and 2008, totaled $18.6
million, $21.0 million and $24.3 million, respectively, and are reflected in
Finance charges and other. In connection with the adoption of SFAS No. 156 the
Company elected to measure its servicing asset or liability at fair value, and
report changes in the fair value in earnings in the period of change. As such, a
$0.7 million cumulative-effect adjustment was recorded to Retained earnings at
February 1, 2007, net of related tax effects, to recognize a $1.1 million
72
servicing liability. The Company uses a discounted cash flow model to estimate
its servicing liability using the portfolio performance and discount rate
assumptions discussed above, and an estimate of the servicing fee a market
participant would require to service the portfolio. In developing its estimate,
based on the provisions of SFAS No. 157, the Company reviewed available
information regarding the servicing fees received by other companies and
estimated an expected risk premium a market participant would add to the current
fee structure to receive adequate compensation.
The following are reconciliations of the beginning and ending balances of
the Interests in securitized assets and the beginning and ending balances of the
servicing liability for the fiscal year ended January 31, 2008 (in thousands):
Reconciliation of Interests in Securitized
Assets:
--------------------------------------------
Balance of Interests in securitized assets at January 31, 2007 $136,848
Amounts recorded in Finance charges and other:
Fair value increase associated with net increase in portfolio balances 1,130
Fair value increase due to change in portfolio yield 585
Fair value increase due to lower projected interest rates 2,969
Fair value decrease due to expected funding mix (4,195)
Fair value decrease due to higher portfolio loss rate (1,233)
Fair value increase due to change in risk-free interest rate component
of discount rate 5,117
Fair value decrease due to higher risk premium included in discount rate (8,512)
Other changes (520)
-----------
Net change in fair value included in Finance charges and other (4,659)
Change in balance of subordinated security and equity interest due to
transfers of receivables 45,961
-----------
Balance of Interests in securitized assets at January 31, 2008 $178,150
===========
Reconciliation of Servicing
Liability:
-----------------------------------
Balance of servicing liability at January 31, 2007 $1,052
Amounts recorded in Finance charges and other:
Increase associated with change in portfolio balances 147
Decrease due to higher discount rate (13)
Other changes 11
-----------
Net change included in Finance charges and other 145
Balance of servicing liability at January 31, 2008 $1,197
===========
Prior to February 1, 2007, gain or loss on the sales of the receivables
depended in part on the previous carrying amount of the financial assets
involved in the transfer, allocated between the assets sold and the retained
interests, based on their relative fair value at the date of transfer. Retained
interests were carried at fair value on the Company's balance sheet as
available-for-sale securities in accordance with SFAS No. 115, Accounting for
Certain Investments in Debt and Equity Securities. Impairment and interest
income are recognized in accordance with Emerging Issues Task Force (EITF) No.
99-20, Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets. Servicing fees are
recognized monthly as they are earned.
73
3. Interests in Securitized Receivables
The Company has an agreement to sell customer receivables. As part of
this agreement, the Company sells eligible retail installment contracts and
revolving receivable accounts to a QSPE that pledges the transferred accounts to
a trustee for the benefit of investors. The following table summarizes the
availability of funding under the Company's securitization program at January
31, 2008 (in thousands):
Capacity Utilized Available
---------- ---------- ----------
2002 Series A $450,000 $278,000 $172,000
2002 Series B - Class A 24,000 24,000 -
2002 Series B - Class B 11,556 11,556 -
2002 Series B - Class C 4,444 4,444 -
2006 Series A - Class A 90,000 90,000 -
2006 Series A - Class B 43,333 43,333 -
2006 Series A - Class C 16,667 16,667 -
---------- ---------- ----------
Total $640,000 $468,000 $172,000
========== ========== ==========
The 2002 Series A program functions as a credit facility to fund the
initial transfer of eligible receivables. When the facility approaches a
predetermined amount, the QSPE (Issuer) is required to seek financing to pay
down the outstanding balance in the 2002 Series A variable funding note. The
amount paid down on the facility then becomes available to fund the transfer of
new receivables or to meet required principal payments on other series as they
become due. The new financing could be in the form of additional notes, bonds or
other instruments as the market and transaction documents might allow. The 2002
Series A program, which was increased from $300 million to $450 million during
the year ended January 31, 2008, is divided into two tranches: a $250 million
364-day tranche that matures in July 2008, and a $200 million tranche that
matures in August 2011. The 364-day tranche was increased during the fiscal year
ended January 31, 2008, by $150 million. The $150 million increase in the
commitment will stay in place until the first to occur of: (i) the QSPE
completes a medium-term bond issuance, or (ii) the note is not renewed by the
note holders. The 2002 Series B program (which was non-amortizing for the first
four years) matures officially on September 1, 2010, although it is expected
that the principal payments, which began in October 2006, will retire the bonds
prior to that date. The 2006 Series A program, which was consummated in August
2006, is non-amortizing for the first four years and officially matures in April
2017. However, it is expected that the principal payments, which begin in
September 2010, will retire the bonds prior to that date.
The agreement contains certain covenants requiring the maintenance of
various financial ratios and receivables performance standards. The Issuer was
in compliance with the requirements of the agreement as of January 31, 2008. As
part of the securitization program, the Company and Issuer arranged for the
issuance of a stand-by letter of credit in the amount of $20.0 million to
provide assurance to the trustee on behalf of the bondholders that funds
collected monthly by the Company, as servicer, will be remitted as required
under the base indenture and other related documents. The letter of credit has a
term of one year, and the maximum potential amount of future payments is the
face amount of the letter of credit. The letter of credit is callable, at the
option of the trustee, if the Company, as servicer, fails to make the required
monthly payments of the cash collected to the trustee.
Through its retail sales activities, the Company generates customer
retail installment contracts and revolving receivable accounts. The Company
enters into securitization transactions to sell these accounts to the QSPE. In
these securitizations, the Company retains servicing responsibilities and
subordinated interests. The Company receives annual servicing fees and other
benefits approximating 4.1% of the outstanding balance and rights to future cash
flows arising after the investors in the securities issued by or on behalf of
the QSPE have received from the trustee all contractually required principal and
interest amounts. The Company records a servicing liability related to the
servicing obligations (See Note 2). The investors and the securitization trustee
have no recourse to the Company's other assets for failure of the individual
customers of the Company and the QSPE to pay when due. The Company's retained
interests are subordinate to the investors' interests. Their value is subject to
credit, prepayment, and interest rate risks on the transferred financial assets.
The fair values of the Company's interest in securitized assets were as
follows (in thousands):
74
January 31,
------------------------------
2007 2008
------------- --------------
Interest-only strip $26,358 $31,866
Subordinated securities 110,490 146,284
------------- --------------
Total fair value of interests in securitized
assets $136,848 $178,150
============= ==============
The table below summarizes valuation assumptions used for each period
presented:
Year Ended January 31,
--------------------------------
2006 2007 2008
--------- --------- ------------
Net interest spread
Primary installment 12.8% 12.6% 13.6%
Primary revolving 12.8% 12.6% 13.6%
Secondary installment 14.7% 14.2% 14.1%
Expected losses
Primary installment 3.0% 3.0% 3.3%
Primary revolving 3.0% 3.0% 3.3%
Secondary installment 3.0% 3.0% 3.3%
Projected expense
Primary installment 4.1% 4.1% 4.1%
Primary revolving 4.1% 4.1% 4.1%
Secondary installment 4.1% 4.1% 4.1%
Discount rates
Primary installment 13.0% 13.6% 15.6%
Primary revolving 13.0% 13.6% 15.6%
Secondary installment 17.0% 17.6% 19.6%
Delinquency and deferral rates
Primary installment 9.3% 9.3% 9.5%
Primary revolving 7.3% 5.5% 5.4%
Secondary installment 14.0% 14.0% 14.3%
75
At January 31, 2008, key economic assumptions and the sensitivity of the
current fair value of the interests in securitized assets to immediate 10% and
20% adverse changes in those assumptions are as follows (dollars in thousands):
Primary Primary Secondary
Portfolio Portfolio Portfolio
Installment Revolving Installment
------------- -------------- ------------
Fair value of interest in securitized assets $124,964 $13,295 $39,891
Expected weighted average life 1.1 years 1.2 years 1.6 years
Net interest spread assumption 13.6% 13.6% 14.1%
Impact on fair value of 10% adverse change $4,245 $452 $2,051
Impact on fair value of 20% adverse change $8,436 $898 $4,054
Expected losses assumptions 3.3% 3.3% 3.3%
Impact on fair value of 10% adverse change $1,025 $109 $479
Impact on fair value of 20% adverse change $2,043 $217 $954
Projected expense assumption 4.1% 4.1% 4.1%
Impact on fair value of 10% adverse change $1,260 $134 $587
Impact on fair value of 20% adverse change $2,521 $268 $1,175
Discount rate assumption 15.6% 15.6% 19.6%
Impact on fair value of 10% adverse change $1,788 $190 $893
Impact on fair value of 20% adverse change $3,516 $374 $1,750
Delinquency and deferral 9.5% 5.4% 14.3%
Impact on fair value of 10% adverse change (1) $122 $13 $71
Impact on fair value of 20% adverse change (1) $264 $28 $158
-------------------------------------------------------
(1) For purposes of this analysis, an adverse change is assumed to be a
decrease in the delinquency and deferral rate. A decrease results in a
faster repayment of the receivables, which reduces the fair value of the
interest-only strip a greater amount than the resulting increase in the
fair value of the subordinated securities. Since it is assumed that none
of the other assumptions would change, an increase in the delinquency and
deferral rate results in an increase in the fair value, (i.e. losses are
not assumed to increase as a result).
