SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2004

Commission file number: 0-24091

     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 o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No o

     Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

TWEETER HOME ENTERTAINMENT GROUP, INC. AND SUBSIDIARIES

INDEX

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Tweeter Home Entertainment Group, Inc. and Subsidiaries
Consolidated Balance Sheets

See notes to unaudited consolidated financial statements.

3

Tweeter Home Entertainment Group, Inc. and Subsidiaries
Consolidated Statements of Operations
(Unaudited)

See notes to unaudited consolidated financial statements.

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Tweeter Home Entertainment Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows

See notes to unaudited consolidated financial statements.

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TWEETER HOME ENTERTAINMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1.    Basis of Presentation

     The unaudited condensed consolidated financial statements of Tweeter Home Entertainment Group, Inc. and its subsidiaries (“Tweeter” or the “Company”), included herein, should be read in conjunction with the consolidated financial statements and notes thereto included in Tweeter’s Annual Report on Form 10-K for the fiscal year ended September 30, 2003.

2.    Accounting Policies

     The unaudited condensed consolidated financial statements of Tweeter have been prepared in accordance with accounting principles generally accepted in the United States of America. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of the interim consolidated financial statements have been included. Operating results for the nine-month period ended June 30, 2004 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2004. Tweeter typically records its highest revenue and earnings in its first fiscal quarter.

     Vendor Allowances, Allowance for Bad and Doubtful Accounts — Accounts receivable are primarily due from the vendors from which the Company buys its product. The various types of accounts receivable are for purchase rebate allowances, cooperative advertising allowances, returned merchandise and warranty work performed by the Company’s service departments.

     Cash discounts earned for timely payments of merchandise invoices are recognized in the income statement upon the sale of the related inventory.

     Purchase rebate allowances and general cooperative advertising allowances are earned based on the purchase of inventory and are recorded in accounts receivable when the inventory is purchased. The carrying value of inventory is initially reduced by the amount of purchase rebates earned, resulting in lower cost of goods sold when the inventory is sold. Certain vendor agreements include stretch goals where the level of funds earned is dependent upon the Company achieving certain purchase levels. These program funds are recorded as a reduction of inventory costs when it is determined that it is likely that the Company will achieve the goal.

     Vendor allowances earned based on specific advertising activities and other activities are recognized as a reduction to advertising expense as these activities are performed and only to the extent that the cost of the activities equals or exceeds the amount of the allowances.

     When the Company returns merchandise to a vendor, typically because it is defective, the Company records a receivable for the value of the merchandise returned and reduces the inventory balance.

     The Company sells products that come with a manufacturer’s warranty, but the Company has service centers that repair products. When the Company repairs products that are still under a manufacturer’s warranty, the vendor reimburses the Company for the parts and the technician’s labor. Once the product is repaired, the Company establishes a receivable for the amounts due from the vendor and records warranty revenue.

     During the quarter ended March 31, 2003, Tweeter adopted EITF 02-16, “Accounting by a Customer for Certain Consideration Received from a Vendor” (“EITF 02-16”) which addresses how and when to reflect consideration received from vendors in the consolidated financial statements. Under EITF 02-16, certain consideration received from vendors that would have previously been recorded as a reduction to selling expenses, is now recorded as a reduction to cost of goods sold. The amount of reimbursements received during the nine months and three months ended June 30, 2004 that were treated as a reduction of cost of goods sold but which would have been recorded as a reduction of advertising expenses (selling expenses) prior to EITF 02-16 amounted to $27.0 million and $8.5 million, respectively. The amount of reimbursements received during both the nine and three months ended June 30, 2003 that were treated as a reduction of cost of goods sold but which would have been recorded as a reduction of advertising expenses (selling expenses) prior to EITF 02-16 amounted to $5.7 million.

     Advertising — Gross advertising including electronic media, newspaper, buyer’s guides and direct mailings, are expensed when released. Cooperative advertising funds specific to advertising activities received from vendors reduce our gross advertising expense.

