a6120367.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549


FORM 10-Q/A

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended October 31, 2009
Commission File Number 000-50421
 
CONN'S, INC.
(Exact name of registrant as specified in its charter)
 
A Delaware Corporation
06-1672840
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification Number)
 
3295 College Street
Beaumont, Texas 77701
(409) 832-1696
(Address, including zip code, and telephone
number, including area code, of registrant's
principal executive offices)

NONE
(Former name, former address and former
fiscal year, if changed since last report)

Indicate by check mark whether the registrant (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes [ x ]   No [   ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes [   ]   No [   ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):
Large accelerated filer [   ]  Accelerated filer [ x ]  Non-accelerated filer [   ]  smaller reporting company [   ]
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes [   ]  No [ x ]

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of November 23, 2009:
 
       
    Class
  
Outstanding
  
    Common stock, $.01 par value per share
    22,462,565  
 
 
EXPLANATORY NOTE
 
Correction of Consolidated Financial Statements
 
We are amending our Quarterly Report on Form 10-Q (the "Original Filing") for the quarter ended October 31, 2009, to correct mistakes in our consolidated balance sheet as of October 31, 2009 and our consolidated statement of cash flows for the nine months ended October 31, 2009 filed with our Quarterly Report on Form 10-Q for the quarter ended October 31, 2009, which was filed with the Securities and Exchange Commission on November 25, 2009. This amendment and correction are necessitated by a typographical error in the consolidated balance sheets, specifically in the line entitled "Common stock", which led to the omission of those balances from the balance sheets, and typographical errors in the consolidated statement of cash flows, specifically on those lines in "Cash flows from operating activities" titled "(Gains) losses on interest in securitized assets" and "Changes in operating assets and liabilities - Inventory" and "Changes in operating assets and liabilities - Deferred revenues and allowances" where a close parentheses punctuation mark was inadvertently included at the end of each line.
 
All of the information in this Form 10-Q/A is as of October 31, 2009 and does not reflect any subsequent information or events other than the correction indicated above. Only the following items have been amended as a result of the correction:
 
Part I - Item 1 - Financial Statements, Consolidated Balance Sheets, Page 1
Part I - Item 1 - Financial Statements, Consolidated Statements of Cash Flows, Page 4
 
Other than as discussed above, this Form 10-Q/A does not reflect events occurring after the filing of the Original Filing or modify or update disclosures (including the exhibits to the Original Filing) affected by subsequent events. Accordingly, this Form 10-Q/A should be read in conjunction with our periodic filings made with the Securities and Exchange Commission subsequent to the date of the Original Filing, including any amendments to those filings. In addition, this Form 10-Q/A includes updated certifications from our Chief Executive Officer and Chief Financial Officer as Exhibits 31.1, 31.2, and 32.1.
 
 
TABLE OF CONTENTS
 
 
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Conn's, Inc.
  
 
(in thousands, except share data)
  
Assets
  
January 31,
2009
    
October 31,
2009
  
Current assets
        
(unaudited)
  
Cash and cash equivalents
   $ 11,798     $ 10,582  
Other accounts receivable, net of allowance of $60 and $63, respectively
     32,878       19,611  
Customer accounts receivable, net of allowance of $2,338 and $6,207 respectively
     61,125       136,600  
Interests in securitized assets
     176,543       149,366  
Inventories
     95,971       71,698  
Deferred income taxes
     13,354       15,070  
Prepaid expenses and other assets
     5,933       17,475  
      Total current assets
    397,602       420,402  
Long-term portion of customer accounts receivable, net of
                
    allowance of $1,575 and $3,632, respectively
     41,172       79,934  
Property and equipment
                
Land
     7,682       7,682  
Buildings
     12,011       14,263  
Equipment and fixtures
     21,670       22,898  
Transportation equipment
     2,646       2,413  
Leasehold improvements
     83,361       88,719  
      Subtotal
     127,370       135,975  
Less accumulated depreciation
     (64,819 )     (74,364 )
      Total property and equipment, net
     62,551       61,611  
Goodwill, net
     9,617       -  
Non-current deferred income tax asset
     2,035       3,830  
Other assets, net
     3,652       3,344  
       Total assets
   $ 516,629     $ 569,121  
Liabilities and Stockholders' Equity
                
Current liabilities
                
Current portion of long-term debt
   $ 5     $ 156  
Accounts payable
     57,809       40,845  
Accrued compensation and related expenses
     11,473       5,935  
Accrued expenses
     23,703       35,225  
Income taxes payable
     4,334       2,294  
Deferred revenues and allowances
     15,505       15,530  
      Total current liabilities
     112,829       99,985  
Long-term debt
     62,912       125,308  
Other long-term liabilities
     5,702       5,396  
Fair value of interest rate swaps
     -       328  
Deferred gains on sales of property
     1,036       937  
Stockholders' equity
                
