Attached files
file | filename |
---|---|
8-K - FORM 8-K - CONNS INC | h74249e8vk.htm |
EX-99.2 - EX-99.2 - CONNS INC | h74249exv99w2.htm |
EX-99.1 - EX-99.1 - CONNS INC | h74249exv99w1.htm |
EX-23.1 - EX-23.1 - CONNS INC | h74249exv23w1.htm |
EX-99.4 - EX-99.4 - CONNS INC | h74249exv99w4.htm |
EX-12.1 - EX-12.1 - CONNS INC | h74249exv12w1.htm |
Exhibit 99.3
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis of our financial condition and results of
operations in conjunction with our consolidated financial statements and related notes included as
Exhibit 99.4 to this Current Report on Form 8-K.
This report includes statements that express our opinions, expectations, beliefs, plans,
objectives, assumptions or projections regarding future events or future results, and therefore
are, or may be deemed to be, forward-looking statements. These forward-looking statements can
generally be identified by the use of forward-looking terminology, including the terms believes,
estimates, anticipates, expects, estimates, seeks, projects, intends, plans, may,
will or should or, in each case, their negative or other variations or comparable terminology.
These forward-looking statements include all matters that are not historical facts.
By their nature, forward-looking statements involve risks and uncertainties because they relate to
events and depend on circumstances that may or may not occur in the future. We believe that these
risks and uncertainties include, but are not limited to:
| our inability to maintain compliance with debt covenant requirements, including taking the actions necessary to maintain compliance with the covenants, such as obtaining amendments to the borrowing facilities that modify the covenant requirements, which could result in higher borrowing costs; | ||
| reduced availability under our revolving credit facility as a result of borrowing base requirements and the impact on the borrowing base calculation of changes in the performance or eligibility of the customer receivables financed by that facility; | ||
| 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 existing markets; | ||
| our ability to open and profitably operate new stores in existing, adjacent and new geographic markets; | ||
| our intention to update or expand existing stores; | ||
| our ability to introduce additional product categories; | ||
| our ability to obtain capital for required capital expenditures and costs related to the opening of new stores or to update, relocate or expand existing stores; | ||
| our ability to fund our operations, capital expenditures, debt repayment and expansion from cash flows from operations, borrowings from our revolving line of credit and proceeds from securitizations, and proceeds from accessing debt or equity markets; | ||
| our ability to obtain additional funding for the purpose of funding the customer receivables generated by us, including limitations on our ability to obtain financing through our commercial paper-based funding sources and our ability to maintain the current credit rating issued by a recognized statistical rating organization; | ||
| our ability to renew or replace our revolving credit facility on or before its maturity date; | ||
| the cost or terms of any amended, renewed or replacement credit facilities; | ||
| the ability of the financial institutions to provide lending facilities to us and fund their commitments; |
- 1 -
| the effect of any downgrades by rating agencies on our borrowing costs; | ||
| the effect on our borrowing cost of changes in laws and regulations affecting the providers of debt financing; | ||
| the effect of rising interest rates or borrowing spreads that could increase our cost of borrowing or reduce securitization income; | ||
| the effect of rising interest rates or other economic conditions on mortgage borrowers that could impair our customers ability to make payments on outstanding credit accounts; | ||
| our inability to make customer financing programs available that allow consumers to purchase products at levels that can support our growth and maintain profitable operations; | ||
| the potential for deterioration in the delinquency status of our credit portfolio or higher than historical net charge-offs in the customer receivables portfolio could adversely impact earnings; | ||
| technological and market developments, growth trends and projected sales in the home appliance and consumer electronics industry, including, with respect to digital products like Blu-ray players, HDTV, LED and 3-D televisions, GPS devices, home networking devices and other new products, and our ability to capitalize on such growth; | ||
| the potential for price erosion or lower unit sales points that could result in declines in revenues; | ||
| the effect of changes in oil and gas prices that 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; | ||
| the ability to attract and retain qualified personnel; | ||
| 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; | ||
| changes in laws and regulations and/or interest, premium and commission rates allowed by regulators on our credit, credit insurance, repair service and product replacement agreements as allowed by those laws and regulations; | ||
| our relationships with key suppliers and their ability to provide products at competitive prices and support sales of their products through their rebate and discount programs; | ||
| the adequacy of our distribution and information systems and management experience to support our expansion plans; | ||
| the accuracy of our expectations regarding competition and our competitive advantages; | ||
| changes in our stock price or the number of shares we have outstanding; | ||
| the potential for market share erosion that could result in reduced revenues; | ||
| the accuracy of our expectations regarding the similarity or dissimilarity of our existing markets as compared to new markets we enter; | ||
| the use of third parties to complete certain of our distribution, delivery and home repair services; | ||
| general economic conditions in the regions in which we operate; and |
- 2 -
| the outcome of litigation or government investigations affecting our business. |
Additional important factors that could cause our actual results to differ materially from our
expectations are discussed under Risk Factors in our Annual Report on Form 10-K. These factors
should not be construed as exhaustive and should be read with the other cautionary statements in
this report.
Although we base these forward-looking statements on assumptions that we believe are reasonable
when made, we caution you that forward-looking statements are not guarantees of future performance
and that our actual results of operations, financial condition and liquidity, and the development
of the industry in which we operate may differ materially from those made in or suggested by the
forward-looking statements contained in this report. In addition, even if our results of
operations, financial condition and liquidity, and the development of the industry in which we
operate are consistent with the forward-looking statements contained in this report, those results
or developments may not be indicative of results or developments in subsequent periods.
Given these risks and uncertainties, you are cautioned not to place undue reliance on these
forward-looking statements. Any forward-looking statements which we make in this report speak only
as of the date of such statement, and we do not undertake, and specifically decline, any obligation
to update such statements or to publicly announce the results of any revisions to any such
statements to reflect future events or developments. Comparisons of results for current and any
prior periods are not intended to express any future trends or indications of future performance,
unless expressed as such, and should only be viewed as historical data.
- 3 -
General
We intend the following discussion and analysis to provide you with a better understanding of
the financial condition and performance of our retail and credit segments for 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 76 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, repair service 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
Conns name, after our founders 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.
Our management evaluates performance and allocates resources based on
the operating results of its retail and credit segments.
The five cornerstones of our business which represent, in our view, the five components of our
business model that drive profitability are strong merchandising systems, flexible credit
options for our customers, extensive warehousing and distribution systems, service systems 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 our Business discussion included as Exhibit 99.1 to this Current Report on Form 8-K.
We derive the majority of our revenues from our product sales and repair service agreement
commissions, which are generated by sales of third-party and company-obligor repair service
agreements and product replacement policies. However, unlike many of our competitors, we provide
in-house credit options for our customers product purchases. Additionally, we derive a portion of
our revenues from the sale of credit insurance products of third-party insurers to our customers.
In the last three years, we have financed, on average, approximately 61% of our retail sales
through our 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. In addition to interest-bearing installment and
revolving charge contracts, at times, we offer promotional credit programs to certain of our
primary credit portfolio customers that provide for same as cash or deferred interest
interest-free periods of varying terms, generally three, six, 12, 18, 24 and 36 months, and require
monthly payments beginning in the month after the sale. In turn, we finance substantially all of
our customer receivables from these credit options through our revolving credit facility and an
asset-backed securitization facility. In addition to our own credit programs, we use third-party
financing programs to provide a portion of the non-interest bearing financing for purchases made by
our customers. As part of our asset-backed securitization facility, we have created a
bankruptcy-remote variable interest entity, which we refer to as the VIE, to purchase customer
receivables from us and to issue medium-term and variable funding notes secured by the customer
receivables to finance its acquisition of the customer receivables. We transfer eligible customer
receivables, consisting of retail installment and revolving account receivables extended to our
customers, to the VIE in exchange for cash and subordinated securities. The VIE is consolidated in
our financial statements. Customer receivables not sold to the VIE have been funded by our
revolving credit facility.
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.
- 4 -
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.
Customer accounts receivable.
Customer accounts receivable reported in our consolidated balance sheet include receivables
transferred to our VIE and those receivables not transferred to our VIE. We include the amount of
principal and accrued interest on those receivables that are expected to be collected within the
next twelve months, based on contractual terms, in current assets on our consolidated balance
sheet. Those amounts expected to be collected after twelve months, based on contractual terms, are
included in long-term assets. Typically, a receivable is considered delinquent if a payment has not
been received on the scheduled due date. Additionally, we offer reage programs to customers with
past due balances that have experienced a financial hardship, if they meet the conditions of our
reage policy. Reaging a customers account can result in updating it from a delinquent status to a
current status. 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 for
doubtful accounts and interest accrued subsequent to the last payment will be reversed. We have a
secured interest in the merchandise financed by these receivables and therefore have the
opportunity to recover a portion of any charged-off amount.
Interest income on customer accounts receivable.
Interest income is accrued using the Rule of 78s method for installment contracts and the
simple interest method for revolving charge accounts, and is reflected in Finance charges and
other. Typically, interest income is accrued until the contract or account is paid off or
charged-off and we provide an allowance for estimated uncollectible interest. Interest income is
recognized on our interest-free promotional accounts based on our historical experience related to
customers who fail to satisfy the requirements of the interest-free programs. Additionally, for
sales on deferred interest and same as cash programs that exceed one year in duration, we
discount the sales to their fair value, resulting in a reduction in sales and receivables, and
amortize the discount amount in to Finance charges and other over the term of the program.
Allowance for doubtful accounts.
We record an allowance for doubtful accounts, including estimated uncollectible interest, for
our Customer accounts receivable, based on our historical net loss experience and expectations for
future losses. The net charge-off data used in computing the loss rate is reduced by the amount of
post-charge-off recoveries received, including cash payments, and amounts realized from the
repossession of the products financed and, at times, payments received under credit insurance
policies. Additionally, we separately evaluate the Primary and Secondary portfolios when estimating
the allowance for doubtful accounts. The balance in the allowance for doubtful accounts and
uncollectible interest for customer receivables was $26.9 million and $35.8 million, at January 31,
2009, and 2010, respectively. Additionally, as a result of our practice of reaging customer
accounts, if the account is not ultimately collected, the timing and amount of the charge-off is
impacted. If these accounts had been charged-off sooner the net loss rates might have been higher.
Reaged customer receivable balances represented 19.6% of the total portfolio balance at January 31,
2010. If the loss rate used to calculate the allowance for doubtful accounts was increased by 10%
at January 31, 2010, we would have increased our Provision for bad debts by approximately $3.6
million for fiscal 2010.
- 5 -
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 and discounts of
promotional credit sales that will extend beyond one year. We sell repair service agreements and
credit insurance contracts on behalf of unrelated third parties. For contracts where the third
parties are the obligors on the contract, commissions are recognized in revenues at the time of
sale, and in the case of retrospective commissions, at the time that they are earned. Where we sell
repair service renewal agreements in which we are deemed to be the obligor on the contract at the
time of sale, revenue is recognized ratably, on a straight-line basis, over the term of the repair
service agreement. These repair service agreements are renewal contracts that provide our customers
protection against product repair costs arising after the expiration of the manufacturers warranty
and the third party obligor contracts. These agreements typically have terms ranging from 12 to 36
months. These agreements are separate units of accounting and are valued based on the agreed upon
retail selling price. The amount of repair service agreement revenues deferred at January 31, 2009
and 2010 were $7.2 million and $7.3 million, respectively, and are included in Deferred revenues
and allowances in the accompanying consolidated balance sheets. The amounts of repair service
agreement revenue recognized for the fiscal years ended January 31, 2008, 2009 and 2010 were $5.7
million, $6.5 million and $7.0 million, respectively.