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Below are the gross expense, cooperative funds received and net advertising for the three and nine months ended June 30, 2003 and 2004.

     Stock-based compensation — Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, addresses the financial accounting and reporting standards for stock or other equity-based compensation arrangements. The Company accounts for stock based compensation to employees using the intrinsic method. The Company provides disclosures based on the fair value as permitted by SFAS No. 123. Stock or other equity-based compensation for non-employees must be accounted for under the fair value-based method as required by SFAS No. 123 and EITF No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, and other related interpretations. Under this method, the equity-based instrument is valued at either the fair value of the consideration received or the equity instrument issued on the date of grant. The resulting compensation cost is recognized and charged to operations over the service period, which is usually the vesting period.

     For purposes of determining the disclosures required by SFAS No. 123, the fair value of each stock option granted in the three and nine months ended June 30, 2003 and June 30, 2004 under the Company’s stock option plan was estimated on the date of grant using the Black-Scholes option-pricing model. Key assumptions used to apply this pricing model were as follows:

     Had compensation cost for the Company’s stock option plans been determined using the fair value method, pro forma net income and pro forma diluted earnings per share would have been:

3.    Earnings per Share

     The weighted average shares used in computing basic and diluted net income per share are presented in the table below. Certain options are not included in the earnings per share calculation when the exercise price is greater than the average market price for the period or when the Company has a net loss, in which case all options would be anti-dilutive. The number of options excluded in each period is reflected in the table.

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4.    Comprehensive Income

     Comprehensive loss for the three and nine months ended June 30, 2003 and June 30, 2004 was as follows:

5.    Intangible Assets

     The financial information for acquired intangible assets is as follows:

     For the nine months ended June 30, 2003 and 2004, the aggregate amortization expense was $510,000 in each period. For each of the fiscal years 2004 through 2005, the amortization expense is estimated to be approximately $680,000 and for fiscal year 2006, the amortization expense is estimated to be approximately $567,000.

6.    Related-Party Transactions

     On June 30, 2003, Tweeter made an additional investment in Tivoli Audio, LLC, a manufacturer of consumer electronic products, which increased its ownership to 25%. The Company accounts for this investment in Tivoli under the equity method of accounting, recognizing the Company’s share of Tivoli’s income or loss in the Company’s statement of income. For the nine months ended June 30, 2003 and June 30, 2004 the Company purchased $1.1 million and $833,000, respectively, of product from Tivoli. Dividends received from Tivoli amounted to $426,000 and $647,000 for the nine months ended June 30, 2003 and June 30, 2004, respectively. Amounts payable to Tivoli were $39,800 and $52,700 at June 30, 2003 and June 30, 2004, respectively.

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7.    Reclassifications

     Certain 2003 reclassifications have been made to conform to the 2004 presentation.

8.    Subsequent Events

     On July 1, 2004, Tweeter completed the acquisition of Sumarc Electronics Incorporated d/b/a NOW! AudioVideo (“NOW!”), by acquiring all of its outstanding capital stock. This transaction will be accounted for as a purchase and, accordingly, the results of operations of the Company’s business relating to NOW! will be included in the consolidated statements of income from the acquisition date. The total purchase price was approximately $4.6 million of which $3.8 million was paid in cash and $800,000 was paid through the issuance of 133,824 shares of the Company’s common stock.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

INTRODUCTION

     Tweeter Home Entertainment Group, Inc. (“Tweeter” or the “Company”) is a specialty retailer of mid- to high-end audio and video consumer electronics products. Tweeter currently operates 175 stores under the Tweeter, HiFi Buys, Sound Advice, Bang & Olufsen, Electronic Interiors, Showcase Home Entertainment and Hillcrest names in the New England, Mid-Atlantic, Southeast, Texas, Southern California, Chicago, Florida and Phoenix markets.