Preferred stock ($0.01 par value, 1,000,000 shares authorized; none issued or outstanding)
     -       -  
Common stock ($0.01 par value, 40,000,000 shares authorized;
                
24,167,445 and 24,185,770 shares issued at January 31, 2009 and October 31, 2009, respectively)     242       242  
Additional paid-in capital
     103,553       105,587  
Accumulated other comprehensive loss
     -       (213 )
Retained earnings
     267,426       268,622  
Treasury stock, at cost, 1,723,205 shares
     (37,071 )     (37,071 )
      Total stockholders' equity
     334,150       337,167  
         Total liabilities and stockholders' equity
   $ 516,629     $ 569,121  
 
See notes to consolidated financial statements.
 
1
 
Conn's, Inc.
  
 
(unaudited)
  
(in thousands, except earnings per share)
  
                         
   
Three Months Ended
October 31,
    
Nine Months Ended
October 31,
  
                         
   
2008
    
2009
    
2008
    
2009
  
                         
                         
Revenues
                        
Product sales
   $ 160,253     $ 148,463     $ 515,404     $ 508,669  
Repair service agreement commissions, net
     8,547       7,320       28,428       25,968  
Service revenues
     5,129       5,599       15,809       17,195  
                                 
Total net sales
     173,929       161,382       559,641       551,832  
                                 
Finance charges and other
     25,567       25,184       81,224       84,790  
Net decrease in fair value
     (15,750 )     (3,731 )     (20,029 )     (2,250 )
                                 
Total finance charges and other
     9,817       21,453       61,195       82,540  
                                 
Total revenues
     183,746       182,835       620,836       634,372  
                                 
Cost and expenses
                                
Cost of goods sold, including warehousing
                                
  and occupancy costs
     127,007       120,963       402,853       407,594  
Cost of parts sold, including warehousing
                                
  and occupancy costs
     2,479       2,672       7,073       8,056  
Selling, general and administrative expense
     62,361       65,548       185,629       193,040  
Goodwill impairment
     -       9,617       -       9,617  
Provision for bad debts
     2,802       3,504       3,394       7,645  
                                 
Total cost and expenses
     194,649       202,304       598,949       625,952  
                                 
Operating income (loss)
     (10,903 )     (19,469 )     21,887       8,420  
Interest expense, net
     468       1,281       368       2,809  
Other (income) expense, net
     (4 )     (33 )     102       (54 )
                                 
Income (loss) before income taxes
     (11,367 )     (20,717 )     21,417       5,665  
                                 
Provision (benefit) for income taxes
     (3,625 )     (5,443 )     8,351       4,469  
                                 
Net income (loss)
   $ (7,742 )   $ (15,274 )   $ 13,066     $ 1,196  
                                 
Earnings (loss) per share
                                
Basic
   $ (0.35 )   $ (0.68 )   $ 0.58     $ 0.05  
Diluted
   $ (0.35 )   $ (0.68 )   $ 0.58     $ 0.05  
Average common shares outstanding
                                
Basic
     22,422       22,459       22,404       22,453  
Diluted
     22,422       22,459       22,604       22,658  
 
See notes to consolidated financial statements.
 
2
 
Conn's, Inc.
  
 
Nine Months Ended October 31, 2009
  
(unaudited)
  
(in thousands, except descriptive shares)
  
                                           
                     
Other
                    
               
Additional
    
Compre-
                    
   
Common Stock
    
Paid-in
    
hensive
    
Retained
    
Treasury
        
   
Shares
    
Amount
    
Capital
    
Loss
    
Earnings
    
Stock
    
Total
  
                                           
Balance January 31, 2009
     24,167     $ 242     $ 103,553     $ -     $ 267,426     $ (37,071 )   $ 334,150  
 
                                                        
                                                         
Issuance of shares of common
                                                        
stock under Employee
                                                        
Stock Purchase Plan
     19               165                               165  
                      -                                  
Stock-based compensation
                     1,869                               1,869  
                                                         
Net income
                                     1,196               1,196  
                                                         
Adjustment of fair value of
                                                        
interest rate swaps
                                                        
net of tax of $81
                             (213 )                     (213 )
Total comprehensive income
                                                        
(Total comprehensive loss of
                                                        
of $15,337 for three months
                                                        
ended October 31, 2009)
                                                     983  
                                                         
Balance October 31, 2009
     24,186     $ 242     $ 105,587     $ (213 )   $ 268,622     $ (37,071 )   $ 337,167  
 
See notes to consolidated financial statements.
 