Vendor allowances.
We receive funds from vendors for price protection, product rebates (earned upon purchase or
sale of product), marketing, training and promotion programs which are recorded on the accrual
basis as a reduction to the related product cost, cost of goods sold, compensation expense 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 directly related to promotion, marketing or compensation expense
paid related to the product, the allowances, credits, or payments are recorded as a reduction of
the applicable expense in the period in which the expense is incurred. We received $36.1 million,
$46.2 million and $51.3 million in vendor allowances during the fiscal years ended January 31,
2008, 2009 and 2010, respectively, of which $6.6 million, $6.4 million and $5.1 million,
respectively, represented advertising assistance allowances. The increase in fiscal year 2010 was
due to increased use of instant rebates by vendors to drive sales. Over the past three years we
have received funds from approximately 50 vendors, with the terms of the programs ranging between
one month and one year.
Accounting for leases.
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.
Year ended January 31, 2009 compared to the year ended January 31, 2010
Executive overview
This overview is intended to provide an executive level overview of our operations for our
fiscal year ended January 31, 2010. Our performance during fiscal 2010 was impacted by the
slowdown in the
- 6 -
economy and rising unemployment in our markets that occurred during the year. Following are
significant financial items in managements view:
| Our revenues for the fiscal year ended January 31, 2010, decreased by 8.7%, or $83.9 million, from fiscal year 2009, to $875.6 million due primarily to a decline in product sales and related reduction in repair service agreement commissions. Sales declined during the year largely as a result of the slowdown in the economic conditions in our markets, reduced average selling prices for televisions and were also impacted by tighter credit underwriting standards implemented during the year to improve the credit quality of our consumer receivable portfolio. Our same store sales declined 13.8% in the fiscal year ended January 31, 2010, as compared to an increase of 2.0% for fiscal 2009, with the sharpest decline occurring in the fourth quarter, when same store sales fell 31.7%. | ||
| The addition of stores in our existing Dallas/Fort Worth, Houston, Southeast and South Texas markets and the opening of three stores in Oklahoma in fiscal 2009 had a positive impact on our revenues. We achieved approximately $20.3 million of increases in product sales and repair service agreement (RSA) commissions for the year ended January 31, 2010, from the opening of nine new stores in these markets since February 2008. While we have no current plans to open additional stores, we have additional sites under consideration for future development and continue to evaluate our store opening plans for future periods, provided we have adequate capital availability. | ||
| 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, 2010, $130.7 million, or 19.6%, of our product sales were financed by deferred interest and same as cash plans. We have been able to reduce the volume of promotional credit as a percent of product sales, as compared to the prior year. For the comparable period in the prior year, product sales financed by deferred interest and same as cash sales were $155.8 million, or 21.0%. 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. During the fiscal year ended January 31, 2010, we began offering promotional credit programs through third-party consumer credit programs, which financed $15.3 million of our product and repair service agreement sales during the year. | ||
| Finance charges and other decreased 1.1% for the fiscal year ended January 31, 2010, when compared to the same period last year, primarily due to a decline in insurance commissions and retrospective commissions on our repair service agreements, which offset a slight increase in interest income and other fees. | ||
| Our gross margin, defined as total revenues less cost of goods and parts sold, was 37.8% for fiscal 2010, a decrease from 38.5% in fiscal 2009, primarily as a result of: |
o | reduced gross margin realized on product sales from 22.0% in the year ended January 31, 2009, to 19.9% in fiscal year 2010, which negatively impacted the total gross margin by 150 basis points. The product gross margins were negatively impacted by a highly price-competitive retail market and our successful strategy early in the fiscal year to grow market share through competitive pricing, and | ||
o | a change in the revenue mix in the year ended January 31, 2010, such that higher gross margin finance charge and other revenues contributed a larger percentage of total revenues, partially offset by reduced revenue contribution from repair service agreement commissions, which contributed a smaller percentage of total revenues, and resulted in an increase in the total gross margin of approximately 80 basis points. |
| During the fiscal year ended January 31, 2010, Selling, general and administrative (SG&A) expense increased as a percent of revenues to 29.2% from 26.5% in the prior year period, primarily due to the litigation reserves we established to reflect our best estimate of the amount we expect will be required to settle outstanding litigation as well as the increase in expenses |
- 7 -
related to the new stores opened during the prior fiscal year and the general de-leveraging effect of the decline in same store sales. | |||
| During the fiscal year ended January 31, 2010, we determined, as a result of the sustained decline in our market capitalization, the increasingly challenging economic environment and its impact on our comparable store sales, credit portfolio performance and operating results, that an interim goodwill impairment test was necessary. A two-step method was utilized for determining goodwill impairment. Our valuation was performed utilizing the services of outside valuation consultants using both an income approach utilizing our discounted debt-free cash flows and comparable valuation multiples. Upon completion of the impairment test, we concluded that the carrying value of our recorded goodwill was impaired. As a result, we recorded a goodwill impairment charge of $9.6 million to write-off the carrying value of our goodwill during the three month period ended October 31, 2009. | ||
| The provision for bad debts increased to $36.8 million in fiscal 2010, from $28.0 million in the prior year. This increase is due to higher actual and expected net credit charge-offs on customer receivables. Actual net charge-offs increased approximately $6.6 million, or 29.4%, in fiscal 2010, compared to fiscal 2009. As a result of the recent credit portfolio performance and expectations about future net charge-offs, the bad debt and uncollectible interest reserves for customer receivables were increased, as a percent of the customer receivable balance, to 5.0% at January 31, 2010, from 3.6% at January 31, 2009. | ||
| Net interest expense decreased in fiscal 2010, due primarily to reduced outstanding debt balances. | ||
| The provision for income taxes was negatively impacted by the effect of the taxes for the state of Texas, which are based on gross margin, instead of income before taxes. |
Operational changes and outlook
We have implemented, continued to focus on, or modified operating initiatives that we believe
will positively impact future results, including:
| Increased emphasis on sales of furniture and mattresses by enhancing our product offerings and displays; | ||
| Increased emphasis on improving gross margin; and | ||
| Adjusted credit underwriting guidelines to improve the credit quality and profitability of our in-house credit programs. |
During the year, we opened one new store in the Houston market and one in the Dallas/Fort
Worth market and closed two of our clearance centers, one in the Houston market and one in the San
Antonio market. We have additional areas under consideration for future store locations and
continue to evaluate our store opening plans for future periods, provided we have adequate capital
availability.
In order to improve the credit quality of our credit portfolio and reduce the amount of
capital used in our credit operations, we reduced the amount of credit granted as a percentage of
sales during the past fiscal year. Additionally, as a result of these changes, we have seen the mix
between the primary and secondary customer receivables portfolios shift to a greater proportion of
the customer receivables being in the higher quality primary portfolio.
While we benefited from our operations being concentrated in the Texas, Louisiana and Oklahoma
region in the earlier months of 2009, recent weakness in the national and state economies,
including instability in the financial markets, declining consumer confidence and the volatility of
oil prices, have and will present significant challenges to our operations in the coming quarters.
Specifically, future sales volumes, gross profit margins and credit portfolio performance could be
negatively impacted, and thus impact our overall profitability. Additionally, declines in our
future operating performance could impact compliance with our credit facility covenants, which we
recently renegotiated to avoid potentially triggering the default provisions of our credit
facilities. As a result, while we will strive to maintain our market share, improve credit
portfolio performance and reduce expenses, we will also work to maintain our access to the
liquidity necessary to maintain our operations through these challenging times.
- 8 -
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, | ||||||||||||
2008 | 2009 | 2010 | ||||||||||
Revenues: |
||||||||||||
Product sales |
77.2 | % | 77.5 | % | 76.2 | % | ||||||
Repair service agreement commissions (net) |
4.2 | 4.2 | 3.8 | |||||||||
Service revenues |
2.6 | 2.2 | 2.5 | |||||||||
Total net sales |
84.0 | 83.9 | 82.5 | |||||||||
Finance charges and other |
16.0 | 16.1 | 17.5 | |||||||||
Total revenues |
100.0 | 100.0 | 100.0 | |||||||||
Cost and expenses: |
||||||||||||
Cost of goods sold, including warehousing
and occupancy costs |
58.4 | 60.5 | 61.0 | |||||||||
Cost of parts sold, including warehousing
and occupancy costs |
1.0 | 1.0 | 1.2 | |||||||||
Selling, general and administrative expense |
28.2 | 26.5 | 29.2 | |||||||||
Goodwill impairment |
0.0 | 0.0 | 1.1 | |||||||||
Provision for bad debts |
2.2 | 2.9 | 4.2 | |||||||||
Total costs and expenses |
89.8 | 90.9 | 96.7 | |||||||||
Operating income |
10.2 | 9.1 | 3.3 | |||||||||
Interest expense |
2.9 | 2.5 | 2.4 | |||||||||
Other (income) expense |
(0.1 | ) | 0.0 | 0.0 | ||||||||
Earnings before income taxes |
7.4 | 6.6 | 0.9 | |||||||||
Provision for income taxes |
2.6 | 2.4 | 0.5 | |||||||||
Net income |
4.8 | % | 4.2 | % | 0.4 | % | ||||||
Analysis of consolidated statements of operations
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.