RESULTS OF OPERATIONS

THREE MONTHS ENDED JUNE 30, 2004 AS COMPARED TO THREE MONTHS ENDED JUNE 30, 2003

     Total Revenue. Total revenue includes delivered merchandise, labor, net commissions on service contracts sold, completed service center work orders, insurance replacement and corporate sales. Total revenue decreased $1.9 million, or 1.1%, to $168.6 million for the three months ended June 30, 2004 from $170.5 million for the three months ended June 30, 2003. Comparable store sales decreased $3.3 million, or 2.1%. Comparable store sales are a term we use to compare the year-over-year sales performance of our stores. A store is included in the comparable store sales base after it is in operation for 12 full months. An acquired store is included after 12 full months from the date of acquisition. Remodeled or relocated stores are excluded from the comparable store base until they have competed 12 full months of operation from the date the remodeling was completed or the store re-opened after relocation. In addition, to offset the decrease in comparable store sales, $722,000 of sales were generated from new stores that have not been opened for a twelve-month period and are therefore not yet includable in the comparable store sales base. There was also a decrease in sales of $1.3 million related to stores that closed. In addition, our corporate sales/insurance replacement sales increased by $1.4 million. For the quarter ended June 30, 2004, flat panel television sales grew to 20.8% of total sales compared to 15.7% for the quarter ended June 30, 2003. For the quarter ended June 30, 2004, plasma televisions were 73.9% of the flat panel category’s dollars and 50.6% of the units sold. The television monitors category decreased to 3.3% of revenue from 6.7% of revenue for the quarters ended June 30, 2004 and June 30, 2003, respectively. The projection television category increased to 18.3% of revenue from 17.4% of revenue for the quarters ended June 30, 2004 and June 30, 2003, respectively. Home installation labor revenue grew to 4.1% of revenues during the quarter ended June 30, 2004 from 3.1% during the quarter ended June 30, 2003.

     Cost of Sales and Gross Profit. Cost of sales includes merchandise costs, net delivery costs, distribution costs, home installation labor costs, purchase discount and vendor allowances. Cost of sales decreased $4.3 million, or 4.0%, to $102.8 million for the three months ended June 30, 2004 from $107.1 million for the three months ended June 30, 2003. Gross profit increased $2.4 million, or 3.8%, to $65.8 million for the three months ended June 30, 2004 from $63.4 million for the three months ended June 30, 2003. The gross margin percentage increased 180 basis points to 39.0% for the three months ended June 30, 2004 from 37.2% for the three months ended June 30, 2003. The quarters ended June 30, 2004 and 2003 include $8.5 million and $5.7 million, respectively, that were recorded as a reduction to cost of goods sold that would have previously been recorded as a reduction of selling expenses prior to the adoption of EITF 02-16 during the quarter ended March 31, 2003. The reclassification moved certain vendor allowances out of cooperative advertising (selling expenses) and into vendor rebates (cost of sales). Without the reclassification, the gross margin percentage for the quarter ended June 30, 2004 would have been 34.0%, an increase of 20 basis points from the prior year. Overall margins, excluding vendor allowances, distribution and labor costs, increased by 20 basis points. Vendor allowances increased by 20 basis points, excluding the EITF 02-16 reclassification. Distribution costs decreased by 45 basis points, mainly attributable to lower compensation costs, and labor costs increased by 20 basis points.

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     Selling Expenses. Selling expenses include the compensation of store personnel and store specific support functions, occupancy costs, store level depreciation, advertising, pre-opening expenses and bank service fees. Selling expenses increased $3.6 million, or 6.1%, to $62.2 million for the three months ended June 30, 2004 from $58.6 million for the three months ended June 30, 2003. As a percentage of revenue, selling expenses increased to 36.9% for the three months ended June 30, 2004 from 34.4% for the three months ended June 30, 2003. The quarters ended June 30, 2004 and 2003 include a reclassification of $8.5 million and $5.7 million,