3
 
Conn’s, Inc.
  
 
(unaudited) (in thousands)
  
   
Nine Months Ended
October 31,
  
   
2008
    
2009
  
             
Cash flows from operating activities
            
Net income
   $ 13,066     $ 1,196  
Adjustments to reconcile net income to net cash used in operating activities:
                
Depreciation
     9,462       10,062  
Amortization / (Accretion), net
     (234 )     833  
Provision for bad debts
     3,394       7,645  
Stock-based compensation
     2,465       1,869  
Goodwill impairment
     -       9,617  
Discounts on promotional credit
     4,254       3,220  
(Gains) losses on interest in securitized assets
     (17,090 )     5,165  
(Increase) decrease in fair value of securitized assets
     20,029       2,250  
Provision for deferred income taxes
     (9,276 )     (2,520 )
(Gains) losses on sales of property and equipment
     77       (79 )
Changes in operating assets and liabilities:
                
Customer accounts receivable
     (81,325 )     (123,867 )
Other accounts receivable
     6,310       13,267  
Interest in securitized assets
     9,205       17,741  
Inventory
     (24,844 )     24,273  
Prepaid expenses and other assets
     (3,249 )     (1,113 )
Accounts payable
     34,050       (16,964 )
Accrued expenses
     7,243       5,984  
Income taxes payable
     185       (13,345 )
Deferred revenue and allowances
     2,984       304  
Net cash used in operating activities
    (23,294 )     (54,462 )
Cash flows from investing activities
                
Purchases of property and equipment
     (14,971 )     (8,627 )
Proceeds from sales of property
     212       57  
Net cash used in investing activities
     (14,759 )     (8,570 )
Cash flows from financing activities
                
Proceeds from stock issued under employee benefit plans
     745       165  
Excess tax benefits from stock-based compensation
     39       -  
Borrowings under lines of credit
     95,334       220,447 )
Payments on lines of credit
     (61,934 )     (158,347 )
Increase in deferred financing costs
     (2,772 )     (423 )
Payment of promissory notes
     (91 )     (26 )
Net cash provided by financing activities
     31,321       61,816  
Net change in cash
     (6,732 )     (1,216 )
Cash and cash equivalents
                
Beginning of the year
     11,015       11,798  
End of period
  $ 4,283     $ 10,582  
                 
Supplemental disclosure of non-cash activity
                
Cash interest received from interests in securitized assets
   $ 23,146     $ 32,712  
Cash proceeds from new securitizations
     243,619       114,669  
Cash flows from servicing fees
     19,462       18,169  
Purchases of property and equipment financed by notes payable
     -       473  
 
See notes to consolidated financial statements.
 
4
 
Conn’s , Inc.  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
October 31, 2009

1.  Summary of Significant Accounting Policies
 
Basis of Presentation. The accompanying unaudited, condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. The accompanying financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. All such adjustments are of a normal recurring nature, except as otherwise described herein.  Operating results for the three and nine month period ended October 31, 2009, are not necessarily indicative of the results that may be expected for the fiscal year ending January 31, 2010.  The financial statements should be read in conjunction with the Company’s (as defined below) audited consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K filed on March 26, 2009.

The Company’s balance sheet at January 31, 2009, has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial presentation.  Please see the Company’s Form 10-K for the fiscal year ended January 31, 2009, for a complete presentation of the audited financial statements at that date, together with all required footnotes, and for a complete presentation and explanation of the components and presentations of the financial statements.

Principles of Consolidation. The consolidated financial statements include the accounts of Conn’s, Inc. and all of its wholly-owned subsidiaries (the Company).  All material intercompany transactions and balances have been eliminated in consolidation.

The Company enters into securitization transactions to sell eligible retail installment and revolving customer receivables and retains servicing responsibilities and subordinated interests. These securitization transactions are accounted for as sales because the Company has relinquished control of the receivables. Additionally, the Company has transferred the receivables to a qualifying special purpose entity (QSPE). Accordingly, neither the transferred receivables nor the accounts of the QSPE are included in the consolidated financial statements of the Company. The Company's retained interest in the transferred receivables is recorded at fair value. The Company elected the fair value option because it believes that the fair value option provides a more easily understood presentation for financial statement users. The fair value option simplifies the treatment of changes in the fair value of the asset, by reflecting all changes in the fair value of its Interests in securitized assets in current earnings, in Finance charges and other.