These sensitivities are hypothetical and should be used with caution. As
the figures indicate, changes in fair value based on a 10% variation in
assumptions generally cannot be extrapolated because the relationship of the
change in assumption to the change in fair value may not be linear. Also, the
effect of the variation in a particular assumption on the fair value of the
interest-only strip is calculated without changing any other assumption; in
reality, changes in one factor may result in changes in another (i.e. increases
in market interest rates may result in lower prepayments and increased credit
losses), which might magnify or counteract the sensitivities.
The following illustration presents quantitative information about the
receivables portfolios managed by the Company (in thousands):
Total Principal Amount Principal Amount Over
of Receivables 60 Days Past Due (1)
January 31, January 31,
----------------------- ----------------------
2007 2008 2007 2008
----------- ----------- ---------- -----------
Primary portfolio:
Installment $382,482 $463,257 $24,853 $29,997
Revolving 53,125 48,329 1,171 1,561
----------- ----------- ---------- -----------
Subtotal 435,607 511,586 26,024 31,558
Secondary portfolio:
Installment 133,944 143,281 11,638 18,220
----------- ----------- ---------- -----------
Total receivables managed 569,551 654,867 37,662 49,778
Less receivables sold 559,619 645,862 35,677 47,778
----------- ----------- ---------- -----------
Receivables not sold 9,932 9,005 $1,985 $2,000
========== ===========
Non-customer receivables 21,805 27,095
----------- -----------
Total accounts
receivable, net $31,737 $36,100
=========== ===========
76
Average Balances Credit Charge-offs
January 31, January 31, (2)
----------------------- ----------------------
2007 2008 2007 2008
----------- ----------- ---------- -----------
Primary portfolio:
Installment $371,240 $414,558
Revolving 46,507 50,871
----------- -----------
Subtotal 417,747 465,429 $13,507 $12,429
Secondary portfolio:
Installment 116,749 141,202 3,896 4,989
----------- ----------- ---------- -----------
Total receivables managed 534,496 606,631 17,403 17,418
Less receivables sold 524,256 597,286 16,575 16,492
----------- ----------- ---------- -----------
Receivables not sold $10,240 $9,345 $828 $926
=========== =========== ========== ===========
(1) Amounts are based on end of period balances.
(2) Amounts represent total credit charge-offs, net of recoveries, on
total receivables. The higher level of net credit losses in the year
ended January 31, 2007, relative to the average balance outstanding,
is primarily a result of the impact on our credit operations of
Hurricane Rita that hit the Gulf Coast during September 2005.
4. Notes Payable and Long-Term Debt
At January 31, 2008, the Company had $47.6 million of its $50 million
revolving credit facility available for borrowings. The amounts utilized under
the revolving credit facility reflected $2.4 million related to letters of
credit issued. The letters of credit were issued under a $5.0 million sublimit
provided under the facility for standby letters of credit. Additionally, there
were no amounts outstanding under a short-term revolving bank agreement that
provides up to $8.0 million of availability on an unsecured basis. This
unsecured facility matures in June 2008 and has a floating rate of interest,
equal to Prime minus 50 basis points, which totaled 5.50% at January 31, 2008.
Long-term debt consists of the following (in thousands, except
repayment explanations):
January 31,
--------------------
2007 2008
--------- ----------
Revolving credit facility with interest at variable rates (4.15% at
January 31, 2008) $- $-
Promissory notes, due in monthly installments 198 119
--------- ----------
Total long-term debt 198 119
Less amounts due within one year (110) (102)
--------- ----------
Amounts classified as long-term $88 $17
========= ==========
The revolving facility is subject to the Company maintaining various
financial and non-financial covenants. In addition, the provisions of the bank
credit facility include a $50.0 million limit on the payment of dividends on the
Company's common stock and purchase of treasury stock. As of January 31, 2007
and January 31, 2008, the Company was in compliance with all financial and
non-financial covenants.
The current agreement provides for a revolving facility capacity of $50
million, with a $5 million letter of credit sublimit and an $8.0 million
sublimit for a swingline of credit. Interest rates are variable and are
determined, at the option of the Company, at the Base Rate (the greater of
Agent's prime rate or federal funds rate plus 0.50%) plus the Base Rate Margin
(which ranges from 0.00% to 0.50%) or LIBOR Rate plus the LIBOR Margin (which
ranges from 0.75% to 1.75%). Both the Base Rate Margin and the LIBOR Margin are
determined quarterly based on a debt coverage ratio equal to the rolling
four-quarter relationship of total debt (including lease obligations) to
earnings before interest, taxes, depreciation, amortization and rent. The
Company is obligated to pay a non-use fee on a quarterly basis on the
non-utilized portion of the revolving facility at rates ranging from .20% to
..375%. The revolving facility is secured by the assets of the Company not
otherwise encumbered and a pledge of substantially all of the stock of the
Company's present and future subsidiaries and matures in November 2010.
77
Interest expense incurred on notes payable and long-term debt totaled
$0.2, $0.4 and $0.5 million for the years ended January 31, 2006, 2007 and 2008,
respectively. The Company capitalized borrowing costs of $0.3 million during
each of the years ended January 31, 2007 and 2008. Aggregate maturities of
long-term debt as of January 31 in the year indicated are as follows (in
thousands):
2009 $ 102
2010 5
2011 5
2012 5
2013 2
-----------
Total $ 119
===========
5. Letters of Credit
The Company utilizes unsecured letters of credit to secure payments due
to the QSPE related to its asset-backed securitization program, deductibles
under the Company's insurance programs and international product purchases. At
January 31, 2007 and January 31, 2008, the Company had outstanding unsecured
letters of credit of $22.7 million and $23.5 million, respectively. These
letters of credit were issued under the three following facilities:
o The Company has a $5.0 million sublimit provided under its revolving
line of credit for stand-by and import letters of credit. At January
31, 2008, $2.4 million of letters of credit were outstanding and
callable at the option of the Company's insurance carrier if the
Company does not honor its requirement to fund deductible amounts as
billed under its insurance program.
o The Company has arranged for a $20.0 million stand-by letter of credit
to provide assurance to the trustee of the asset-backed securitization
program that funds collected by the Company, as the servicer, would be
remitted as required under the base indenture and other related
documents. The letter of credit has a term of one year and expires in
August 2008.
o The Company obtained a $10.0 million commitment for trade letters of
credit to secure product purchases under an international arrangement.
At January 31, 2008, there were $1.1 million of letters of credit
outstanding under this commitment. The letter of credit commitment has
a term of one year and expires in May 2008.
The maximum potential amount of future payments under these letter of
credit facilities is considered to be the aggregate face amount of each letter
of credit commitment, which total $35.0 million as of January 31, 2008.