The following table presents certain operations information, on a consolidated and segment
basis, in dollars and percentage changes from year to year:
Total Consolidated:
2009 vs. 2008 | 2010 vs. 2009 | |||||||||||||||||||||||||||
Year Ended January 31, | Incr/(Decr) | Incr/(Decr) | ||||||||||||||||||||||||||
(in thousands except percentages) | 2008 | 2009 | 2010 | Amount | Pct | Amount | Pct | |||||||||||||||||||||
Revenues |
||||||||||||||||||||||||||||
Product sales |
$ | 671,571 | $ | 743,729 | $ | 667,401 | $ | 72,158 | 10.7 | % | $(76,328 | ) | (10.3 | )% | ||||||||||||||
Repair service agreement
commissions (net) |
36,424 | 40,199 | 33,272 | 3,775 | 10.4 | (6,927 | ) | (17.2 | ) | |||||||||||||||||||
Service revenues |
22,997 | 21,121 | 22,115 | (1,876 | ) | (8.2 | ) | 994 | 4.7 | |||||||||||||||||||
Total net sales |
730,992 | 805,049 | 722,788 | 74,057 | 10.1 | (82,261 | ) | (10.2 | ) | |||||||||||||||||||
Finance charges and other |
139,538 | 154,492 | 152,797 | 14,954 | 10.7 | (1,695 | ) | (1.1 | ) | |||||||||||||||||||
Total revenues |
870,530 | 959,541 | 875,585 | 89,011 | 10.2 | (83,956 | ) | (8.7 | ) | |||||||||||||||||||
Cost and expenses |
||||||||||||||||||||||||||||
Cost of goods and parts sold |
517,166 | 590,061 | 544,700 | 72,895 | 14.1 | (45,361 | ) | (7.7 | ) | |||||||||||||||||||
Gross Profit |
353,364 | 369,480 | 330,885 | 16,116 | 4.6 | (38,595 | ) | (10.4 | ) | |||||||||||||||||||
Gross Margin |
40.6 | % | 38.5 | % | 37.8 | % | ||||||||||||||||||||||
Selling, general and administrative expense |
233,633 | 241,631 | 241,930 | 7,998 | 3.4 | 299 | 0.1 | |||||||||||||||||||||
Depreciation and amortization |
12,128 | 12,541 | 14,012 | 413 | 3.4 | 1,471 | 11.7 | |||||||||||||||||||||
Goodwill impairment |
| | 9,617 | | N/A | 9,617 | N/A |
- 9 -
2009 vs. 2008 | 2010 vs. 2009 | |||||||||||||||||||||||||||
Year Ended January 31, | Incr/(Decr) | Incr/(Decr) | ||||||||||||||||||||||||||
(in thousands except percentages) | 2008 | 2009 | 2010 | Amount | Pct | Amount | Pct | |||||||||||||||||||||
Provision for bad debts |
19,465 | 27,952 | 36,843 | 8,487 | 43.6 | 8,891 | 31.8 | |||||||||||||||||||||
Operating income |
88,138 | 87,356 | 28,483 | (782 | ) | (0.9 | ) | (58,873 | ) | (67.4 | ) | |||||||||||||||||
Operating Margin |
10.1 | % | 9.1 | % | 3.3 | % | ||||||||||||||||||||||
Interest expense |
24,839 | 23,597 | 20,571 | (1,242 | ) | (5.0 | ) | (3,026 | ) | (12.8 | ) | |||||||||||||||||
Other (income) expense |
(943 | ) | 117 | (123 | ) | 1,060 | (112.4 | ) | (240 | ) | (205.1 | ) | ||||||||||||||||
Pretax Income |
64,242 | 63,642 | 8,035 | (600 | ) | (0.9 | ) | (55,607 | ) | (87.4 | ) | |||||||||||||||||
Provision for income taxes |
22,575 | 23,624 | 4,111 | 1,049 | 4.6 | (19,513 | ) | (82.6 | ) | |||||||||||||||||||
Net Income |
$ | 41,667 | $ | 40,018 | $ | 3,924 | $(1,649 | ) | (4.0 | )% | $(36,094 | ) | (90.2 | )% | ||||||||||||||
Retail Segment:
2009 vs. 2008 | 2010 vs. 2009 | |||||||||||||||||||||||||||
Year Ended January 31, | Incr/(Decr) | Incr/(Decr) | ||||||||||||||||||||||||||
(in thousands except percentages) | 2008 | 2009 | 2010 | Amount | Pct | Amount | Pct | |||||||||||||||||||||
Revenues |
||||||||||||||||||||||||||||
Product sales |
$ | 671,571 | $ | 743,729 | $ | 667,401 | $ | 72,158 | 10.7 | % | $(76,328 | ) | (10.3 | )% | ||||||||||||||
Repair service agreement
commissions (net) (a) |
44,735 | 50,778 | 44,119 | 6,043 | 13.5 | (6,659 | ) | (13.1 | ) | |||||||||||||||||||
Service revenues |
22,997 | 21,121 | 22,115 | (1,876 | ) | (8.2 | ) | 994 | 4.7 | |||||||||||||||||||
Total net sales |
739,303 | 815,628 | 733,635 | 76,325 | 10.3 | (81,993 | (10.1 | ) | ||||||||||||||||||||
Finance charges and other |
950 | 2,161 | 532 | 1,211 | 127.5 | (1,629 | ) | (75.4 | ) | |||||||||||||||||||
Total revenues |
740,253 | 817,789 | 734,167 | 77,536 | 10.5 | (83,622 | ) | (10.2 | ) | |||||||||||||||||||
Cost and expenses |
||||||||||||||||||||||||||||
Cost of goods and parts sold |
517,166 | 590,061 | 544,700 | 72,895 | 14.1 | (45,361 | ) | (7.7 | ) | |||||||||||||||||||
Gross Profit |
223,087 | 227,728 | 189,467 | 4,641 | 2.1 | (38,261 | ) | (16.8 | ) | |||||||||||||||||||
Gross Margin |
30.1 | % | 27.8 | % | 25.8 | % | ||||||||||||||||||||||
Selling, general and administrative
expense (b) |
179,354 | 182,703 | 180,911 | 3,349 | 1.9 | (1,792 | ) | (1.0 | ) | |||||||||||||||||||
Depreciation and amortization |
11,331 | 11,218 | 12,288 | (113 | ) | (1.0 | ) | (1,070 | 9.5 | |||||||||||||||||||
Provision for bad debts |
190 | 160 | 97 | (30 | ) | (15.8 | ) | (63 | ) | (39.4 | ) | |||||||||||||||||
Operating income (loss) |
32,212 | 33,647 | (3,829 | ) | 1,435 | 4.5 | (37,476 | ) | (111.4 | ) | ||||||||||||||||||
Operating Margin |
4.4 | % | 4.1 | % | (0.5 | )% | ||||||||||||||||||||||
Other (income) expense |
(943 | ) | 117 | (123 | ) | 1,060 | (112.4 | ) | (240 | ) | (205.1 | ) | ||||||||||||||||
Segment income (loss) before income
taxes |
$ | 33,155 | $ | 33,530 | $(3,706 | ) | $ | 375 | 1.1 | % | $(37,236 | ) | 111.1 | % | ||||||||||||||
Credit Segment:
2009 vs. 2008 | 2010 vs. 2009 | |||||||||||||||||||||||||||
Year Ended January 31, | Incr/(Decr) | Incr/(Decr) | ||||||||||||||||||||||||||
(in thousands except percentages) | 2008 | 2009 | 2010 | Amount | Pct | Amount | Pct | |||||||||||||||||||||
Revenues |
||||||||||||||||||||||||||||
Repair service agreement
commissions (net) (a) |
$ | (8,311 | ) | $ | (10,579 | ) | $ | (10,847 | ) | $ | (2,268 | ) | (27.3 | )% | $ | (268 | ) | (2.5 | )% | |||||||||
Total net sales |
(8,311 | ) | (10,579 | ) | (10,847 | ) | (2,268 | ) | (27.3 | ) | (268 | ) | (2.5 | ) | ||||||||||||||
Finance charges and other |
138,588 | 152,331 | 152,265 | 13,743 | 9.9 | (66 | ) | (0.0 | ) | |||||||||||||||||||
Total revenues |
130,277 | 141,752 | 141,418 | 11,475 | 8.8 | (334 | ) | (0.2 | ) | |||||||||||||||||||
Cost and expenses |
||||||||||||||||||||||||||||
Selling, general and administrative
expense (b) |
54,279 | 58,928 | 61,019 | 4,649 | 8.6 | 2,091 | 3.5 | |||||||||||||||||||||
Depreciation and amortization |
797 | 1,323 | 1,724 | 526 | 66.0 | 401 | 30.3 | |||||||||||||||||||||
Goodwill impairment |
| | 9,617 | | N/A | 9,617 | N/A |
- 10 -
2009 vs. 2008 | 2010 vs. 2009 | |||||||||||||||||||||||||||
Year Ended January 31, | Incr/(Decr) | Incr/(Decr) | ||||||||||||||||||||||||||
(in thousands except percentages) | 2008 | 2009 | 2010 | Amount | Pct | Amount | Pct | |||||||||||||||||||||
Provision for bad debts |
19,275 | 27,792 | 36,746 | 8,517 | 44.2 | 8,954 | 32.2 | |||||||||||||||||||||
Operating income |
55,926 | 53,709 | 32,312 | (2,217 | ) | (4.0 | ) | (21,397 | ) | (39.8 | ) | |||||||||||||||||
Operating Margin |
42.9 | % | 37.9 | % | 22.8 | % | ||||||||||||||||||||||
Interest expense |
24,839 | 23,597 | 20,571 | (1,242 | ) | (5.0 | ) | (3,026 | ) | (12.8 | ) | |||||||||||||||||
Segment income before income taxes |
$ | 31,087 | $ | 30,112 | $ | 11,741 | $ | (975 | ) | (3.1 | )% | $ | (18,371 | ) | (61.0 | )% | ||||||||||||
(a) | Retail repair service agreement commissions exclude repair service agreement cancellations that are the result of consumer credit account charge-offs. These amounts are reflected in repair service agreement commissions for the credit segment. | |
(b) | Selling, general and administrative expenses include the direct expenses of the retail and credit operations, allocated overhead expenses and a charge to the credit segment to reimburse the retail segment for expenses it incurs related to occupancy, personnel, advertising and other direct costs of the retail segment which benefit the credit operations by sourcing credit customers and collecting payments. The reimbursement received by the retail segment from the credit segment is estimated using an annual rate of 2.5% times the average portfolio balance for each applicable period. The amount of overhead allocated to each segment was approximately $7.4 million, $9.6 million and $9.1 million for the fiscal years ended January 31, 2010, 2009 and 2008, respectively. The amount of reimbursement made to the retail segment by the credit segment was approximately $18.6 million, $17.4 million and $15.2 million for the fiscal years ended January 31, 2010, 2009 and 2008, respectively. |
Year ended January 31, 2010 compared to the year ended January 31, 2009.
Refer to the above Analysis of consolidated statements of operations while reading the operations
review on a year-by-year basis.