Fair Value of Financial Instruments.    The fair value of cash and cash equivalents, receivables retained on our balance sheet, and accounts payable approximate their carrying amounts because of the short maturity of these instruments. The fair value of the Company’s interests in securitized receivables is determined by estimating the present value of future expected cash flows using management’s best estimates of the key assumptions, including credit losses, forward yield curves and discount rates commensurate with the risks involved. See Note 3. The fair value of the Company’s long-term debt is determined by estimating the present value of future cash flows as if the debt were being carried at the interest rate the Company would currently incur if it were to complete a similar transaction.  The fair value of the Company’s long-term debt as of October 31, 2009 was approximately $121.1 million, based on the assumption that the interest spread would be approximately 200 basis points higher than the current spread in the revolving facility. The carrying amount of the long-term debt as of October 31, 2009 was approximately $125.3 million. The Company’s interest rate swaps are presented on the balance sheet at fair value.

Provision / (Benefit) for Income Taxes.    The provision (benefit) for income taxes for the three months and nine months ended October 31, 2009, were impacted primarily by the change in pre-tax income. The effective tax rate was higher during the 2009 period because taxes for the state of Texas are based on gross margin, and, as a result, partially offset the benefit for income taxes due to our loss before income taxes in the current year periods.  Additionally, the Company is uncertain as to what amount of its litigation reserves will be ultimately deductible for taxes and, as such, approximately $1.6 million of tax benefit related to that expense has not yet been recognized.
 
5

Use of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.  Actual results could differ from those estimates. See the discussion under Note 3 regarding the changes in the inputs used in the Company’s valuation of its Interests in securitized assets.

Earnings(Loss) Per Share. The Company calculates basic earnings per share by dividing net income (loss) by the weighted average number of common shares outstanding. Diluted earnings per share include the dilutive effects of any stock options granted, as calculated under the treasury-stock method. The weighted average number of anti-dilutive stock options not included in calculating diluted EPS was 1.1 million for the three and nine months ended October 31, 2008 and 1.5 million for the three and nine months ended October 31, 2009. Due to the net loss incurred for the three months ended October 31, 2008 and the three months ended October 31, 2009, no stock options were included in the computation of diluted loss per share. 209,706 and 166,438 stock options for the 2008 and 2009 period, respectively, were excluded from the calculation of diluted EPS for the quarter. The following table sets forth the shares outstanding for the earnings (loss) per share calculations:

The following table sets forth the shares outstanding for the earnings (loss) per share calculations:
 
   
Three Months Ended
  
   
October 31,
  
   
2008
    
2009
  
             
Common stock outstanding, net of treasury stock, beginning of period
     22,410,400       22,457,486  
Weighted average common stock issued in stock option exercises
     10,076       -  
Weighted average common stock issued to employee stock purchase plan
     1,512       1,767  
Shares used in computing basic earnings (loss) per share
     22,421,988       22,459,253  
Dilutive effect of stock options, net of assumed repurchase of treasury stock
     -       -  
Shares used in computing diluted earnings (loss) per share
     22,421,988       22,459,253  
                 
                 
   
Nine Months Ended
  
   
October 31,
  
      2008       2009  
                 
Common stock outstanding, net of treasury stock, beginning of period
     22,374,966       22,444,240  
Weighted average common stock issued in stock option exercises
     23,022       -  
Weighted average common stock issued to employee stock purchase plan
     6,002       9,189  
Shares used in computing basic earnings per share
     22,403,990       22,453,429  
Dilutive effect of stock options, net of assumed repurchase of treasury stock
     200,379       204,729  
Shares used in computing diluted earnings per share
     22,604,369       22,658,158  
 
Reclassifications. Certain reclassifications have been made in the prior year’s financial statements to conform to the current year’s presentation. The Company reclassified approximately $5.7 million from Deferred revenues and allowances in current liabilities to Other long-term liabilities. This represents the amount of deferred revenues on tenant improvement allowances that will be realized beyond 12 months.
 
Adoption of New Accounting Pronouncements. In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification™ and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162” (“ASC 105-10-65/FAS 168”). The standard establishes the FASB Accounting Standards Codification™ (the “Codification” or “ASC”) as the single source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP, and is intended to simplify user access to all authoritative GAAP by providing all the authoritative literature related to a particular topic in one place. Subsequently, the Codification will require companies to change how they reference GAAP throughout the financial statements.  The Company has adopted the Codification which became effective in the current quarter and has provided the pre-Codification reference along with the related ASC references to allow readers an opportunity to see the impact of the Codification on its financial statements and disclosures.
 