6. Income Taxes
Deferred income taxes reflect the net effects of temporary timing
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's net deferred tax assets result primarily from
differences between financial and tax methods of accounting for income
recognition on service contracts and residual interests, capitalization of costs
in inventory, and deductions for depreciation and doubtful accounts, and the
fair value of derivatives.
78
The deferred tax assets and liabilities are summarized as follows (in
thousands):
January 31,
--------------------
2007 2008
-------- -----------
Deferred Tax Assets
Allowance for doubtful accounts and warranty and
insurance cancellations $431 $314
Deferred revenue 2,084 2,558
Stock-based compensation 606 1,033
Property and equipment 3,952 151
Inventories 1,177 1,327
Accrued vacation and other 1,459 1,501
-------- -----------
Total deferred tax assets 9,709 6,884
Deferred Tax Liabilities
Sales tax receivable (1,002) (1,026)
Interest in securitized assets (3,487) (1,430)
Goodwill (1,141) (1,372)
Other (608) (568)
-------- -----------
Total deferred tax liabilities (6,238) (4,396)
-------- -----------
Net Deferred Tax Asset $3,471 $2,488
======== ===========
Effective February 1, 2007, the Company adopted FASB Interpretation No.
48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB
Statement 109 (FIN 48). This statement clarifies the criteria that an individual
tax position must satisfy for some or all of the benefits of that position to be
recognized in a company's financial statements. FIN 48 prescribes a recognition
threshold of more-likely-than-not, and a measurement attribute for all tax
positions taken or expected to be taken on a tax return, in order to be
recognized in the financial statements. No cumulative adjustment was required to
effect the adoption of FIN 48 and the Company currently has no liability accrued
or potential penalties or interest recorded for uncertain tax positions. To the
extent penalties and interest are incurred, the Company records these charges as
a component of its Provision for income taxes. The Company is subject to U.S.
federal income tax as well as income tax in multiple state jurisdictions. Tax
returns for the fiscal years subsequent to January 31, 2005, remain open for
examination by the Company's major taxing jurisdictions.
Income taxes were impacted during the years ended January 31, 2007 and
2008, by the replacement of the existing franchise tax in Texas with a taxed
based on margin. Taxable margin is generally defined as total federal tax
revenues minus the greater of (a) cost of goods sold or (b) compensation. The
tax rate to be paid by retailer and wholesalers is 0.5% on taxable margin.
During June 2007, the Company completed a reorganization to simplify its legal
entity structure, by merging certain of its Texas limited partnerships into
their corporate partners. The reorganization also resulted in the one-time
elimination of the Texas margin tax owed by those partnerships, representing
virtually all of the margin tax owed by the Company. Accordingly, the Company
reversed approximately $0.9 million of accrued Texas margin tax as of June 2007,
net of federal tax. The Company began accruing the margin tax for the entities
that acquired the operations through the mergers in July 2007 and expects its
effective tax rate to be between 36.5% and 37.5% in future quarters.
Additionally, the acceleration of certain allowance for doubtful accounts
deductions resulted in a decrease in current tax expense and an increase in
deferred tax expense of $1.9 million in fiscal year 2007.
79
The significant components of income taxes were as follows (in
thousands):
Year Ended January 31,
---------------------------------
2006 2007 2008
---------- ---------- -----------
Current:
Federal $23,023 $22,439 $22,264
State 25 916 (8)
---------- ---------- -----------
Total current 23,048 23,355 22,256
Deferred:
Federal (701) (1,013) (728)
State (6) (67) (19)
---------- ---------- -----------
Total deferred (707) (1,080) (747)
---------- ---------- -----------
Total tax provision $22,341 $22,275 $21,509
========== ========== ===========
A reconciliation of the statutory tax rate and the effective tax rate for
each of the periods presented in the statements of operations is as follows:
Year Ended January 31,
-----------------------------
2006 2007 2008
--------- -------- --------
U.S. Federal statutory rate 35.0% 35.0% 35.0%
State and local income taxes, net of federal benefit 0.1 1.0 0.0
Non-deductible entertainment, tax-free interest income
and other 0.2 0.1 0.3
--------- -------- --------
Effective tax rate attributable to continuing operations 35.3% 36.1% 35.3%
Other (0.1) (0.5) (0.2)
--------- -------- --------
Effective tax rate 35.2% 35.6% 35.1%
========= ======== ========
7. Leases
The Company leases certain of its facilities and operating equipment from
outside parties and from a stockholder/officer. The real estate leases generally
have initial lease periods of from 5 to 15 years with renewal options at the
discretion of the Company; the equipment leases generally provide for initial
lease terms of three to seven years and provide for a purchase right by the
Company at the end of the lease term at the fair market value of the equipment.
The following is a schedule of future minimum base rental payments
required under the operating leases that have initial non-cancelable lease terms
in excess of one year (in thousands):
Third Related
Year Ended January 31, Party Party Total
---------------------------- ------------- ---------- -----------
2009 $20,073 $207 $20,280
2010 19,540 207 19,747
2011 18,339 207 18,546
2012 16,703 - 16,703
2013 14,672 - 14,672
Thereafter 64,235 - 64,235
------------- ---------- -----------
Total $153,562 $621 $154,183
============= ========== ===========
Total lease expense was approximately $15.7 million, $17.3 million and
$19.3 million for the years ended January 31, 2006, 2007 and 2008, respectively,
including approximately $0.2 million, $0.2 million and $0.2 million paid to
related parties, respectively.
Certain of our leases are subject to scheduled minimum rent increases or
escalation provisions, the cost of which is recognized on a straight-line basis
over the minimum lease term. Tenant improvement allowances, when granted by the
lessor, are deferred and amortized as contra-lease expense over the term of the
lease.
80
8. Share-Based Compensation
The Company originally approved an Incentive Stock Option Plan to be
granted to various officers and employees at prices equal to the market value on
the date of the grant. The options vest over one to five year periods (depending
on the grant) and expire ten years after the date of grant. As part of the
completion of the IPO in November 2003, the Company amended the Incentive Stock
Option Plan, adopted a Non-Employee Director Stock Option Plan, and adopted an
Employee Stock Purchase Plan. At the Company's annual meeting on May 31, 2006,
amendments to the stock option plans were approved, which increased the shares
available under the Incentive Stock Option Plan to 3,859,767 and increased the
shares available under the Non-Employee Director Stock Option Plan to 600,000.
On July 2, 2007, the Company issued six non-employee directors 60,000 total
options to acquire the Company's stock at $29.24 per share. At January 31, 2008,
the Company had 260,000 options available for grant under the Non-Employee
Director Stock Option Plan.
The Employee Stock Purchase Plan is available to a majority of the
employees of the Company and its subsidiaries, subject to minimum employment
conditions and maximum compensation limitations. At the end of each calendar
quarter, employee contributions are used to acquire shares of common stock at
85% of the lower of the fair market value of the common stock on the first or
last day of the calendar quarter. During the year ended January 31, 2006, 2007
and 2008, the Company issued 10,496, 11,720 and 13,316 shares of common stock,
respectively, to employees participating in the plan, leaving 1,222,889 shares
remaining reserved for future issuance under the plan as of January 31, 2008.
A summary of the Company's Incentive Stock Option Plan activity during
the year ended January 31, 2008 is presented below (shares in thousands):
Weighted
Weighted Average
Average Remaining Aggregate
Exercise Contractual Intrinsic
Shares Price Life (in years) Value
------------- --------------- -------------- ----------
Outstanding, beginning of year 1,755 $ 18.36
Granted 298 19.97
Exercised (211) (9.43)
Forfeited (142) (23.99)
-------------
Outstanding, end of year 1,700 $ 19.25 6.9 million
=============
Exercisable, end of year 891 5.2 million
=============
During the years ended January 31, 2006, 2007 and 2008, the Company
recognized total compensation cost for share-based compensation of approximately
$1.2 million, $1.7 million and $2.7 million, respectively, and recognized tax
benefits related to that compensation cost of approximately $0.2 million, $0.3
million, and $0.5 million, respectively.