Year ended January 31, | Change | |||||||||||||||
(Dollars in Millions) | 2010 | 2009 | $ | % | ||||||||||||
Net sales |
$ | 722.8 | $ | 805.1 | (82.3 | ) | (10.2 | ) | ||||||||
Finance charges and other |
152.8 | 154.4 | (1.6 | ) | (1.0 | ) | ||||||||||
Total Revenues |
$ | 875.6 | $ | 959.5 | (83.9 | ) | (8.7 | ) | ||||||||
The $82.3 million decrease in net sales was made up of the following:
| a $104.5 million decrease resulted from a same store sales decrease of 13.8%, | ||
| a $20.2 million increase generated by nine retail locations that were not open for twelve consecutive months in each period, | ||
| a $1.0 million increase resulted from a decrease in discounts on promotional credit sales, and | ||
| a $1.0 million increase resulted from an increase in service revenues. |
The components of the $82.3 million decrease in net sales were a $76.3 million decrease in
product sales and a $5.9 million net decrease in repair service agreement commissions and service
revenues. The $76.3 million decrease in product sales resulted from the following:
| approximately $40.2 million decrease attributable to an overall decrease in the average unit price. The decrease was due primarily to declines in the average unit price in consumer electronics, furniture, bedding and track, partially offset by an increase in the average unit price for appliances. Consumer electronics, driven primarily by televisions, saw the largest decline with a 26.0% drop in the average unit price, and | ||
| approximately $36.1 million was attributable to decreases in unit sales, due primarily to reduced sales in appliances and track unit sales, partially offset by increases in consumer electronics (especially flat-panel televisions), furniture and bedding sales. |
- 11 -
The $5.9 million decrease in repair service agreement commissions and service revenues
consisted of:
| a $6.6 million decrease in the repair service agreement commissions of the retail segment due primarily to the decline in product sales and due to reduced emphasis on this product as a result of our monitoring of the program offered to consumers and the training of our sales associates, in response to the Texas Attorney Generals litigation; | ||
| a $0.3 million decrease in the repair service agreement commissions of the credit segment due to the higher level of charge-offs experienced; and | ||
| $1.0 million increase in the service revenues of the retail segment due primarily to increased parts sales. |
The following table presents the makeup of net sales by product category in each period,
including repair service 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, | ||||||||||||||||||||
2009 | 2010 | Percentage | ||||||||||||||||||
Category (dollars in thousands) | Amount | Percentage | Amount | Percentage | change | |||||||||||||||
Consumer electronics |
$ | 305,056 | 37.9 | % | $ | 262,751 | 36.4 | % | (13.9 | )%(1) | ||||||||||
Home appliances |
221,474 | 27.5 | 208,470 | 28.8 | (5.9 | ) (2) | ||||||||||||||
Track |
109,799 | 13.6 | 97,463 | 13.5 | (11.2 | ) (3) | ||||||||||||||
Furniture and mattresses |
68,869 | 8.6 | 68,208 | 9.4 | (1.0 | ) (4) | ||||||||||||||
Other |
38,531 | 4.8 | 30,509 | 4.2 | (20.8 | ) (5) | ||||||||||||||
Total product sales |
743,729 | 92.4 | 667,401 | 92.3 | (10.3 | ) | ||||||||||||||
Repair service agreement
commissions (net) |
40,199 | 5.0 | 33,272 | 4.6 | (17.2 | ) (6) | ||||||||||||||
Service revenues |
21,121 | 2.6 | 22,115 | 3.1 | 4.7 | (7) | ||||||||||||||
Total net sales |
$ | 805,049 | 100.0 | % | $ | 722,788 | 100.0 | % | (10.2 | )% | ||||||||||
(1) | This decrease is due to a 26.0% decline in average selling prices on flat-panel televisions, partially offset by an increase in total units sold (increased LCD and plasma unit sales were partially offset by a decline in projection television unit sales). | |
(2) | The home appliance category declined as lower unit sales across the category were partially offset by higher average selling prices, as the appliance market in general showed continued weakness. | |
(3) | The decrease in track sales (consisting largely of computers, computer peripherals, video game equipment, portable electronics and small appliances) is driven primarily by reduced video game equipment, computer monitor, printer, GPS device, camera, camcorder and audio equipment sales. Sales from netbooks and desktop and laptop computers were essentially flat as lower average selling prices offset a 24.4% increase in unit sales of these products. | |
(4) | This decrease is due to the slower economic conditions in our markets in the last half of the fiscal year ended January 31, 2010. | |
(5) | Other category includes lawn and garden, delivery and other miscellaneous items. This category declined primarily due to reduced generator sales as we benefited from an increase in sales of generators in the areas affected by the hurricanes in the prior fiscal year that impacted certain of our markets. Additionally, lower lawn and garden sales due to the drought conditions experienced in many of our markets impacted sales in this category. The decline was also impacted by a reduction in the total number of deliveries due largely to the overall decline in sales. | |
(6) | The repair service agreement commissions decreased due to reduced emphasis on this product as a result of our monitoring of the program offered to consumers and the training of our sales associates, in response to the Texas Attorney Generals litigation. We expect sales in this area to trend towards our historical performance levels over time due to the enhancements made as a result of the review. | |
(7) | This increase was driven by an increase in the cost of parts used to repair higher-priced technology (flat-panel televisions, etc.). |
- 12 -
Year ended January 31, | Change | |||||||||||||||
(Dollars in Thousands) | 2010 | 2009 | $ | % | ||||||||||||
Interest income and fees |
$ | 135,828 | $ | 132,270 | 3,558 | 2.7 | ||||||||||
Insurance commissions |
16,437 | 20,061 | (3,624 | ) | (18.1 | ) | ||||||||||
Other income |
532 | 2,161 | (1,629 | ) | (75.4 | ) | ||||||||||
Finance charges and other |
$ | 152,797 | $ | 154,492 | (1,695 | ) | (1.1 | ) |
Note: | Interest income and fees and insurance commissions are included in Finance charges and other for the credit segment, while Other income is included in Finance charges and other for the retail segment. |
The increase in Interest income and fees of the credit segment resulted primarily from a
6.8% increase in the average balance of customer accounts receivable outstanding for fiscal year
2010, partially offset by a decline in the average interest income and fee yield from 19.0% for the
fiscal year ended January 31, 2009 to 18.3% for the fiscal year ended January 31, 2010. The
interest income and fee yield dropped as a result of the higher level of charge-offs experienced
during the fiscal 2010 period.
Insurance commissions of the credit segment have declined due to lower front-end commissions
as a result of the decline in sales, lower retrospective commissions, which were negatively
impacted by higher claims filings due to Hurricanes Gustav and Ike, and lower interest earnings on
funds held by the insurance company for the payment of claims.
Other income of the retail segment declined primarily due to lower retrospective commissions
on our repair service agreements which were negatively impacted by higher repair and exchange
claims experience.
The following table provides key portfolio performance information for the year ended January
31, 2010 and 2009:
Year Ended January 31, | ||||||||
2010 | 2009 | |||||||
(Dollars in thousands) | ||||||||
Interest income and fees (a) |
$ | 135,828 | $ | 132,270 | ||||
Net charge-offs (b) |
(28,942 | ) | (22,362 | ) | ||||
Borrowing costs (c) |
(20,666 | ) | (24,072 | ) | ||||
Net portfolio yield |
$ | 86,220 | 85,836 | |||||
Average portfolio balance |
$ | 743,756 | $ | 696,202 | ||||
Portfolio yield % |
18.3 | % | 19.0 | % | ||||
Net charge-off % |
3.9 | % | 3.2 | % |
(a) | Included in Finance charges and other. | |
(b) | Included in Provision for bad debts. | |
(c) | Included in Interest expense. |
Year Ended January 31, | Change | |||||||||||||||
(Dollars in Millions) | 2010 | 2009 | $ | % | ||||||||||||
Cost of goods sold |
$ | 534.3 | $ | 580.4 | (46.1 | ) | (7.9 | ) | ||||||||
Product gross margin percentage |
19.9 | % | 22.0 | % | (2.1 | )% |
The product gross margin percentage decreased from the 2009 period to the 2010 period due
to a highly competitive retail environment driven by increased competition for market share.
Year Ended January 31, | Change | |||||||||||||||
(Dollars in Millions) | 2010 | 2009 | $ | % | ||||||||||||
Cost of service parts sold |
$ | 10.4 | $ | 9.6 | 0.8 | 8.3 | ||||||||||
As a percent of service revenues |
47.1 | % | 45.5 | % | 1.6 | % |
This increase was due primarily to a 15.9% increase in parts sales. Parts sales also
increased as a percentage of service revenues from 35.5% in the 2009 period to 39.3% in the 2010
period.
- 13 -
Year Ended January 31, | Change | |||||||||||||||
(Dollars in Millions) | 2010 | 2009 | $ | % | ||||||||||||
Selling, general and administrative expense Retail |
$ | 193.2 | $ | 193.9 | (0.7 | ) | (0.4 | ) | ||||||||
Selling, general and administrative expense Credit |
62.7 | 60.3 | 2.4 | 4.0 | ||||||||||||
Selling, general and administrative expense Total |
$ | 255.9 | $ | 254.2 | 1.7 | 0.7 | ||||||||||
As a percent of total revenues |
29.2 | % | 26.5 | % | 2.7 | % |
The increase in SG&A expense was largely attributable to a $4.9 million increase in our
litigation reserves to reflect the amount that was required to settle the outstanding Texas
Attorney General litigation, the addition of new stores since February 1, 2008, and related
increases in employee and employee-related expenses, partially offset by $1.3 million of expenses,
net of insurance proceeds, incurred related to the hurricanes in the prior year, and lower
advertising, postage, utilities, telephone and fuel expenses in the fiscal year ended January 31,
2010. Additionally, as a result of the decreased product sales volume in the current year, sales
compensation as a percentage of revenues increased as reduced commissions were more than offset by
minimum wage payment requirements. SG&A expense increased as a percent of revenues due to the
general de-leveraging effect of the decline in same store sales.
Significant SG&A expense increases and decreases related to specific business segments
included the following:
Retail Segment
The following are the significant factors affecting the retail segment:
| There was an increase in litigation reserves of $4.9 million for the settlement of the Texas Attorney General litigation. | ||
| Net advertising expense decreased by approximately $4.3 million from the 2009 period. | ||
| Total compensation costs and related expenses decreased approximately $3.1 million from the 2009 period, primarily due to the reduced sales volume. | ||
| Total occupancy expenses increased approximately $1.8 million, primarily as a result of the stores opened during fiscal 2009 and fiscal 2010. | ||
| Bank and credit card fees increased by approximately $1.5 million from the 2009 period, primarily due to the use of the third-party finance providers for certain of our interest-free programs. | ||
| The reimbursement received from the credit segment increased approximately $1.2 million due to the growth in the credit portfolio. |
Credit Segment
The following are the significant factors affecting the credit segment:
| Total compensation costs and related expenses increased approximately $2.4 million from the 2009 period as staffing was increased to address increased levels of delinquencies in the challenging economic environment. | ||
| The reimbursement of SG&A expenses to the retail segment increased approximately $1.2 million due to growth in the credit portfolio. |
- 14 -
| Amortization expense increased approximately $0.4 million from the 2009 period due to entering into our $210 million revolving credit facility in August of fiscal 2009. |
| Corporate overhead expenses allocated decreased approximately $2.2 million, primarily due to the reduction of expenses related to the hurricanes which occurred in the prior year and a reduced bonus payout. |
Year Ended January 31, | Change | |||||||||||||||
(Dollars in Millions) | 2010 | 2009 | $ | % | ||||||||||||
Goodwill impairment |
$ | 9.6 | $ | | 9.6 | N/A |
During the three months ended October 31, 2009, we determined, as a result of the
sustained decline in our market capitalization and the current challenging economic environment and
its impact on our comparable store sales, credit portfolio performance and operating results, that
an interim goodwill impairment test was necessary. We concluded from our analysis that our goodwill
was impaired and recorded a $9.6 million charge to write-off the carrying amount of our goodwill.
Since our goodwill was attributable to our acquisition of credit insurance operations and a portion
of the credit portfolio, the impairment charge is reflected in our credit segment.
Year Ended January 31, | Change | |||||||||||||||
(Dollars in Millions) | 2010 | 2009 | $ | % | ||||||||||||
Provision for bad debts |
$ | 36.8 | $ | 28.0 | $ | 8.8 | 31.4 | |||||||||
As a percent of total revenues |
4.2 | 2.9 | % | 1.3 | % |
The provision for bad debts is primarily related to our credit segment, with
approximately $0.1 million and $0.2 million for the fiscal years ended January 31, 2010 and 2009,
respectively, included in the results of operations for the retail segment.
The provision for bad debts on Other receivables and Customer receivables increased primarily
as a result of the increase in actual and expected net credit charge-offs on customer receivables.