6

On February 1, 2009, the Company was required to adopt SFAS 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133, (“ASC 815-10-65/SFAS 161”). This statement is intended to improve transparency in financial reporting by requiring enhanced disclosures of an entity's derivative instruments and hedging activities and their effects on the entity's financial position, financial performance, and cash flows. ASC 815-10-65/SFAS 161 applies to all derivative instruments within the scope of SFAS 133, as well as related hedged items, bifurcated derivatives, and non-derivative instruments that are designated and qualify as hedging instruments. ASC 815-10-65/FAS 161 only impacts disclosure requirements and therefore will not have an impact on the Company’s financial position, financial performance or cash flows. The required disclosures have been included in Note 6 to the financial statements.
 
In April 2009, the FASB issued FSP FAS 107-1 and Accounting Principles Board ("APB") Opinion No. 28-1 , Interim Disclosures about Fair Value of Financial Instruments, (“ASC 825-10-65/FSP 107-1 and APB 28-1”), which requires the Company to provide disclosures about fair value of financial instruments in each interim and annual period that financial statements are prepared. The Company adopted the provisions of ASC 825-10-65/FSP 107-1 and APB 28-1, which became effective for periods ending after June 15, 2009.
 
In May 2009, the FASB issued SFAS No. 165, Subsequent Events (“ASC 855-10/SFAS165”), which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The Company adopted the provisions of ASC 855-10/SFAS No. 165, which became effective for interim and annual reporting periods ending after June 15, 2009. Subsequent events have been evaluated through the date and time the financial statements were issued on November 25, 2009. No material subsequent events have occurred since October 31, 2009 that required recognition or disclosure in the Company’s current period financial statements.
 
Recently Issued Accounting Pronouncements. In June 2009, the FASB issued revised authoritative guidance to improve the relevance and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. After the effective date, the concept of a qualifying special-purpose entity will no longer be relevant for accounting purposes.  Therefore, formerly qualifying special-purpose entities (as defined under previous accounting standards) should be evaluated for consolidation by reporting entities on and after the effective date in accordance with the applicable consolidation guidance.  If the evaluation on the effective date results in consolidation, the reporting entity should apply the transition guidance provided in the pronouncement that requires consolidation. The new FASB-issued authoritative guidance is effective for fiscal years beginning after November 15, 2009. The Company is currently evaluating the impact that the adoption will have on its consolidated financial statements as it relates to its qualifying special purpose entity, and the adoption could result in the Company’s QSPE, which is currently recorded off-balance sheet, being consolidated in the Company’s balance sheet, in addition to potential changes in the Company’s statement of operations.
 
In June 2009, the FASB issued revised authoritative guidance to improve financial reporting by companies involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. This revised guidance would require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity. This analysis identifies the primary beneficiary of a variable interest entity as the enterprise that has both of the following characteristics:
 
 
a.
The power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance
 
b.
The obligation to absorb losses of the entity that could potentially be significant to the variable interest entity or the right to receive benefits from the entity that could potentially be significant to the variable interest entity.
 
7

The new FASB-issued authoritative guidance is effective for fiscal years beginning after November 15, 2009. The Company is currently evaluating the impact that the adoption of this revised guidance will have on its consolidated financial statements, specifically as it relates to its qualifying special purpose entity.
 
2.  Goodwill

Goodwill represents the excess of consideration paid over the fair value of tangible and identifiable intangible net assets acquired in connection with the acquisitions of certain of the Company’s insurance and finance operations. The Company performs an assessment annually in the fourth quarter testing for the impairment of goodwill, or at any other time when impairment indicators exist. As a result of the sustained decline in the Company’s market capitalization, the increasingly challenging economic environment during the current year third quarter, and its impact on the Company’s comparable store sales, credit portfolio performance and operating results, the Company determined that an interim goodwill impairment test was necessary during the current year third quarter.

A two-step method was utilized for determining goodwill impairment. The valuation of the Company was performed utilizing the services of outside valuation consultants using both an income approach utilizing discounted debt-free cash flows of the Company and comparable valuation multiples. Upon completion of the impairment test, the Company concluded that the carrying value of the Company’s recorded goodwill was impaired. As a result, the Company recorded a goodwill impairment charge of $9.6 million in the current year third quarter, reducing the balance of goodwill on its balance sheet to zero.