The assumptions used in stock pricing model and valuation information for
the years ended January 31, 2006, 2007 and 2008 are as follows:
Year Ended January 31,
-------------------------------------------------
2006 2007 2008
---- ---- ----
Weighted average risk free interest rate................................. 3.9% 4.4% 3.6%
Weighted average expected lives in years ............................. 4.6 6.4 6.4
Weighted average volatility................................................. 32.0% 50.0% 45.0%
Expected dividends.......................................................... - - -
Weighted average grant date fair value of options granted
during the period..................................................... $ 11.09 $12.39 $ 9.94
Weighted average fair value of options vested during the
Period (1)............................................................ $ 4.82 $ 6.88 $ 8.17
Intrinsic value of options exercised during the period................ $ 4.8 million $ 3.9 million $ 3.1 million
(1) Does not include pre-IPO options that were valued using the minimum
value option-pricing method.
81
As provided by Staff Accounting Bulletin No. 107, and amended by Staff
Accounting Bulletin No. 110, which provides guidance relating to share-based
compensation accounting, the Company has used a shortcut method to compute the
weighted average expected life for the stock options granted in the years ended
January 31, 2007 and 2008. The shortcut method is an average based on the
vesting period and the contractual term. The Company uses the shortcut method
due to the lack of adequate historical experience or other comparable
information. The weighted average volatility for the years ended January 31,
2007 and 2008, was calculated using the average historical volatility of the
Company's peer group. As of January 31, 2008, the total compensation cost
related to non-vested awards not yet recognized totaled $8.6 million and is
expected to be recognized over a weighted average period of 3.5 years.
9. Significant Vendors
As shown in the table below, a significant portion of the Company's
merchandise purchases for years ended January 31, 2006, 2007 and 2008 were made
from six vendors:
Year Ended January 31,
--------------------------------
Vendor 2006 2007 2008
--------------------------------------- ---------- ---------- ----------
A 12.2 % 12.1 % 13.1 %
B 7.8 12.7 13.0
C 17.0 12.9 9.1
D 11.4 7.1 7.5
E 1.7 2.1 6.2
F 6.8 5.3 5.9
---------- ---------- ----------
Totals 56.9 % 52.2 % 54.8 %
========== ========== ==========
As part of a program to purchase product inventory from vendors overseas,
the Company had $1.1 million in obligations under stand-by letters of credit at
January 31, 2008.
10. Related Party Transactions
The Company leases one of its stores from its Chief Executive Officer and
Chairman of the Board, under the terms of a lease it entered prior to becoming a
publicly held company. It also leased six store locations from Specialized
Realty Development Services, LP (SRDS), a real estate development company that
was created prior to the Company's becoming publicly held and was owned by
various members of management and individual investors of Stephens Group, Inc.
The Stephens Group, Inc. is a significant shareholder of the Company. Based on
independent appraisals that were performed on each project that was completed,
the Company believes that the terms of the leases were at least comparable to
those that could be obtained in an arms' length transaction. As part of the
ongoing operation of SRDS, the Company received a management fee associated with
the administrative functions that were provided to SRDS of $6,500 for the year
ended January 31, 2006.
The Company engaged the services of Direct Marketing Solutions, Inc.
(DMS), for a substantial portion of its direct mail advertising. DMS, Inc. is
partially owned (less than 50%) by SF Holding Corp., members of the Stephens
family, Jon E. M. Jacoby, and Douglas H. Martin. SF Holding Corp. and the
members of the Stephens family are significant shareholders of the Company, and
Messrs. Jacoby and Martin are members of the Company's Board of Directors. The
fees the Company paid to DMS during the fiscal years ended 2006, 2007 and 2008,
amounted to approximately $2.1 million, $3.6 million and $2.5 million,
respectively. Thomas J. Frank, the Chief Executive Officer and Chairman of the
Board of Directors owned a small percentage (0.7%) at the end of fiscal year
2005, but divested his interest during the first half of fiscal year 2006.
The Company engaged the services of Stephens Inc. to act as its broker
under its stock repurchase program. Stephens Inc. is a shareholder of the
Company, and Doug Martin, an Executive Vice President of Stephens Inc., is a
member of the Company's Board of Directors. During the years ended January 31,
2007 and 2008, the Company incurred fees payable to Stephens Inc. of $5,040 and
$46,644, respectively, related to the purchase of 168,000 and 1,555,205 shares,
82
respectively, of its common stock. Based on a review of competitive bids
received from various broker candidates, the Company believes the terms of this
arrangement are no less favorable than it could have obtained in an arms' length
transaction.
11. Benefit Plans
The Company has established a defined contribution 401(k) plan for
eligible employees who are at least 21 years old and have completed at least
one-year of service. Employees may contribute up to 20% of their eligible pretax
compensation to the plan. The Company will match 100% of the first 3% of the
employees' contributions and 50% of the next 2% of the employees' contributions.
At its option, the Company may make supplemental contributions to the Plan, but
has not made such contributions in the past three years. The matching
contributions made by the company totaled $1.6, $1.8 and $2.1 million during the
years ended January 31, 2006, 2007 and 2008, respectively.
12. Contingencies
Legal Proceedings. The Company is involved in routine litigation
incidental to our business from time to time. Currently, the Company does not
expect the outcome of any of this routine litigation to have a material effect
on its financial condition or results of operations. However, the results of
these proceedings cannot be predicted with certainty, and changes in facts and
circumstances could impact the Company's estimate of reserves for litigation.
Insurance. Because of its inventory, vehicle fleet and general
operations, the Company has purchased insurance covering a broad variety of
potential risks. The Company purchases insurance polices covering general
liability, workers compensation, real property, inventory and employment
practices liability, among others. Additionally, the Company has umbrella
policies with an aggregate limit of $50.0 million. The Company has retained a
portion of the risk under these policies and its group health insurance program.
See additional discussion under Note 1. The Company has a $2.4 million letter of
credit outstanding supporting its obligations under the property and casualty
portion of its insurance program.
Service Maintenance Agreement Obligations. The Company sells service
maintenance agreements under which it is the obligor for payment of qualifying
claims. The Company is responsible for administering the program, including
setting the pricing of the agreements sold and paying the claims. The pricing is
set based on historical claims experience and expectations about future claims.
While the Company is unable to estimate maximum potential claim exposure, it has
a history of overall profitability upon the ultimate resolution of agreements
sold. The revenues related to the agreements sold are deferred at the time of
sales and recorded in revenues in the statement of operations over the life of
the agreements. The amounts deferred are reflected on the face of the balance
sheet in Deferred revenues and allowances, see also Note 1 for additional
discussion.
13. Subsequent Event
On March 26, 2008, the Company executed an amendment to its bank credit
facility, to increase the commitment from $50 million to $100 million, to
provide additional liquidity, if needed, to support its growth plans. In
addition to the expanded commitment, the interest margin added to the applicable
base rate was increased by 25 basis points. The maturity date did not change.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Based on management's evaluation (with the participation of our Chief
Executive Officer (CEO) and Chief Financial Officer (CFO)), as of the end of the
period covered by this report, our CEO and CFO have concluded that our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, as amended (the Exchange Act)), are
effective to ensure that information required to be disclosed by us in reports
that we file or submit under the Exchange Act is recorded, processed,
summarized, and reported within the time periods specified in SEC rules and
forms, and is accumulated and communicated to management, including our
principal executive officer and principal financial officer, as appropriate to
allow timely decisions regarding required disclosure.
83
Management's Report on Internal Control over Financial Reporting
Please refer to Management's Report on Internal Control over Financial
Reporting under Item 8 of this report.
Changes in Internal Controls Over Financial Reporting
There have been no changes in our internal controls over financial
reporting that occurred in the quarter ended January 31, 2008, which have
materially affected, or are reasonably likely to materially affect our internal
controls over financial reporting.
ITEM 9B. OTHER INFORMATION
Adoption of Bonus Program and Other Compensation Changes
On March 25, 2008, the Compensation Committee of our Board of Directors
adopted a cash bonus program for our 2009 fiscal year. Our named executive
officers, as well as certain other executive officers and certain employees, are
eligible to participate in the 2009 bonus program. Below is a description of the
2009 bonus program, as adopted by our Compensation Committee.
The purpose of the 2009 bonus program is to promote the interests of the
Company and its stockholders by providing key employees with financial rewards
upon achievement of specified business objectives, as well as help us attract
and retain key employees by providing attractive compensation opportunities
linked to performance results.