Actual net charge-offs increased approximately $6.6 million, or 29.4%, in fiscal 2010, compared to
fiscal 2009. As a result of credit portfolio performance and expectations about future net
charge-offs, the bad debt and uncollectible interest reserves for receivables were increased, as a
percent of the customer receivable balance, to 5.0% at January 31, 2010, from 3.6% at January 31,
2009. See Business Finance operations Credit quality.
Year Ended January 31, | Change | |||||||||||||||
(Dollars in Millions) | 2010 | 2009 | $ | % | ||||||||||||
Interest expense, net |
$ | 20.6 | $ | 23.6 | (3.0 | ) | (12.7 | ) |
All of our interest expense, net, is included in the results of operations for the credit
segment.
The decrease in net interest expense was driven by a decrease in outstanding debt balances
during the year ended January 31, 2010, as compared to the prior fiscal year.
Year Ended January 31, | Change | |||||||||||||||
(Dollars in Millions) | 2010 | 2009 | $ | % | ||||||||||||
Provision for income taxes |
$ | 4.1 | $ | 23.6 | (19.5 | ) | (82.6 | ) | ||||||||
As a percent of income before income taxes |
51.2 | % | 37.1 | % | 14.0 | % |
The effective tax rate was higher during the 2010 period because taxes for the State of
Texas are based on gross margin and are not affected by changes in income before income taxes.
- 15 -
Year ended January 31, 2008 compared to the year ended January 31, 2009
Year Ended January 31, | Change | |||||||||||||||
(Dollars in Millions) | 2009 | 2008 | $ | % | ||||||||||||
Net sales |
$ | 805.1 | $ | 731.0 | $ | 74.1 | 10.1 | |||||||||
Finance charges and other |
154.4 | 139.5 | 14.9 | 10.7 | ||||||||||||
Revenues |
$ | 959.5 | $ | 870.5 | $ | 89.0 | 10.2 |
The $74.1 million increase in net sales was made up of the following:
| a $13.9 million increase resulted from a same store sales increase of 2.0%, |
| a $60.6 million increase generated by 14 retail locations that were not open for twelve consecutive months in both periods, |
| a $1.5 million increase resulted from a decrease in discounts on promotional credit sales, and |
| a $1.9 million decrease resulted from a decrease in service revenues. |
The components of the $74.1 million increase in net sales were a $72.2 million increase in
product sales and a $1.9 million net increase in repair service agreement commissions and service
revenues. The $72.2 million increase in product sales resulted from the following:
| approximately $42.3 million increase attributable to an overall increase in the average unit price. The increase was due primarily to a change in the mix of product sales, driven by an increase in the consumer electronics category, which has the highest average price point of any category, as a percentage of total product sales. Additionally, there were category price point increases as a result of a shift to higher-priced high-efficiency laundry items and increases in price points on furniture and mattresses, partially offset by a decline in the average price points on lawn and garden, and |
| approximately $29.9 million was attributable to increases in unit sales, due primarily to increased consumer electronics (especially flat-panel televisions), track and lawn and garden sales, partially offset by a decline in appliance sales. The increase in unit sales reflects the incremental net sales generated by our 14 opened retail locations offset by a unit decline in other retail locations. |
The $1.9 million increase in repair service agreement commissions and service revenues
consisted of:
| a $6.1 million increase in the repair service agreement commissions of the retail segment due primarily to the increase in product sales; |
| a $2.3 million decrease in the repair service agreement commissions of the credit segment due to the higher level of charge-offs experienced; and |
| a $1.9 million decrease in the service revenues of the retail segment due primarily to lower service labor revenues. |
- 16 -
The following table presents the makeup of net sales by product category in each period,
including repair service 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, | ||||||||||||||||||||
2009 | 2008 | Percentage | ||||||||||||||||||
Category (Dollars in Thousands) | Amount | Percentage | Amount | Percentage | Change | |||||||||||||||
Consumer electronics |
$ | 305,056 | 37.9 | % | $ | 244,872 | 33.5 | % | 24.6 | %(1) | ||||||||||
Home appliances |
221,474 | 27.5 | 223,877 | 30.6 | (1.1 | ) (2) | ||||||||||||||
Track |
109,799 | 13.6 | 101,289 | 13.9 | 8.4 | (3) | ||||||||||||||
Furniture and mattresses |
68,869 | 8.6 | 62,797 | 8.6 | 9.7 | (4) | ||||||||||||||
Other |
38,531 | 4.8 | 38,736 | 5.3 | (0.1 | ) | ||||||||||||||
Total product sales |
743,729 | 92.4 | 671,571 | 91.9 | 10.7 | |||||||||||||||
Repair service agreement
commissions (net) |
40,199 | 5.0 | 36,424 | 5.0 | 10.4 | (5) | ||||||||||||||
Service revenues |
21,121 | 2.6 | 22,997 | 3.1 | (8.2 | ) (6) | ||||||||||||||
Total net sales |
$ | 805,049 | 100 | % | $ | 730,992 | 100 | % | 10.1 | % |
(1) | This increase is due to continued consumer interest in LCD televisions, which offset declines in projection and plasma televisions. | |
(2) | The home appliance category declined as increased laundry and air conditioning sales were offset by lower refrigeration and cooking sales, as the appliance market in general showed continued weakness. | |
(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 video game equipment, Blu-ray player, laptop computer and GPS device sales, partially offset by declines in camcorder, camera, MP3 player and desktop computer sales. | |
(4) | This increase is due to store expansion and a change in our furniture and mattresses merchandising driven by the multi-vendor strategy implemented during the prior year. | |
(5) | This increase is due to the increase in product sales. | |
(6) | This decrease is driven by a decrease in the number of warranty service calls performed by our technicians. |
Year Ended January 31, | Change | |||||||||||||||
(Dollars in Thousands) | 2009 | 2008 | $ | % | ||||||||||||
Interest income and fees |
$ | 132,270 | $ | 117,186 | $ | 15,084 | 12.9 | |||||||||
Insurance commissions |
20,061 | 21,402 | (1,341 | ) | (6.3 | ) | ||||||||||
Other income |
2,161 | 950 | 1,211 | 127.5 | ||||||||||||
Finance charges and other |
$ | 154,492 | 139,538 | $ | 14,954 | 10.7 |
Note: Interest income and fees and insurance commissions are included in the Finance charges
and other for the credit segment, while Other income is included in Finance charges and other for
the retail segment.
The increase in Interest income and fees of the credit segment resulted primarily from a
14.8% increase in the average balance of customer accounts receivable outstanding for fiscal year
2009 as compared to 2008.
Insurance commissions of the credit segment have declined due to lower retrospective
commissions, which were negatively impacted by higher claims filings due to Hurricanes Gustav and
Ike, and lower interest earnings on funds held by the insurance company for the payment of claims.
Other income of the retail segment increased primarily due to increased retrospective
commissions in our repair service agreement program.
- 17 -
The following table provides key portfolio performance information for the year ended January
31, 2009 and 2008:
Year Ended January 31, | ||||||||
2009 | 2008 | |||||||
(Dollars in thousands) | ||||||||
Interest income and fees (a) |
$ | 132,270 | $ | 117,186 | ||||
Net charge-offs (b) |
(22,362 | ) | (17,418 | ) | ||||
Borrowing costs (c) |
(24,072 | ) | (25,853 | ) | ||||
Net portfolio yield |
$ | 85,836 | $ | 73,915 | ||||
Average portfolio balance |
$ | 696,202 | $ | 606,631 | ||||
Portfolio yield % |
19.0 | % | 19.3 | % | ||||
Net charge-off % |
3.2 | % | 2.9 | % |
(a) | Included in Finance charges and other. | |
(b) | Included in Provision for bad debts. | |
(c) | Included in Interest expense. |
Year Ended January 31, | Change | |||||||||||||||
(Dollars in Millions) | 2009 | 2008 | $ | % | ||||||||||||
Cost of goods sold |
$ | 580.4 | $ | 508.8 | 71.6 | 14.1 | ||||||||||
Product gross margin percentage |
22.0 | % | 24.2 | % | (2.2 | )% |
The product gross margin percentage decreased from the 2008 period to the 2009 period due
to pricing pressures in retailing in general, and specifically in consumer electronics and
appliances.
Year Ended January 31, | Change | |||||||||||||||
(Dollars in Millions) | 2009 | 2008 | $ | % | ||||||||||||
Cost of service parts sold |
$ | 9.6 | $ | 8.4 | 1.2 | 14.3 | ||||||||||
As a percentage of service revenues |
45.5 | % | 36.5 | % | 9.0 | % |
This increase was due primarily to a 22.8% increase in parts sales, which grew faster
than labor sales.
Year Ended January 31, | Change | |||||||||||||||
(Dollars in Millions) | 2009 | 2008 | $ | % | ||||||||||||
Selling, general and administrative expense Retail |
$ | 193.9 | $ | 190.7 | 3.3 | 0.2 | ||||||||||
Selling, general and administrative expense Credit |
60.3 | 55.1 | 5.1 | 9.3 | ||||||||||||
Selling, general and administrative expense Total |
$ | 254.2 | $ | 245.8 | 8.4 | 3.4 | ||||||||||
As a percentage of total revenues |
26.5 | % | 28.2 | % | (1.7 | )% |
The increase in SG&A expense was largely attributable to the addition of new stores and
expenses of approximately $1.4 million, net of estimated insurance proceeds, that we incurred
related to the two hurricanes that occurred during the year. The improvement in our SG&A expense as
a percent of revenues was largely driven by lower compensation costs in absolute dollars and as a
percent of revenues as compared to the prior year, as well as reduced advertising expense as a
percent of revenues. Additionally, reductions in certain store operating expenses, including
repairs and maintenance and janitorial services contributed to the improvement. Partially
offsetting these improvements were increases in utility, credit data processing and stock-based
compensation expenses.
Significant SG&A expense increases and decreases related to specific business segments
included the following:
- 18 -
Retail Segment
The following are the significant factors affecting the retail segment:
| Total occupancy expenses increased approximately $2.6 million primarily due to the opening of new stores. |
| There was an increase of approximately $0.7 million, net of estimated insurance proceeds, incurred related to the two hurricanes that occurred during the fiscal 2009 period. |
| Contract delivery and installation costs increased approximately $2.2 million from the 2008 period primarily driven by increased use of third-parties to provide the service and increased product sales. |
| Net advertising expense increased by approximately $0.8 million, but declined as a percent of revenues. |
| Total compensation costs and related expenses decreased approximately $1.8 million from the fiscal 2008 period. |
| The reimbursement received from the credit segment increased approximately $2.2 million due to the growth in the credit portfolio. |
Credit Segment
The following are the significant factors affecting the credit segment:
| The reimbursement of SG&A expenses to the retail segment increased approximately $2.2 million due to growth in the credit portfolio. |
| Credit data processing expense increased approximately $1.2 million from the 2008 period, primarily due to the use of a new virtual messaging service beginning in fiscal 2009 and growth in the credit portfolio. |
| Forms printing and related postage expense increased approximately $0.8 million from the 2008 period, primarily due to increased collection activity driven by the increase in portfolio balance. |
| Amortization expense increased approximately $0.5 million from the 2008 period due to costs associated with the addition of our asset-based revolving credit facility. |
| Professional fees and legal expenses increased approximately $0.4 million from the 2008 period. |
Year Ended January 31, | Change | |||||||||||||||
(Dollars in Millions) | 2009 | 2008 | $ | % | ||||||||||||
Provision for bad debts- |
$ | 28.0 | $ | 19.5 | 8.5 | 43.6 | ||||||||||
As a percentage of total revenues |
2.9 | % | 2.2 | % | 0.7 | % |
The provision for bad debts is primarily related to our credit segment, with
approximately $0.2 million and $0.2 million for the fiscal years ended January 31, 2009 and 2008,
respectively, included in the results of operations for the retail segment.