3.  Fair Value of Interests in Securitized Assets

The Company estimates the fair value of its Interests in securitized assets using a discounted cash flow model with most of the inputs used being unobservable inputs. The primary unobservable inputs, which are derived principally from the Company’s historical experience, with input from its investment bankers and financial advisors, include the estimated portfolio yield, credit loss rate, discount rate and payment rate and reflect the Company’s judgments about the assumptions market participants would use in determining fair value. In determining the cost of borrowings, the Company uses current actual borrowing rates, and adjusts them, as appropriate, using interest rate futures data from market sources to project interest rates over time. Changes in the inputs over time, including varying credit portfolio performance, market interest rate changes, market participant risk premiums required, or a shift in the mix of funding sources, could result in significant volatility in the fair value of the Interest in securitized assets, and thus the earnings of the Company.

For the three and nine months ended October 31, 2009, Finance charges and other included a non-cash decrease in the fair value our Interests in securitized assets of $3.7 million and $2.2 million, respectively, reflecting primarily a higher weighted-average loss rate included in the inputs during the three months ended October 31, 2009. Based on the Company’s current loss rate expectations and the additional risk premium that a market participant would require on that loss rate, the Company estimated that a market participant would require a loss rate input that was approximately 100 basis points higher than what was utilized at July 31, 2009.  As a result the Company increased the weighted-average loss rate from 4.0% at July 31, 2009 to 5.0% at October 31, 2009. This was partially offset by a lower risk premium included in the discount rate inputs during the nine months ended October 31, 2009. Based on a review of the changes in market risk premiums during the nine months ended October 31, 2009, and discussions with its investment bankers and financial advisors, the Company estimated that a market participant would require a risk premium that was approximately 100 basis points less than was utilized at July 31, 2009, and 550 basis points less than was utilized at January 31, 2009. As a result, the Company decreased the weighted average discount rate input from 30.0% at January 31, 2009 to 25.5% at July 31, 2009, and to 24.3% at October 31, 2009, after reflecting a 3 basis point decrease in the risk-free interest rate included in the discount rate input at July 31, 2009, and a further 11 basis point decrease at October 31, 2009. These changes, along with changes in the funding mix inputs utilized, representing changes in the portion of Company-provided financing as opposed to the funding obtained by the QSPE from third-party sources, and other input changes which decreased the fair value, resulted in a decrease in fair value for the nine month period ended October 31, 2009 (see reconciliation of the balance of interests in securitized assets below). The changes in fair value resulted in a decrease in Income before taxes of $3.7 million and $2.2 million, a decrease in net income of $2.4 million and $1.5 million for the three and nine months ended October 31, 2009, respectively, and a decrease in basic and diluted earnings per share of $0.11 and $0.06 for the three and nine months ended October 31, 2009.
 
8
 
If a market participant were to require a return on investment that is 10% higher than estimated in the Company’s calculation, the fair value of its interest in securitized assets would be decreased by $3.4 million as of October 31, 2009. The Company will continue to monitor financial market conditions and, each quarter, as it reassesses the inputs used, may adjust its inputs up or down, including the risk premiums it estimates a market participant would use. As the financial markets and general economic conditions fluctuate, the Company will likely be required to record additional non-cash gains and losses in future periods.

The Company uses a discounted cash flow model to estimate its servicing liability using the portfolio performance and discount rate assumptions discussed above, and an estimate of the servicing fee a market participant would require to service the portfolio. There is risk to the Company that the expenses incurred to service the portfolio would exceed the amount of liability recorded.

The following is a reconciliation of the beginning and ending balances of the Interests in securitized assets and the beginning and ending balances of the servicing liability for the three months ended October 31, 2008 and 2009 (in thousands):
 
   
Three Months Ended
  
   
October 31,
  
   
2008
    
2009
  
Reconciliation of Interests in Securitized Assets:
            
             
 Balance of Interests in securitized assets at beginning of period
   $ 177,648     $ 164,090  
                 
 Amounts recorded in Finance charges and other:
                
 Gains (losses) associated with changes in portfolio balances
     (45 )     846  
 Changes in fair value due to assumption changes:                
 Fair value increase (decrease) due to changing portfolio yield
     (672 )     (1,055 )
 Fair value increase (decrease) due to lower (higher) projected interest rates
     310       251  
 Fair value increase (decrease) due to lower (higher) projected loss rates
     (3,767 )     (3,691 )
 Fair value increase (decrease) due to changes in funding mix
     (2,749 )     (1,619 )
 Fair value increase (decrease) due to change in risk-free interest rate
                
     component of discount rate
     1,671       164  
 Fair value increase (decrease) due to change in risk premium included
                
  in discount rate
     (11,252 )     1,452  
 Other changes     553       (173 ) 
 Net change in fair value due to assumption changes
     (15,906 )     (4,671 )
                 
 Net losses included in Finance charges and other (a)
     (15,951 )     (3,825 )
                 