The Compensation Committee established four bonus levels for its 2009
bonus program: Level 1, Level 2, Level 3 and Level 4. Each of the levels
represent the attainment by us of certain operating pre-tax profit targets
established by the Compensation Committee (each, a "Profit Goal"). If we do not
achieve the Level 1 Profit Goal, each named executive officer, other executive
officer or employee awarded a bonus pursuant to the 2009 bonus program will
receive a prorata portion of the Level 1 Profit Goal, determined by the actual
pre tax profit as a percentage of the Level 1 Profit Level.
The bonuses that may become distributable based upon our achievement of
the Level 1 through Level 4 Profit Goals will be distributed by our Chief
Executive Officer with approval from the Compensation Committee.
Our Chief Executive Officer will receive a bonus under the 2009 bonus
program that varies based upon our achievement of the Level 1 through Level 4
Profit Goals. The Level 1 bonus amount for the Chief Executive Officer was
established based upon the Compensation Committee's independent evaluation of
his compensation relative to his effect on the Company's performance. The Level
2 bonus is 16.6% greater than the Level 1 bonus, the Level 3 bonus is 33.3%
greater than the Level 1 bonus and the Level 4 bonus is 50.0% greater than the
Level 1 bonus.
Our named executive officers, excluding our Chief Executive Officer,
certain other executive officers and certain employees will receive a bonus
under the 2009 bonus program that varies based upon our achievement of the Level
1 through Level 4 Profit Goals. The Level 1 bonus amount for each Participant
was established based upon the Compensation Committee's independent evaluation
of his or her relative effect on the Company's performance. The Level 2 bonus is
generally 30.8% greater than the Level 1 bonus, the Level 3 bonus is 64.1%
greater than the Level 1 bonus, and the Level 4 bonus is 100% greater than the
Level 1 bonus.
In addition, we established a contingency bonus pool under the 2009 bonus
program that varies based upon our achievement of the Level 1 through Level 4
Profit Goals and additional funds which may accrue for exceptional performance
beyond the Level 4 Profit Goal. The contingency bonus pool will be distributed
at the discretion of our Chairman and Chief Executive Officer with prior
approval from the Compensation Committee.
84
Payment of bonuses (if any) is normally made in February after the end of
the performance period during which the bonuses were earned. Except for certain
executive officers who have executive employment agreements, in order to be
eligible for a bonus under the 2009 bonus program, eligible participants must be
employed through the end of fiscal year ending January 31, 2009. Those executive
officers who have executive employment agreements with us are entitled to, under
certain situations, a prorata bonus if they resign or are terminated prior to
the completion of the fiscal year ended January 31, 2009.
Bonuses normally will be paid in cash in a single lump sum, subject to
payroll taxes and tax withholdings.
Effective April 1, 2008, the base salary of Michael J. Poppe, our chief
financial officer, was increased from $200,000 to $240,000.
PART III
The information required by Items 10 through 14 is included in our
definitive Proxy Statement relating to our 2008 Annual Meeting of Stockholders,
and is incorporated herein by reference.
CROSS REFERENCE TO ITEMS 10-14 LOCATED IN THE PROXY STATEMENT
Caption in the Conn's, Inc.
Item 2008 Proxy Statement
------------------------------------------ ------------------------------------------
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND BOARD OF DIRECTORS, EXECUTIVE OFFICERS
CORPORATE GOVERNANCE
ITEM 11. EXECUTIVE COMPENSATION EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL STOCK OWNERSHIP OF DIRECTORS, EXECUTIVE
OWNERS AND MANAGEMENT OFFICERS AND PRINCIPAL STOCKHOLDERS
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS AND DIRECTOR INDEPENDENCE TRANSACTIONS
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES INDEPENDENT PUBLIC ACCOUNTANTS
85
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) The following documents are filed as a part of this report:
(1) The financial statements listed in response to Item 8 of this
report are as follows:
Consolidated Balance Sheets as of January 31, 2007 and 2008
Consolidated Statements of Operations for the Years Ended January
31, 2006, 2007 and 2008
Consolidated Statements of Stockholders' Equity for the Years
Ended January 31, 2006, 2007 and 2008
Consolidated Statements of Cash Flows for the Years Ended January
31, 2006, 2007 and 2008
(2) Financial Statement Schedule: Report of Independent Auditors on
Financial Statement Schedule for the three years in the period
ended January 31, 2008; Schedule II -- Valuation and Qualifying
Accounts. The financial statement schedule should be read in
conjunction with the consolidated financial statements in our 2008
Annual Report to Stockholders. Financial statement schedules not
included in this report have been omitted because they are not
applicable or the required information is shown in the
consolidated financial statements or notes thereto.
(3) Exhibits: A list of the exhibits filed as part of this report is
set forth in the Index to Exhibits, which immediately precedes
such exhibits and is incorporated herein by reference.
86
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of l934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CONN'S, INC.
(Registrant)
/s/ Thomas J. Frank, Sr.,
-------------------------------
Date: March 27, 2008 Thomas J. Frank, Sr.
Chairman of the Board and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Thomas J. Frank, Sr. Chairman of the Board and
------------------------------------- Chief Executive Officer
Thomas J. Frank, Sr. (Principal Executive
Officer) March 27, 2008
/s/ Michael J. Poppe Chief Financial Officer
------------------------------------- (Principal Financial and
Michael J. Poppe Accounting Officer) March 27, 2008
/s/ Marvin D. Brailsford Director March 27, 2008
-------------------------------------
Marvin D. Brailsford
/s/ Jon E. M. Jacoby Director March 27, 2008
-------------------------------------
Jon E. M. Jacoby
/s/ Bob L. Martin Director March 27, 2008
------------------------------------
Bob L. Martin
/s/ Douglas H. Martin Director March 27, 2008
------------------------------------
Douglas H. Martin
/s/ Dr. William C. Nylin, Jr. Executive Vice Chairman March 27, 2008
------------------------------------
Dr. William C. Nylin, Jr.
/s/ Scott L. Thompson Director March 27, 2008
------------------------------------
Scott L. Thompson
/s/ William T. Trawick Director March 27, 2008
------------------------------------
William T. Trawick
/s/ Theodore M. Wright Director March 27, 2008
------------------------------------
Theodore M. Wright
87
EXHIBIT INDEX
Exhibit
Number Description
------ -----------
2 Agreement and Plan of Merger dated January 15, 2003, by and among
Conn's, Inc., Conn Appliances, Inc. and Conn's Merger Sub, Inc.
(incorporated herein by reference to Exhibit 2 to Conn's, Inc.
registration statement on Form S-1 (file no. 333-109046) as filed
with the Securities and Exchange Commission on September 23,
2003).
3.1 Certificate of Incorporation of Conn's, Inc. (incorporated herein
by reference to Exhibit 3.1 to Conn's, Inc. registration statement
on Form S-1 (file no. 333-109046) as filed with the Securities and
Exchange Commission on September 23, 2003).
3.1.1 Certificate of Amendment to the Certificate of Incorporation of
Conn's, Inc. dated June 3, 2004 (incorporated herein by reference
to Exhibit 3.1.1 to Conn's, Inc. Form 10-Q for the quarterly
period ended April 30, 2004 (File No. 000-50421) as filed with the
Securities and Exchange Commission on June 7, 2004).
3.2 Bylaws of Conn's, Inc. (incorporated herein by reference to
Exhibit 3.2 to Conn's, Inc. registration statement on Form S-1
(file no. 333-109046) as filed with the Securities and Exchange
Commission on September 23, 2003).
3.2.1 Amendment to the Bylaws of Conn's, Inc. (incorporated herein by
reference to Exhibit 3.2.1 to Conn's Form 10-Q for the quarterly
period ended April 30, 2004 (File No. 000-50421) as filed with the
Securities and Exchange Commission on June 7, 2004).
3.2.2 Amendment to the Bylaws of Conn's, Inc. effective as of December
18, 2007 (incorporated by reference to Exhibit 3.1 to Conn's, Inc.
Current Report on Form 8-K as filed with the Securities and
Exchange Commission on December 18, 2007.