The provision for bad debts on Other receivables and Customer receivables increased primarily
as a result of the growth in the customer receivables portfolio and an increase in actual and
expected net charge-offs. Actual net charge-offs of Customer receivables increased approximately
$4.9 million in fiscal 2009, as compared to fiscal 2008. The allowance for bad debts increased
approximately $3.8 million as a result of the growth in the customer receivables portfolio and our
expectations about credit portfolio performance. See the notes to the financial statements for
information regarding the performance of the credit portfolio.
Year Ended January 31, | Change | |||||||||||||||
(Dollars in Millions) | 2009 | 2008 | $ | % | ||||||||||||
Interest expense, net |
$ | 23.6 | $ | 24.8 | (1.2 | ) | (4.8 | ) |
All of our interest expense, net, is included in the results of operations for the credit
segment, as all of our interest expense is attributable to debt incurred to finance customer
receivables.
- 19 -
The decrease in net interest expense was a result of lower interest rates incurred on the debt
outstanding, partially offset by higher average balances being outstanding during the 2009 fiscal
period.
Year Ended January 31, | Change | |||||||||||||||
(Dollars in Thousands) | 2009 | 2008 | $ | % | ||||||||||||
Other
(income) expense, net |
$ | 117 | $ | (943 | ) | 1,060 | (112.4 | ) |
We realized gains on sales of property in the year ended January 31, 2008. Additionally,
during the year ended January 31, 2008, there were approximately $1.2 million of gains realized,
but not recognized, on transactions qualifying for sale-leaseback accounting that were deferred and
are being amortized as a reduction of rent expense on a straight-line basis over the minimum lease
terms.
Year Ended January 31, | Change | |||||||||||||||
(Dollars in Millions) | 2009 | 2008 | $ | % | ||||||||||||
Provision for income taxes |
$ | 23.6 | $ | 22.6 | 1.0 | 4.4 | ||||||||||
As a percent of income before income taxes |
37.1 | % | 35.1 | % | 2.1 | % |
The effective tax rate was higher during the 2009 period because taxes for the State of
Texas are based on gross margin and are not affected by changes in income before income taxes. The
fiscal 2008 effective tax rate was reduced by the reversal of previously accrued Texas margin tax
as a result of a legal entity reorganization completed during that year.
Impact of inflation and changing prices
We do not believe that inflation has had a material effect on our net sales or results of
operations. However, price deflation, primarily in consumer electronics has impacted our net sales
and results of operations. A 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. In
addition, historically our results of operations and portfolio performance for our first fiscal
quarter are stronger than for our second fiscal quarter. Over the four quarters of fiscal 2010,
gross margins were 38.1%, 37.7%, 37.4% and 37.9%. During the same period, operating margins were
9.6%, 6.0%, -6.6% and 2.2%. Our quarterly results may fluctuate materially depending on factors
such as the following:
| timing of new product introductions, new store openings and store relocations; |
| sales contributed by new stores; |
| increases or decreases in comparable store sales; |
| adverse weather conditions; |
| shifts in the timing of certain holidays or promotions; |
| one-time charges incurred, such as goodwill impairment and litigation reserves incurred in the third quarter of fiscal 2010; and |
| changes in our merchandise mix. |
Results for any quarter are not necessarily indicative of the results that may be achieved for
a full year.
The following tables set forth certain unaudited quarterly statement of operations information
for the eight quarters ended January 31, 2010. The unaudited quarterly information has been
prepared on a consistent basis, includes all normal recurring adjustments that management considers
necessary for a fair presentation of the information shown and includes the effects of the
retrospective application of our
- 20 -
change in our method of accounting for our interest in our variable interest entity effective
February 1, 2010.
Fiscal Year 2010 | ||||||||||||||||
Quarter Ended | ||||||||||||||||
Apr. 30 | Jul. 31 | Oct. 31 | Jan. 31 | |||||||||||||
(dollars and shares in thousands, except per share amounts) | ||||||||||||||||
Revenues |
||||||||||||||||
Product sales |
$ | 184,817 | $ | 175,389 | $ | 148,463 | $ | 158,732 | ||||||||
Repair service agreement commissions (net) |
9,790 | 8,858 | 7,320 | 7,304 | ||||||||||||
Service revenues |
5,544 | 6,052 | 5,599 | 4,920 | ||||||||||||
Total net sales |
200,151 | 190,299 | 161,382 | 170,956 | ||||||||||||
Finance charges and other |
39,700 | 40,128 | 36,116 | 36,853 | ||||||||||||
Total revenues |
239,851 | 230,427 | 197,498 | 207,809 | ||||||||||||
Percent of annual revenues |
27.4 | % | 26.3 | % | 22.6 | % | 23.7 | % | ||||||||
Cost and expenses |
||||||||||||||||
Cost of
goods sold, including warehousing and occupancy costs |
145,870 | 140,761 | 120,963 | 126,705 | ||||||||||||
Cost of
service parts sold, including warehousing and occupancy costs |
2,587 | 2,797 | 2,672 | 2,345 | ||||||||||||
Selling, general and administrative expense |
62,738 | 64,979 | 65,661 | 62,564 | ||||||||||||
Goodwill impairment |
| | 9,617 | | ||||||||||||
Provision for bad debts |
5,644 | 8,026 | 12,651 | 10,522 | ||||||||||||
Total cost and expenses |
216,839 | 216,563 | 211,564 | 202,136 | ||||||||||||
Operating income (loss) |
23,012 | 13,864 | (14,066 | ) | 5,673 | |||||||||||
Operating profit (loss) as a % total revenues |
9.6 | % | 6.0 | % | (7.1 | )% | 2.7 | % | ||||||||
Interest expense |
5,004 | 5,341 | 5,295 | 4,931 | ||||||||||||
Other income |
(8 | ) | (13 | ) | (33 | ) | (69 | ) | ||||||||
Income (loss) before income taxes |
18,016 | 8,536 | (19,328 | ) | 811 | |||||||||||
Provision (benefit) for income taxes |
6,660 | 3,312 | (4,955 | ) | (906 | ) | ||||||||||
Net income (loss) |
$ | 11,356 | $ | 5,224 | $ | (14,373 | ) | $ | 1,717 | |||||||
Net income (loss) as a % of revenue |
4.7 | % | 2.3 | % | (7.3 | )% | 0.8 | % | ||||||||
Outstanding shares: |
||||||||||||||||
Basic |
22,447 | 22,454 | 22,459 | 22,466 | ||||||||||||
Diluted |
22,689 | 22,660 | 22,459 | 22,467 | ||||||||||||
Earnings per share: |
||||||||||||||||
Basic |
$ | 0.51 | $ | 0.23 | $ | (0.64 | ) | $ | 0.08 | |||||||
Diluted |
$ | 0.50 | $ | 0.23 | $ | (0.64 | ) | $ | 0.08 |
Fiscal Year 2009 | ||||||||||||||||
Quarter Ended | ||||||||||||||||
Apr. 30 | Jul. 31 | Oct. 31 | Jan. 31 | |||||||||||||
(dollars and shares in thousands, except per share amounts) | ||||||||||||||||
Revenues |
||||||||||||||||
Product sales |
$ | 179,911 | $ | 175,240 | $ | 160,253 | $ | 228,325 | ||||||||
Repair service agreement commissions (net) |
9,970 | 9,911 | 8,547 | 11,771 | ||||||||||||
Service revenues |
5,192 | 5,488 | 5,129 | 5,312 | ||||||||||||
Total net sales |
195,073 | 190,639 | 173,929 | 245,408 | ||||||||||||
Finance charges and other |
37,044 | 38,838 | 37,863 | 40,747 | ||||||||||||
Total revenues |
232,117 | 229,477 | 211,792 | 286,155 | ||||||||||||
Percent of annual revenues |
24.2 | % | 23.9 | % | 22.1 | % | 29.8 | % | ||||||||
Cost and expenses |
||||||||||||||||
Cost of
goods sold, including warehousing and occupancy costs |
139,058 | 136,787 | 127,007 | 177,571 | ||||||||||||
Cost of
service parts sold, including warehousing and occupancy costs |
2,330 | 2,264 | 2,479 | 2,565 | ||||||||||||
Selling, general and administrative expense |
60,436 | 62,968 | 62,472 | 68,296 | ||||||||||||
Provision for bad debts |
6,860 | 6,226 | 7,193 | 7,673 | ||||||||||||
Total cost and expenses |
208,684 | 208,245 | 199,151 | 256,105 | ||||||||||||
- 21 -
Fiscal Year 2009 | ||||||||||||||||
Quarter Ended | ||||||||||||||||
Apr. 30 | Jul. 31 | Oct. 31 | Jan. 31 | |||||||||||||
(dollars and shares in thousands, except per share amounts) | ||||||||||||||||
Operating income |
23,433 | 21,232 | 12,641 | 30,050 | ||||||||||||
Operating profit as a % total revenues |
10.1 | % | 9.3 | % | 6.0 | % | 10.5 | % | ||||||||
Interest expense |
5,486 | 5,130 | 6,783 | 6,198 | ||||||||||||
Other (income) expense |
(22 | ) | 128 | (4 | ) | 15 | ||||||||||
Income before income taxes |
17,969 | 15,974 | 5,862 | 23,837 | ||||||||||||
Provision for income taxes |
6,472 | 5,918 | 2,428 | 8,806 | ||||||||||||
Net income |
$ | 11,497 | $ | 10,056 | $ | 3,434 | $ | 15,031 | ||||||||
Net income as a % of revenue |
5.0 | % | 4.4 | % | 1.6 | % | 5.3 | % | ||||||||
Outstanding shares: |
||||||||||||||||
Basic |
22,382 | 22,407 | 22,422 | 22,439 | ||||||||||||
Diluted |
22,560 | 22,620 | 22,632 | 22,494 | ||||||||||||
Earnings per share: |
||||||||||||||||
Basic |
$ | 0.51 | $ | 0.45 | $ | 0.15 | $ | 0.67 | ||||||||
Diluted |
$ | 0.51 | $ | 0.44 | $ | 0.15 | $ | 0.67 |
Liquidity and capital resources
Current activities.
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 customer receivables and inventory.
We have historically financed our operations through a combination of cash flow generated from
earnings 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 customer receivables to our asset-backed securitization facilities.
Since we extend credit in connection with a large portion of our retail, repair service
agreement and credit insurance sales, we have entered into an asset-based revolving credit
facility, obtained a $10 million unsecured bank line of credit and created a securitization program
to fund the customer receivables generated by the extension of credit. In order to fund the
purchases of eligible customer receivables from us under the securitization program, we have issued
medium-term and variable funding notes through our variable interest entity, or VIE, secured by the
receivables to third parties to obtain cash for these purchases under the securitization program.
Asset based lending facility.