Change in balance of subordinated security and equity interest due to
                
transfers of receivables
     492       (10,899 )
                 
 Balance of Interests in securitized assets at end of period
   $ 162,189     $ 149,366  
                 
Reconciliation of Servicing Liability:
                
                 
Balance of servicing liability at beginning of period
   $ 1,279     $ 985  
                 
Amounts recorded in Finance charges and other:
                
Increase (decrease) associated with change in portfolio balances
     (134 )     (71 )
Increase (decrease) due to change in discount rate
     (46 )     7  
Other changes     (21 )      (30 ) 
Net change included in Finance charges and other (b)
     (201 )     (94 )
                 
Balance of servicing liability at end of period
   $ 1,078     $ 891  
                 
Net decrease in fair value included
                
in Finance charges and other (a) - (b)
   $ (15,750 )   $ (3,731 )
 
9
 
The following is a reconciliation of the beginning and ending balances of the Interests in securitized assets and the beginning and ending balances of the servicing liability for the nine months ended October 31, 2008 and 2009 (in thousands):
 
   
Nine Months Ended
  
   
October 31,
  
   
2008
    
2009
  
Reconciliation of Interests in Securitized Assets:
            
             
 Balance of Interests in securitized assets at beginning of period
   $ 178,150     $ 176,543  
                 
 Amounts recorded in Finance charges and other:
                
Gains associated with changes in portfolio balances
     122       1,527  
Changes in fair value due to assumption changes:
                
 Fair value increase (decrease) due to changing portfolio yield
     (1,488 )     (1,531 )
 Fair value increase (decrease) due to lower (higher) projected interest rates
    187       384  
 Fair value increase (decrease) due to lower (higher) projected loss rates
     (3,767 )     (3,691 )
 Fair value increase (decrease) due to changes in funding mix
     (1,496 )     (6,505 )
 Fair value increase (decrease) due to change in risk-free interest rate
                
     component of discount rate
     1,433       187  
 Fair value increase (decrease) due to change in risk premium included
                
     in discount rate
     (16,380 )     7,949  
Other changes
     1,241       (836 )
Net change in fair value due to assumption changes
     (20,270 )     (4,043 )
                 
Net losses included in Finance charges and other (a)
     (20,148 )     (2,516 )
                 
Change in balance of subordinated security and equity interest due to
                
transfers of receivables
     4,187       (24,661 )
                 
 Balance of Interests in securitized assets at end of period
   $ 162,189     $ 149,366  
                 
Reconciliation of Servicing Liability:
                
                 
Balance of servicing liability at beginning of period
   $ 1,197     $ 1,157  
                 
Amounts recorded in Finance charges and other:
                
Increase (decrease) associated with change in portfolio balances
     (48 )     (250 )
Increase (decrease) due to change in discount rate
     (66 )     37  
Other changes
     (5 )     (53 )
Net change included in Finance charges and other (b)
     (119 )     (266 )
                 
Balance of servicing liability at end of period
   $ 1,078     $ 891  
                 
Net decrease in fair value included
                
in Finance charges and other (a) - (b)
   $ (20,029 )   $ (2,250 )
 
10
 
4.      Supplemental Disclosure of Revenue
 
The following is a summary of the classification of the amounts included as Finance charges and other for the three and nine months ended October 31, 2008 and 2009 (in thousands):
 
   
Three Months ended
    
Nine Months ended
  
   
October 31,
    
October 31,
  
   
2008
    
2009
    
2008
    
2009
  
                         
Securitization income:
                        
Servicing fees received
   $ 6,602     $ 5,548     $ 19,462     $ 18,169  
Gains (losses) on sale of receivables, net
     1,682       (3,807 )     17,090       (5,165 )
Change in fair value of securitized assets
     (15,750 )     (3,731 )     (20,029 )     (2,250 )
Interest earned on retained interests
     8,314       9,710       23,146       32,712  
Total securitization income
     848       7,720       39,669       43,466  
Insurance commissions
     4,396       3,355       15,336       13,056  
Interest income from receivables not sold and other
     4,573       10,378       6,190       26,018  
Finance charges and other
   $ 9,817     $ 21,453     $ 61,195     $ 82,540  
 
5.      Interests in Securitized Receivables

The Company has an agreement to sell customer receivables.  As part of this agreement, the Company sells eligible retail installment contracts and revolving receivable accounts to a QSPE that pledges the transferred accounts to a trustee for the benefit of investors. The following table summarizes the availability of funding under the Company’s securitization program at October 31, 2009 (in thousands):
 