4.1 Specimen of certificate for shares of Conn's, Inc.'s common stock
(incorporated herein by reference to Exhibit 4.1 to Conn's, Inc.
registration statement on Form S-1 (file no. 333-109046) as filed
with the Securities and Exchange Commission on October 29, 2003).
10.1 Amended and Restated 2003 Incentive Stock Option Plan
(incorporated herein by reference to Exhibit 10.1 to Conn's, Inc.
registration statement on Form S-1 (file no. 333-109046) as filed
with the Securities and Exchange Commission on September 23,
2003).t
10.1.1 Amendment to the Conn's, Inc. Amended and Restated 2003 Incentive
Stock Option Plan (incorporated herein by reference to Exhibit
10.1.1 to Conn's Form 10-Q for the quarterly period ended April
30, 2004 (File No. 000-50421) as filed with the Securities and
Exchange Commission on June 7, 2004).t
10.1.2 Form of Stock Option Agreement (incorporated herein by reference
to Exhibit 10.1.2 to Conn's, Inc. Form 10-K for the annual period
ended January 31, 2005 (File No. 000-50421) as filed with the
Securities and Exchange Commission on April 5, 2005).t
10.2 2003 Non-Employee Director Stock Option Plan (incorporated herein
by reference to Exhibit 10.2 to Conn's, Inc. registration
statement on Form S-1 (file no. 333-109046)as filed with the
Securities and Exchange Commission on September 23, 2003).t
10.2.1 Form of Stock Option Agreement (incorporated herein by reference
to Exhibit 10.2.1 to Conn's, Inc. Form 10-K for the annual period
ended January 31, 2005 (File No. 000-50421) as filed with the
Securities and Exchange Commission on April 5, 2005).t
88
10.3 Employee Stock Purchase Plan (incorporated herein by reference to
Exhibit 10.3 to Conn's, Inc. registration statement on Form S-1
(file no. 333-109046) as filed with the Securities and Exchange
Commission on September 23, 2003).t
10.4 Conn's 401(k) Retirement Savings Plan (incorporated herein by
reference to Exhibit 10.4 to Conn's, Inc. registration statement
on Form S-1 (file no. 333-109046) as filed with the Securities and
Exchange Commission on September 23, 2003).t
10.5 Shopping Center Lease Agreement dated May 3, 2000, by and between
Beaumont Development Group, L.P., f/k/a Fiesta Mart, Inc., as
Lessor, and CAI, L.P., as Lessee, for the property located at 3295
College Street, Suite A, Beaumont, Texas (incorporated herein by
reference to Exhibit 10.5 to Conn's, Inc. registration statement
on Form S-1 (file no. 333-109046) as filed with the Securities and
Exchange Commission on September 23, 2003).
10.5.1 First Amendment to Shopping Center Lease Agreement dated September
11, 2001, by and among Beaumont Development Group, L.P., f/k/a
Fiesta Mart, Inc., as Lessor, and CAI, L.P., as Lessee, for the
property located at 3295 College Street, Suite A, Beaumont, Texas
(incorporated herein by reference to Exhibit 10.5.1 to Conn's,
Inc. registration statement on Form S-1 (file no. 333-109046) as
filed with the Securities and Exchange Commission on September 23,
2003).
10.6 Industrial Real Estate Lease dated June 16, 2000, by and between
American National Insurance Company, as Lessor, and CAI, L.P., as
Lessee, for the property located at 8550-A Market Street, Houston,
Texas (incorporated herein by reference to Exhibit 10.6 to Conn's,
Inc. registration statement on Form S-1 (file no. 333-109046) as
filed with the Securities and Exchange Commission on September 23,
2003).
10.6.1 First Renewal of Lease dated November 24, 2004, by and between
American National Insurance Company, as Lessor, and CAI, L.P., as
Lessee, for the property located at 8550-A Market Street, Houston,
Texas (incorporated herein by reference to Exhibit 10.6.1 to
Conn's, Inc. Form 10-K for the annual period ended January 31,
2005 (File No. 000-50421) as filed with the Securities and
Exchange Commission on April 5, 2005).
10.7 Lease Agreement dated December 5, 2000, by and between Prologis
Development Services, Inc., f/k/a The Northwestern Mutual Life
Insurance Company, as Lessor, and CAI, L.P., as Lessee, for the
property located at 4810 Eisenhauer Road, Suite 240, San Antonio,
Texas (incorporated herein by reference to Exhibit 10.7 to Conn's,
Inc. registration statement on Form S-1 (file no. 333-109046) as
filed with the Securities and Exchange Commission on September 23,
2003).
10.7.1 Lease Amendment No. 1 dated November 2, 2001, by and between
Prologis Development Services, Inc., f/k/a The Northwestern Mutual
Life Insurance Company, as Lessor, and CAI, L.P., as Lessee, for
the property located at 4810 Eisenhauer Road, Suite 240, San
Antonio, Texas (incorporated herein by reference to Exhibit 10.7.1
to Conn's, Inc. registration statement on Form S-1 (file no.
333-109046) as filed with the Securities and Exchange Commission
on September 23, 2003).
10.8 Lease Agreement dated June 24, 2005, by and between Cabot
Properties, Inc. as Lessor, and CAI, L.P., as Lessee, for the
property located at 1132 Valwood Parkway, Carrollton, Texas
(incorporated herein by reference to Exhibit 99.1 to Conn's, Inc.
Current Report on Form 8-K (file no. 000-50421) as filed with the
Securities and Exchange Commission on June 29, 2005).
10.9 Credit Agreement dated October 31, 2005, by and among Conn
Appliances, Inc. and the Borrowers thereunder, the Lenders party
thereto, JPMorgan Chase Bank, National Association, as
Administrative Agent, Bank of America, N.A., as Syndication Agent,
and SunTrust Bank, as Documentation Agent (incorporated herein by
reference to Exhibit 10.9 to Conn's, Inc. Quarterly Report on Form
10-Q (file no. 000-50421) as filed with the Securities and
Exchange Commission on December 1, 2005).
89
10.9.1 Letter of Credit Agreement dated November 12, 2004 by and between
Conn Appliances, Inc. and CAI Credit Insurance Agency, Inc., the
financial institutions listed on the signature pages thereto, and
JPMorgan Chase Bank, as Administrative Agent (incorporated herein
by reference to Exhibit 99.2 to Conn's Inc. Current Report on Form
8-K (File No. 000-50421) as filed with the Securities and Exchange
Commission on November 17, 2004).
10.9.2 First Amendment to Credit Agreement dated August 28, 2006 by and
between Conn Appliances, Inc. and CAI Credit Insurance Agency,
Inc., the financial institutions listed on the signature pages
thereto, and JPMorgan Chase Bank, as Administrative Agent
(incorporated herein by reference to Exhibit 10.1 to Conn's Inc.
Current Report on Form 8-K (File No. 000-50421) as filed with the
Securities and Exchange Commission on August 28, 2006).
10.9.3 Second Amendment to Credit Agreement dated March 26, 2008 by and
among Conn Appliances, Inc. and CAI Credit Insurance Agency, Inc.,
the financial institutions listed on the signature pages thereto,
and JPMorgan Chase Bank, as Administrative Agent (filed herewith).
10.10 Receivables Purchase Agreement dated September 1, 2002, by and
among Conn Funding II, L.P., as Purchaser, Conn Appliances, Inc.
and CAI, L.P., collectively as Originator and Seller, and Conn
Funding I, L.P., as Initial Seller (incorporated herein by
reference to Exhibit 10.10 to Conn's, Inc. registration statement
on Form S-1 (file no. 333-109046) as filed with the Securities and
Exchange Commission on September 23, 2003).
10.10.1 First Amendment to Receivables Purchase Agreement dated August 1,
2006, by and among Conn Funding II, L.P., as Purchaser, Conn
Appliances, Inc. and CAI, L.P., collectively as Originator and
Seller (incorporated herein by reference to Exhibit 10.10.1 to
Conn's, Inc. Form 10-Q for the quarterly period ended July 31,
2006 (File No. 000-50421) as filed with the Securities and
Exchange Commission on September 15, 2006).