Our $210 million asset-based revolving credit facility provides funding based on a borrowing
base calculation that includes accounts customer receivable and inventory and matures in August
2011. Our revolving credit facility bears interest at LIBOR plus a spread ranging from 325 basis
points to 375 basis points, based on a fixed charge coverage ratio. In addition to the fixed charge
coverage ratio, our revolving credit facility includes a total liabilities to tangible net worth
ratio requirement, a minimum customer receivables cash recovery percentage requirement, a net
capital expenditures limit and combined portfolio performance covenants. Additionally, our
revolving credit facility contains cross-default provisions, such that, any default under another
of our credit facilities or our VIEs securitization facilities would result in a default under our
revolving credit facility, and any default under our revolving credit facility would result in a
default under those agreements. We expect, based on current facts and circumstances, that we will
be in compliance with the above covenants through fiscal 2011.
At January 31, 2010, we had additional capacity of $34.1 million under our revolving credit
facility and $10 million under an unsecured bank line of credit immediately available to us for
general corporate purposes. In addition to the $34.1 million currently available under the
revolving credit facility, an additional $46.7 million may become available under the borrowing
base calculation as we grow the balance of eligible customer receivables retained by us and when
there is growth in total eligible inventory balances. Recent credit portfolio performance resulted
in a reduction in availability under the revolving credit facility of approximately $6.0 million at
January 31, 2010. This amount may become available in the
- 22 -
future if customer credit portfolio performance improves, however, a further decline in credit
performance could lead to further reductions in availability. The principal payments received on
customer receivables, which averaged approximately $35 million per month during the fiscal year
ended January 31, 2010, will also be available each month to fund new customer receivables
generated. The weighted average interest rate on borrowings outstanding under the revolving credit
facility at January 31, 2010 was 3.3%, including the interest expense associated with our interest
rate swaps. 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, together with
cash generated from operations. While we have no new stores currently under development for fiscal
2011, our long-term plans are to grow our store base by approximately 10% a year, dependent upon
future capital availability. 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 and our liquidity needs we may, at times, slow or suspend our new store growth plans,
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.
A summary of the significant financial covenants that govern our revolving credit facility
compared to our actual compliance status at January 31, 2010, as amended, is presented below. These
covenants were amended in February 2010 as discussed below, and the amendment required the
covenants to be calculated on a consolidated basis to reflect the impact of inclusion of the
securitization program.
Required Minimum/ | ||||||||
Actual | Maximum | |||||||
Fixed charge coverage ratio must exceed required minimum (1) |
1.24 to 1.00 | 1.10 to 1.00 | ||||||
Total liabilities to tangible net worth ratio must be lower
than the required maximum (1) |
1.61 to 1.00 | 2.00 to 1.00 | ||||||
Cash recovery percentage must exceed required minimum (1) |
5.00% | 4.75% | ||||||
Capital expenditures, net must be lower than the required
maximum |
$10.1 million | $22.0 million |
(1) | These covenants are also covenants of our existing asset-backed securitization facility. |
Note: | All terms in the above table are defined by our revolving credit facility and may or may not agree directly to the financial statement captions in this document. The covenants are calculated on a trailing four quarter basis, except for the Cash recovery percentage, which is calculated on a trailing three month basis. |
As we have done in the past, we will adjust the volume of new customer receivables
transferred to the securitization program to allow it to use the proceeds of principal repayments
from its customer accounts receivable portfolio to reduce the balance outstanding under its
revolving credit facility prior to the commitment reduction date. As of January 31, 2010, the
balance under the securitization programs revolving credit facility was $200.0 million. Events of
default under our revolving credit facility include, but are not limited to, 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. Any repayment requirement or acceleration of amounts owed could have a
material adverse affect on our business operations. Our obligations under our revolving credit
facility are secured by all of our and our subsidiaries assets, excluding customer receivables
transferred to the securitization program and certain inventory subject to vendor floor plan
arrangements.
Asset-backed securitization facility.
During the twelve months ended January 31, 2010, our VIE reduced its receivable portfolio by
$123.8 million and paid off $96.1 million in outstanding borrowings, while we borrowed $42.6
million to
- 23 -
finance a $106.3 million increase in customer receivables on balance sheet. As a result, the
combined borrowings of us and our VIE declined $53.5 million.
Under our asset-backed securitization facility, the VIE is subject to certain affirmative and
negative covenants contained in the transaction documents governing the 2002 Series A variable
funding note and 2006 Series A bonds, including covenants that restrict, subject to specified
exceptions: the incurrence of non-permitted indebtedness and other obligations and the granting of
additional liens; mergers, acquisitions, investments and disposition of assets; maintenance of a
minimum net worth by the VIE; and the use of proceeds of the program. The VIE also makes
representations and warranties relating to compliance with certain laws, payment of taxes,
maintenance of its separate legal entity, preservation of its existence, and protection of
collateral and financial reporting.
A summary of the significant financial covenants that govern the 2002 Series A variable
funding note compared to actual compliance status at January 31, 2010, is presented below:
Required | ||||||||
Minimum/ | ||||||||
As reported | Maximum | |||||||
VIE interest must exceed required minimum
|
$93.2 million | $84.8 million | ||||||
Gross loss rate must be lower than required maximum (a)
|
6.1% | 10.0% | ||||||
Serviced portfolio gross loss rate must be lower than required maximum (b)
|
5.2% | 10.0% | ||||||
Net portfolio yield must exceed required minimum (a)
|
5.8% | 2.0% | ||||||
Serviced portfolio net portfolio yield must exceed required minimum (b)
|
8.0% | 2.0% | ||||||
Payment rate must exceed required minimum (a)
|
6.3% | 3.0% | ||||||
Serviced portfolio payment rate must exceed required minimum (a)
|
5.00% | 4.75% | ||||||
Consolidated net worth must exceed required minimum
|
$345.4 million | $246.6 million |
(a) | Calculated for those customer receivables transferred to our existing securitization program. | |
(b) | Calculated for the total of customer receivables transferred to our existing securitization program and those retained by us. |
Note: | All terms in the above table are defined by our existing securitization program and may or may not agree directly to the financial statement captions in this document. |
The various same as cash and deferred interest credit programs we offer are eligible
for securitization up to the limits provided for in our securitization agreements. This limit is
currently 30.0% of eligible securitized customer 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
customer receivables for the promotional period. The percentage of eligible securitized customer
receivables represented by promotional customer receivables was 17.3% and 13.0%, as of January 31,
2009, and 2010, respectively. There is no limitation on the amount of same as cash or deferred
interest program accounts that can be carried as collateral under our revolving credit facility.
The percentage of all managed customer receivables represented by promotional customer receivables
was 15.3% as of January 31, 2010, as compared to 16.4% at January 31, 2009.
We expect, based on current facts and circumstances, that we will be in compliance with the
above covenants through fiscal 2011. Events of default under the 2002 Series A variable funding
note and the 2006 Series A bonds, subject to grace periods and notice provisions in some
circumstances, include, among others: failure of the VIE to pay principal, interest or fees;
violation by the VIE of any of its covenants or agreements; inaccuracy of any representation or
warranty made by the VIE; certain servicer defaults; failure of the trustee to have a valid and
perfected first priority security interest in the collateral; default under or acceleration of
certain other indebtedness; bankruptcy and insolvency events; failure to maintain certain loss
ratios and portfolio yield; change of control provisions and certain other events pertaining to us.
The VIEs obligations under the program are secured by the customer receivables and proceeds.
As a result of the declines in our profitability beginning in the quarter ended October 31,
2009, due to the slowdown in the economic conditions in our markets, we determined that there was a
reasonable likelihood that we would trigger the default provisions of our credit facilities. Based
on that expectation, we began working with our revolving credit facility lenders and VIE
noteholders to amend the covenants in our revolving credit facility and our securitization
facilities. We completed the necessary amendments in March 2010, which resulted in the following
changes:
- 24 -
| Fixed charge coverage ratio requirement for our revolving credit facility and our securitization facilities were reduced to 1.1 to 1.0 for the twelve month periods ended January 31, 2010, and April 30, 2010, before returning to a requirement of 1.3 to 1.0 beginning with the quarter ending July 31, 2010, | ||
| The leverage ratio for our revolving credit facility and our securitization facilities was replaced with a maximum total liabilities to tangible net worth requirement, beginning as of January 31, 2010 with a required maximum of 2.00 to 1.00 at January 31, 2010, declining to 1.75 to 1.00 as of July 31, 2010 and then to 1.50 to 1.00 as of April 30, 2011 and each fiscal quarter thereafter, | ||
| The interest rate on our revolving credit facility increased by 100 basis points to LIBOR plus a spread ranging from 325 basis points to 375 basis points, | ||
| We will be required to pay a fee, as servicer of the customer receivables transferred to the securitization program, equal to the following rates multiplied times the total available borrowing commitment under the securitization programs revolving credit facility on the dates shown: |
o | 50 basis points on May 1, 2010, | ||
o | 100 basis points on August 1, 2010, | ||
o | 110 basis points on November 1, 2010, | ||
o | 115 basis points on February 1, 2011, | ||
o | 115 basis point on May 1, 2011, and | ||
o | 123 basis points on August 1, 2011, |
| The total available commitments under the securitization programs revolving credit facility will be reduced from the current level of $200 million to $170 million in April 2010 and then to $130 million in April 2011, | ||
| We will use the proceeds from any capital raising activity to further reduce the commitments and debt outstanding under the securitization programs debt facilities, | ||
| The maturity date on the securitization programs variable funding note was reduced from September 2012 to August 2011, and | ||
| We may be required to complete certain additional tasks as servicer of the customer receivables transferred to the securitization program, so long as commitments remain outstanding under the securitization programs revolving credit facility. |
There are two series of notes and bonds outstanding under our securitization program. The 2002
Series A program functions as a revolving credit facility to fund the transfer of eligible customer
receivables. When the facility approaches a predetermined amount, the VIE 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 customer
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. Given the current state of the financial markets, especially
with respect to asset-backed securitization financing, we have been unable to issue medium-term
notes or increase the availability under the existing variable funding note program. The 2002
Series A program is renewable annually, at our option, until August 2011 and bears interest at
commercial paper rates plus a spread of 250 basis points. The total commitment under the 2002
Series A program was reduced from $200 million to $170 million in April 2010. Additionally, in
connection with recent amendments to the 2002 Series A facility, we agreed to reduce the total
available commitment to $130 million in April 2011. The weighted average interest on the variable
funding note during the month of January 2010 was 2.8%. 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 scheduled $7.5 million principal payments, which begin
in September 2010, will retire the bonds prior to that date. Private institutional investors,
primarily insurance companies, purchased the 2006 Series A bonds at a weighted fixed rate of 5.75%.
The securitization borrowing agreements contain certain covenants requiring the maintenance of
various financial ratios and customer receivables performance standards. If the three-month average
net portfolio yield, as defined by agreements, falls below 5.0%, then the VIE may be required to
fund additions to the cash reserves in the restricted cash accounts. The three-month average net
portfolio yield was 5.8% at January 31, 2010. The investors and the securitization trustee have no
recourse to our other assets for failure of our or the VIEs individual customers to pay when due.
If the VIE is unable to repay the 2002 Series A note and 2006
- 25 -
Series A bonds due to its inability to collect the transferred customer accounts, the VIE could not
pay the subordinated notes it has issued to us in partial payment for transferred customer
accounts, and the 2006 Series A bond holders could claim the balance in its $6.0 million restricted
cash account. We are responsible under a $20.0 million letter of credit that secures the
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.