10.11 Base Indenture dated September 1, 2002, by and between Conn
Funding II, L.P., as Issuer, and Wells Fargo Bank Minnesota,
National Association, as Trustee (incorporated herein by reference
to Exhibit 10.11 to Conn's, Inc. registration statement on Form
S-1 (file no. 333-109046) as filed with the Securities and
Exchange Commission on September 23, 2003).
10.11.1 First Supplemental Indenture dated October 29, 2004 by and between
Conn Funding II, L.P., as Issuer, and Wells Fargo Bank, National
Association, as Trustee (incorporated herein by reference to
Exhibit 99.1 to Conn's, Inc. Current Report on Form 8-K (File No.
000-50421) as filed with the Securities and Exchange Commission on
November 4, 2004).
10.11.2 Second Supplemental Indenture dated August 1, 2006 by and between
Conn Funding II, L.P., as Issuer, and Wells Fargo Bank, National
Association, as Trustee (incorporated herein by reference to
Exhibit 99.1 to Conn's, Inc. Current Report on Form 8-K (File No.
000-50421) as filed with the Securities and Exchange Commission on
August 23, 2006).
10.12 Amended and Restated Series 2002-A Supplement dated September 10,
2007, by and between Conn Funding II, L.P., as Issuer, and Wells
Fargo Bank, National Association, as Trustee (incorporated herein
by reference to Exhibit 99.2 to Conn's, Inc. Current Report on
Form 8-K (File No. 000-50421) as filed with the Securities and
Exchange Commission on September 11, 2007).
10.12.1 Amended and Restated Note Purchase Agreement dated September 10,
2007 by and between Conn Funding II, L.P., as Issuer, and Wells
Fargo Bank, National Association, as Trustee (incorporated herein
by reference to Exhibit 99.3 to Conn's, Inc. Current Report on
Form 8-K (File No. 000-50421) as filed with the Securities and
Exchange Commission on September 11, 2007).
90
10.13 Series 2002-B Supplement to Base Indenture dated September 1,
2002, by and between Conn Funding II, L.P., as Issuer, and Wells
Fargo Bank Minnesota, National Association, as Trustee
(incorporated herein by reference to Exhibit 10.13 to Conn's, Inc.
registration statement on Form S-1 (file no. 333-109046) as filed
with the Securities and Exchange Commission on September 23,
2003).
10.13.1 Amendment to Series 2002-B Supplement dated March 28, 2003, by and
between Conn Funding II, L.P., as Issuer, and Wells Fargo Bank
Minnesota, National Association, as Trustee (incorporated herein
by reference to Exhibit 10.13.1 to Conn's, Inc. Form 10-K for the
annual period ended January 31, 2005 (File No. 000-50421) as filed
with the Securities and Exchange Commission on April 5, 2005).
10.14 Servicing Agreement dated September 1, 2002, by and among Conn
Funding II, L.P., as Issuer, CAI, L.P., as Servicer, and Wells
Fargo Bank Minnesota, National Association, as Trustee
(incorporated herein by reference to Exhibit 10.14 to Conn's, Inc.
registration statement on Form S-1 (file no. 333-109046) as filed
with the Securities and Exchange Commission on September 23,
2003).
10.14.1 First Amendment to Servicing Agreement dated June 24, 2005, by and
among Conn Funding II, L.P., as Issuer, CAI, L.P., as Servicer,
and Wells Fargo Bank, National Association, as Trustee
(incorporated herein by reference to Exhibit 10.14.1 to Conn's,
Inc. Form 10-Q for the quarterly period ended July 31, 2005 (File
No. 000-50421) as filed with the Securities and Exchange
Commission on August 30, 2005).
10.14.2 Second Amendment to Servicing Agreement dated November 28, 2005,
by and among Conn Funding II, L.P., as 10.14.2 Issuer, CAI, L.P.,
as Servicer, and Wells Fargo Bank, National Association, as
Trustee (incorporated herein by reference to Exhibit 10.14.2 to
Conn's, Inc. Form 10-Q for the quarterly period ended July 31,
2005 (File No. 000-50421) as filed with the Securities and
Exchange Commission on August 30, 2005).
10.14.3 Third Amendment to Servicing Agreement dated May 16, 2006, by and
among Conn Funding II, L.P., as Issuer, CAI, L.P., as Servicer,
and Wells Fargo Bank, National Association, as Trustee
(incorporated herein by reference to Exhibit 10.14.3 to Conn's,
Inc. Form 10-Q for the quarterly period ended July 31, 2006 (File
No. 000-50421) as filed with the Securities and Exchange
Commission on September 15, 2006).
10.14.4 Fourth Amendment to Servicing Agreement dated August 1, 2006, by
and among Conn Funding II, L.P., as Issuer, CAI, L.P., as
Servicer, and Wells Fargo Bank, National Association, as Trustee
(incorporated herein by reference to Exhibit 10.14.4 to Conn's,
Inc. Form 10-Q for the quarterly period ended July 31, 2006 (File
No. 000-50421) as filed with the Securities and Exchange
Commission on September 15, 2006).
10.15 Form of Executive Employment Agreement (incorporated herein by
reference to Exhibit 10.15 to Conn's, Inc. registration statement
on Form S-1 (file no. 333-109046) as filed with the Securities and
Exchange Commission on October 29, 2003).t
10.15.1 First Amendment to Executive Employment Agreement between Conn's,
Inc. and Thomas J. Frank, Sr., Approved by the stockholders May
26, 2005 (incorporated herein by reference to Exhibit 10.15.1 to
Conn's, Inc. Form 10-Q for the quarterly period ended July 31,
2005 (file No. 000-50421) as filed with the Securities and
Exchange Commission on August 30, 2005).t
10.16 Form of Indemnification Agreement (incorporated herein by
reference to Exhibit 10.16 to Conn's, Inc. registration statement
on Form S-1 (file no. 333-109046) as filed with the Securities and
Exchange Commission on September 23, 2003).t
91
10.17 Description of Compensation Payable to Non-Employee Directors
(incorporated herein by reference to Form 8-K (file no. 000-50421)
filed with the Securities and Exchange Commission on June 2,
2005).t
10.18 Dealer Agreement between Conn Appliances, Inc. and Voyager Service
Programs, Inc. effective as of January 1, 1998 (incorporated
herein by reference to Exhibit 10.19 to Conn's, Inc. Form 10-K for
the annual period ended January 31, 2006 (File No. 000-50421) as
filed with the Securities and Exchange Commission on March 30,
2006).
10.18.1 Amendment #1 to Dealer Agreement by and among Conn Appliances,
Inc., CAI, L.P., Federal Warranty Service Corporation and Voyager
Service Programs, Inc. effective as of July 1, 2005 (incorporated
herein by reference to Exhibit 10.19.1 to Conn's, Inc. Form 10-K
for the annual period ended January 31, 2006 (File No. 000-50421)
as filed with the Securities and Exchange Commission on March 30,
2006).
10.18.2 Amendment #2 to Dealer Agreement by and among Conn Appliances,
Inc., CAI, L.P., Federal Warranty Service Corporation and Voyager
Service Programs, Inc. effective as of July 1, 2005 (incorporated
herein by reference to Exhibit 10.19.2 to Conn's, Inc. Form 10-K
for the annual period ended January 31, 2006 (File No. 000-50421)
as filed with the Securities and Exchange Commission on March 30,
2006).
10.18.3 Amendment #3 to Dealer Agreement by and among Conn Appliances,
Inc., CAI, L.P., Federal Warranty Service Corporation and Voyager
Service Programs, Inc. effective as of July 1, 2005 (incorporated
herein by reference to Exhibit 10.19.3 to Conn's, Inc. Form 10-K
for the annual period ended January 31, 2006 (File No. 000-50421)
as filed with the Securities and Exchange Commission on March 30,
2006).
10.18.4 Amendment #4 to Dealer Agreement by and among Conn Appliances,
Inc., CAI, L.P., Federal Warranty Service Corporation and Voyager
Service Programs, Inc. effective as of July 1, 2005 (incorporated
herein by reference to Exhibit 10.19.4 to Conn's, Inc. Form 10-K
for the annual period ended January 31, 2006 (File No. 000-50421)
as filed with the Securities and Exchange Commission on March 30,
2006).