Securitization Facilities
We finance a portion of our customer receivables through asset-backed securitization facilities
We finance a portion of our customer receivables through asset-backed securitization facilities
We continue to service the transferred accounts for the VIE, and we receive 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 customer receivables serviced, including the amount of average
aggregate defaulted customer receivables. The VIE records revenues equal to the interest charged
to the customer on the receivables less losses, the cost of funds, the program administration fees
paid in connection with either the 2002 Series A or 2006 Series A bond holders, the servicing fee
and additional earnings to the extent they are available.
We will continue to finance our operations and future growth through a combination of cash
flow generated from operations and external borrowings, including primarily bank debt, extended
vendor terms for purchases of inventory, acquisition of inventory under consignment arrangements,
and the asset-backed securitization facilities. Based on our current operating plans, we believe
that cash generated from operations, available borrowings under our revolving credit facility and
unsecured credit line, extended vendor terms for purchases of inventory, acquisition of inventory
under consignment arrangements and cash flows from the asset-backed securitization program will be
sufficient to fund our operations for at least twelve months, subject to continued compliance with
the covenants in the credit facilities. If there is a default under any of the facilities that is
not waived by the various lenders, it could result in the requirement to immediately begin
repayment of all amounts owed under our credit facilities, as all of the facilities have
cross-default provisions that would result in default under all of the facilities if there is a
default under any one of the facilities. If the repayment of amounts owed under our credit
facilities is accelerated, we may not have sufficient cash and liquid assets at such time to be
able to immediately repay all the amounts owed under the facilities.
Both the revolving 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 business operations. Funding of current and
future customer receivables under the borrowing facilities can be adversely affected if we exceed
certain predetermined levels of re-aged customer receivables, size of the secondary portfolio, the
amount of promotional customer receivables, write-offs, bankruptcies or other ineligible customer
receivable amounts.
- 26 -
There are several factors that could decrease cash availability, including:
| reduced demand or margins for our products; | ||
| more stringent vendor terms on our inventory purchases; | ||
| loss of ability to acquire inventory on consignment; | ||
| increases in product cost that we may not be able to pass on to our customers; | ||
| reductions in product pricing due to competitor promotional activities; | ||
| changes in inventory requirements based on longer delivery times of the manufacturers or other requirements which would negatively impact our delivery and distribution capabilities; | ||
| an acceleration of the growth of the credit portfolio; | ||
| increases in the retained portion of our customer receivables portfolio under our current asset-backed securitization program as a result of changes in performance or types of receivables transferred (promotional versus non-promotional and primary versus secondary portfolio), or as a result of a change in the mix of funding sources available under the asset-backed securitization program, requiring higher collateral levels, or limitations on our ability to obtain financing through commercial paper-based funding sources; | ||
| reduced availability under our revolving credit facility as a result of borrowing base requirements and the impact on the borrowing base calculation of changes in the performance or eligibility of the customer receivables financed by that facility; | ||
| reduced availability under our revolving credit facility or asset-backed securitization facilities as a result of non-compliance with the covenant requirements; | ||
| reduced availability under our revolving credit facility or asset-backed securitization facilities as a result of the inability of any of the financial institutions providing those facilities to fund their commitment, | ||
| reductions in the capacity or inability to expand the capacity available for financing our customer receivables portfolio under existing or replacement asset-backed securitization programs or a requirement that we retain a higher percentage of the credit portfolio under such programs; | ||
| increases in borrowing costs (interest and administrative fees relative to our customer receivables portfolio associated with the funding of our customer receivables); | ||
| increases in personnel costs or other costs for us to stay competitive in our markets; and | ||
| inability to renew or replace all or a portion of our current credit facilities at their annual maturity dates (our asset-based revolving credit facility and the revolving facility of our securitization program mature in August 2011, and the medium term notes issued under the securitization program begin repayment in September 2010 and we expect them to be fully repaid by April 2012). |
We are discussing various options to renew or replace our existing credit facilities,
including exploring opportunities to raise capital in the various debt and equity capital markets.
If we are unable to renew or replace our existing credit facilities we could be required to further
reduce the size of the customer credit portfolio in order to repay the amounts outstanding under
our credit facilities. In order to reduce the size of the credit portfolio we would be required to
reduce, or possibly cease, originating new customer receivables until the amounts due under our
credit facilities are repaid. If necessary, in addition to available cash balances, cash flow from
operations and borrowing capacity under our revolving facilities, additional cash to fund our
operations and customer receivables balances could be obtained by:
| reducing capital expenditures for updates of existing stores or new store openings; | ||
| taking advantage of longer payment terms and financing available for inventory purchases; |
- 27 -
| utilizing third-party sources to provide financing to our customers; | ||
| reducing the size of our customer credit portfolio; | ||
| reducing operating costs; | ||
| negotiating to expand the capacity available under existing credit facilities; and | ||
| accessing new debt or equity markets. |
We can provide no assurance that we will be able to obtain these sources of funding on
favorable terms, if at all.
Capital expenditures.
We lease 72 of our 76 stores, and our plans for future store locations include primarily
leases, but do not exclude store ownership. Our capital expenditures for future new 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 $1.4 million per store,
and for our existing store remodels, in the range of $250,000 per store remodel, depending on store
size. In the event we purchase existing properties, our capital expenditures will depend on the
particular property and whether it is improved when purchased. We are continuously reviewing new
relationship and funding sources and alternatives for new stores, which may include
sale-leaseback or direct purchase-lease programs, as well as other funding sources for our
purchase and construction of those projects. If we are successful in these relationship developments, our direct cash needs should include only our capital expenditures
for tenant improvements to leased properties and our remodel programs for existing stores, but
could include full ownership if it meets our cash investment strategy. As a result of the recent
volatility in the capital markets, we modified our store opening plans and currently have no new
store openings planned. We have historically grown our new store count by about 10% per year and in
the future expect to return to this modest, controlled pace based on capital availability.
Cash flow.
Operating activities.
During the year ended January 31, 2010, net operating cash flows increased to $64.2 million
provided by operating activities, from $20.5 million used in operating activities in the twelve
months ended January 31, 2009. Operating cash flows for the year ended January 31, 2010 were
impacted primarily by decreased used of cash flow for customer receivables and a reduction in
inventories in light of reduced product sales. Operating cash flows were also increased by a drop
in Other accounts receivable, as amounts due from our vendors fell in the year ended January 31,
2010, as our vendors did not use sales incentive programs to the extent they did in fourth quarter
of the prior year. These increases were partially offset by a decrease in accounts payable
balances, due largely to the reduction of inventory. There was also the impact of the decrease in
taxes payable due to the reduction in our taxable income in the year ended January 31, 2010 and the
overpayment of estimated taxes leading to the recoverable income taxes balance at year end.
During
the year ended January 31, 2009, net cash used in operating
activities decreased to
$20.5 million, from $39.4 million used in operating activities in the twelve months ended January
31, 2008. Operating cash flows for the current period were impacted primarily by the increased
retention of customer accounts receivable and increased inventories to support newly opened stores,
partially offset by an increase in accounts payable balances, due to the timing of inventory
purchases and taking advantage of payment terms available from our vendors.
- 28 -
Investing activities.
Net cash used in investing activities decreased by $3.2 million, from $13.3 million used in
the fiscal 2009 period to $10.1 million used in the fiscal 2010 period. The net decrease in cash
used in investing activities resulted primarily from a decline in purchases of property and
equipment compared to the prior fiscal year, as we opened fewer new stores in the fiscal 2010
period.
Net cash used in investing activities increased by $7.3 million, from $6.0 million used in the
fiscal 2008 period to $13.3 million used in the fiscal 2009 period. The net increase in cash used
in investing activities resulted primarily from a decline in proceeds from sales of property and
equipment as compared to the same period in the prior fiscal year. 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.
Financing activities.
Net cash from financing activities decreased by $88.5 million from $34.7 million provided
during the year ended January 31, 2009, to $53.8 million used during the year ended January 31,
2010, as we decreased the amount of net borrowings after repayments under our revolving credit
facility to fund the customer receivables generated and retained on our consolidated balance sheet.
Net cash from financing activities increased by $34.9 million from $0.2 million used during
the year ended January 31, 2008, to $34.7 million provided during the year ended January 31, 2009,
as we terminated our stock repurchase program in the period ended January 31, 2009 and increased
borrowings under our revolving credit facility to fund the new customer receivables generated and
retained on our consolidated balance sheet.
Certain transactions.
Since 1996, we have leased a retail store location of approximately 19,150 square feet in
Houston, Texas from Mr. Thomas J. Frank, Sr. Mr. Frank served as our Chairman of the Board and
Chief Executive Officer until June, 2009 and is the father of our 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 $206,820 in fiscal 2008, 2009 and 2010, 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 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 ours, and
Messrs. Jacoby and Martin are members of our Board of Directors. The fees we paid to DMS during
fiscal years ended 2008, 2009 and 2010 amounted to approximately $2.5 million, $4.0 million and
$2.4 million, respectively.
Contractual obligations.
The following table presents a summary of our known contractual obligations as of January 31,
2010, with respect to the specified categories, classified by payments due per period.
Payments due by period | ||||||||||||||||||||
Less Than | 1-3 | 3-5 | More Than 5 | |||||||||||||||||
Total | 1 Year | Years | Years | Years | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
Long term debt: |
||||||||||||||||||||
Revolving credit facility (1) |
$ | 105,904 | $ | 155 | $ | 105,749 | $ | | $ | | ||||||||||
Fixed rate notes of VIE (2) |
162,755 | 45,884 | 116,871 | | | |||||||||||||||
Variable rate notes of VIE (3) |
196,400 | 26,400 | 170,000 | | | |||||||||||||||
Operating leases: |
||||||||||||||||||||
Real estate |
153,394 | 22,008 | 41,469 | 34,724 | 55,193 | |||||||||||||||
Equipment |
4,236 | 1,630 | 1,766 | 385 | 455 | |||||||||||||||
Capital leases |
- 29 -
Payments due by period | ||||||||||||||||||||
Less Than | 1-3 | 3-5 | More Than 5 | |||||||||||||||||
Total | 1 Year | Years | Years | Years | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
Purchase obligations(4) |
2,501 | 2,248 | 253 | | | |||||||||||||||
Total contractual cash obligations |
$ | 625,190 | $ | 98,325 | $ | 436,108 | $ | 35,109 | $ | 55,648 | ||||||||||
(1) | If the outstanding balance as of January 31, 2010 and the interest rate in effect at that time were to remain the same over the remaining life of the facility, interest expense on the facility would be approximately $3.1 million and $1.6 million for the fiscal years ended January 31, 2011 and 2012, respectively. | |
(2) | Includes interest payments due on the notes. | |
(3) | The $200 million 2002 Series A variable funding note is renewable at our option until August 2011. If the outstanding balance as of January 31, 2010 and the interest rate in effect at that time were to remain the same over the remaining lives of the notes, interest expense on the notes would be approximately $5.6 million and $2.8 million for the fiscal years ended January 31, 2011 and 2012, respectively. | |
(4) | 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. |
- 30 -