10.18.5 Amendment #5 to Dealer Agreement by and among Conn Appliances,
Inc., CAI, L.P., Federal Warranty Service Corporation and Voyager
Service Programs, Inc. effective as of April 7, 2007 (incorporated
herein by reference to Exhibit 10.18.5 to Conn's, Inc. Form 10-Q
for the quarterly period ended July 31, 2007 (File No. 000-50421)
as filed with the Securities and Exchange Commission on August 30,
2007).
10.19 Service Expense Reimbursement Agreement between Affiliates
Insurance Agency, Inc. and American Bankers Life Assurance Company
of Florida, American Bankers Insurance Company Ranchers & Farmers
County Mutual Insurance Company, Voyager Life Insurance Company
and Voyager Property and Casualty Insurance Company effective July
1, 1998 (incorporated herein by reference to Exhibit 10.20 to
Conn's, Inc. Form 10-K for the annual period ended January 31,
2006 (File No. 000-50421) as filed with the Securities and
Exchange Commission on March 30, 2006).
10.19.1 First Amendment to Service Expense Reimbursement Agreement by and
among CAI, L.P., Affiliates Insurance Agency, Inc., American
Bankers Life Assurance Company of Florida, Voyager Property &
Casualty Insurance Company, American Bankers Life Assurance
Company of Florida, American Bankers Insurance Company of Florida
and American Bankers General Agency, Inc. effective July 1, 2005
(incorporated herein by reference to Exhibit 10.20.1 to Conn's,
Inc. Form 10-K for the annual period ended January 31, 2006 (File
No. 000-50421) as filed with the Securities and Exchange
Commission on March 30, 2006).
92
10.20 Service Expense Reimbursement Agreement between CAI Credit
Insurance Agency, Inc. and American Bankers Life Assurance Company
of Florida, American Bankers Insurance Company Ranchers & Farmers
County Mutual Insurance Company, Voyager Life Insurance Company
and Voyager Property and Casualty Insurance Company effective July
1, 1998 (incorporated herein by reference to Exhibit 10.21 to
Conn's, Inc. Form 10-K for the annual period ended January 31,
2006 (File No. 000-50421) as filed with the Securities and
Exchange Commission on March 30, 2006).
10.20.1 First Amendment to Service Expense Reimbursement Agreement by and
among CAI Credit Insurance Agency, Inc., American Bankers Life
Assurance Company of Florida, Voyager Property & Casualty
Insurance Company, American Bankers Life Assurance Company of
Florida, American Bankers Insurance Company of Florida, American
Reliable Insurance Company, and American Bankers General Agency,
Inc. effective July 1, 2005 (incorporated herein by reference to
Exhibit 10.21.1 to Conn's, Inc. Form 10-K for the annual period
ended January 31, 2006 (File No. 000-50421) as filed with the
Securities and Exchange Commission on March 30, 2006).
10.21 Consolidated Addendum and Amendment to Service Expense
Reimbursement Agreements by and among Certain Member Companies of
Assurant Solutions, CAI Credit Insurance Agency, Inc. and
Affiliates Insurance Agency, Inc. effective April 1, 2004
(incorporated herein by reference to Exhibit 10.22 to Conn's, Inc.
Form 10-K for the annual period ended January 31, 2006 (File No.
000-50421) as filed with the Securities and Exchange Commission on
March 30, 2006).
10.22 Series 2006-A Supplement to Base Indenture, dated August 1, 2006,
by and between Conn Funding II, L.P., as Issuer, and Wells Fargo
Bank, National Association, as Trustee (incorporated herein by
reference to Exhibit 10.23 to Conn's, Inc. Form 10-Q for the
quarterly period ended July 31, 2006 (File No. 000-50421) as filed
with the Securities and Exchange Commission on September 15,
2006).
10.23 Fourth Amended and Restated Subordination and Priority Agreement,
dated August 31, 2006, by and among Bank of America, N.A. and
JPMorgan Chase Bank, as Agent, and Conn Appliances, Inc. and/or
its subsidiary CAI, L.P (incorporated herein by reference to
Exhibit 10.24 to Conn's, Inc. Form 10-Q for the quarterly period
ended October 31, 2006 (File No. 000-50421) as filed with the
Securities and Exchange Commission on November 30, 2006).
10.23.1 Fourth Amended and Restated Security Agreement, dated August 31,
2006, by and among Conn Appliances, Inc. and CAI, L.P. and Bank of
America, N.A (incorporated herein by reference to Exhibit 10.24.1
to Conn's, Inc. Form 10-Q for the quarterly period ended October
31, 2006 (File No. 000-50421) as filed with the Securities and
Exchange Commission on November 30, 2006).
10.24 Letter of Credit and Reimbursement Agreement, dated September 1,
2002, by and among CAI, L.P., Conn Funding II, L.P. and SunTrust
Bank (incorporated herein by reference to Exhibit 10.25 to Conn's,
Inc. Form 10-Q for the quarterly period ended October 31, 2006
(File No. 000-50421) as filed with the Securities and Exchange
Commission on November 30, 2006).
10.24.1 Amendment to Standby Letter of Credit dated August 23, 2006, by
and among CAI, L.P., Conn Funding II, L.P. and SunTrust Bank
(incorporated herein by reference to Exhibit 10.25.1 to Conn's,
Inc. Form 10-Q for the quarterly period ended October 31, 2006
(File No. 000-50421) as filed with the Securities and Exchange
Commission on November 30, 2006).
10.24.2 Amendment to Standby Letter of Credit dated September 20, 2006, by
and among CAI, L.P., Conn Funding II, L.P. and SunTrust Bank
(incorporated herein by reference to Exhibit 10.25.2 to Conn's,
Inc. Form 10-Q for the quarterly period ended October 31, 2006
(File No. 000-50421) as filed with the Securities and Exchange
Commission on November 30, 2006).
11.1 Statement re: computation of earnings per share is included under
Note 1 to the financial statements.
21 Subsidiaries of Conn's, Inc. (incorporated herein by reference to
Exhibit 21 to Conn's, Inc. Form 10-Q for the quarterly period
ended July 31, 2007 (File No. 000-50421) as filed with the
Securities and Exchange Commission on August 30, 2007).
23.1 Consent of Ernst & Young LLP (filed herewith).
31.1 Rule 13a-14(a)/15d-14(a) Certification (Chief Executive Officer)
(filed herewith).
93
31.2 Rule 13a-14(a)/15d-14(a) Certification (Chief Financial Officer)
(filed herewith).
32.1 Section 1350 Certification (Chief Executive Officer and Chief
Financial Officer) (furnished herewith).
99.1 Subcertification by Executive Vice-Chairman of the Board in
support of Rule 13a-14(a)/15d-14(a) Certification (Chief Executive
Officer) (filed herewith).
99.2 Subcertification by Chief Operating Officer in support of Rule
13a-14(a)/15d-14(a) Certification (Chief Executive Officer) (filed
herewith).
99.3 Subcertification by Treasurer in support of Rule
13a-14(a)/15d-14(a) Certification (Chief Financial Officer) (filed
herewith).
99.4 Subcertification by Secretary in support of Rule
13a-14(a)/15d-14(a) Certification (Chief Financial Officer) (filed
herewith).
99.5 Subcertification of Executive Vice-Chairman of the Board, Chief
Operating Officer, Treasurer and Secretary in support of Section
1350 Certifications (Chief Executive Officer and Chief Financial
Officer) (furnished herewith).
t Management contract or compensatory plan or arrangement.
94
Schedule II-Valuation and Qualifying Accounts
Conn's, Inc.
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Col A Col B Col C Col D Col E
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Additions
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Charged
Balance at Charged to to Other Balance
Beginning of Costs and Accounts- Deductions- at End of
Description Period Expenses Describe Describe(1) Period
------------------------------------------------------------------------------------------------------------------------
Year ended January 31, 2006
Reserves and allowances from asset accounts:
Allowance for doubtful accounts 2,211 1,133 - (2,430) 914
Year ended January 31, 2007
Reserves and allowances from asset accounts:
Allowance for doubtful accounts 914 1,476 - (1,569) 821
Year ended January 31, 2008
Reserves and allowances from asset accounts:
Allowance for doubtful accounts 821 1,908 - (1,769) 960
1 Uncollectible accounts written off, net of recoveries