   
Capacity
    
Utilized
    
Available
  
2002 Series A
   $ 200,000     $ 188,000     $ 12,000  
2006 Series A – Class A
     90,000       90,000       -  
2006 Series A – Class B
     43,333       43,333       -  
2006 Series A – Class C
     16,667       16,667       -  
Total
   $ 350,000     $ 338,000     $ 12,000  
 
The 2002 Series A program functions as a credit facility to fund the initial transfer of eligible receivables. When the facility approaches a predetermined amount, the QSPE (Issuer) is required to seek financing to pay down the outstanding balance in the 2002 Series A variable funding note. The amount paid down on the facility then becomes available to fund the transfer of new receivables or to meet required principal payments on other series as they become due. The new financing could be in the form of additional notes, bonds or other instruments as the market and transaction documents might allow. The 2002 Series A program consists of $200 million that is renewable annually, at our option, until September 2012. The 2006 Series A program, which was consummated in August 2006, is non-amortizing for the first four years and officially matures in April 2017. However, it is expected that the principal payments, which begin in September 2010, will retire the bonds prior to that date.

The agreement contains certain covenants requiring the maintenance of various financial ratios and receivables performance standards. The Issuer was in compliance with the covenants at October 31, 2009. Additionally, the agreement contains cross-default provisions, such that, any default under another credit facility of the Company or the Issuer would result in a default under this agreement, and any default under this agreement would result in a default under those agreements. Based on recent declines in the economic conditions in the Company’s markets and the related impacts on its operating results, there is a reasonable likelihood that the Company could trigger the default provisions of its credit facilities beginning January 31, 2010, unless it is able to sufficiently improve operating trends, reduce the amount of debt outstanding on its balance sheet or amend the covenants contained in its and the QSPE’s credit facilities prior to January 31, 2010. Any amendment to the credit facilities would likely result in higher borrowing costs, among other potential requirements. 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 the Company’s and QSPE’s credit facilities. If the repayment of amounts owed under the Company's credit facility is accelerated, it may not have sufficient cash and liquid assets at such time to be able to immediately repay all the amounts owed under the facility. Any repayment requirement or acceleration of amounts owed could have a material adverse affect on the business operations of the Company.
 
11

As part of the securitization program, the Company and Issuer arranged for the issuance of a stand-by letter of credit in the amount of $20.0 million to provide assurance to the trustee on behalf of the bondholders that funds collected monthly by the Company, as servicer, will be remitted as required under the base indenture and other related documents. The letter of credit expires in August 2010, and the maximum potential amount of future payments is the face amount of the letter of credit. The letter of credit is callable, at the option of the trustee, if the Company, as servicer, fails to make the required monthly payments of the cash collected to the trustee.

Through its retail sales activities, the Company generates customer retail installment contracts and revolving receivable accounts. The Company enters into securitization transactions to sell eligible accounts to the QSPE. In these securitizations, the Company retains servicing responsibilities and subordinated interests. The Company receives annual servicing fees and other benefits approximating 4.0% of the outstanding balance and rights to future cash flows arising after the investors in the securities issued by or on behalf of the QSPE have received from the trustee all contractually required principal and interest amounts. The Company records a servicing liability related to the servicing obligations (See Note 3). The investors and the securitization trustee have no recourse to the Company’s other assets for failure of the individual customers of the Company and the QSPE to pay when due. The Company’s retained interests are subordinate to the investors’ interests, and would not be paid if the Issuer is unable to repay the amounts due under the 2002 Series A and 2006 Series A programs. Their value is subject to credit, prepayment, and interest rate risks on the transferred financial assets.

The fair values of the Company’s interest in securitized assets were as follows (in thousands):
 
   
January 31,
    
October 31,
  
   
2009
    
2009
  
Interest-only strip
   $ 31,958     $ 19,061  
Subordinated securities
     144,585       130,305  
Total fair value of interests in securitized assets
   $ 176,543     $ 149,366  
                 
 
The table below summarizes valuation assumptions used for each period presented:
 
   
January 31,
    
October 31,
  
   
2009
    
2009
  
Net interest spread
            
Primary installment
     14.5 %     14.4 %
Primary revolving
     14.5 %     14.4 %
Secondary installment
     14.1 %     12.5 %
Expected losses
                
Primary installment
     3.4 %     4.5 %
Primary revolving
     3.4 %     4.5 %
Secondary installment
     5.5 %     6.5 %
Projected expense
                
Primary installment
     3.9 %     4.0 %
Primary revolving
     3.9 %     4.0 %
Secondary installment
     3.9 %     4.0 %
Discount rates
                
Primary installment
     29.2 %     23.7 %
Primary revolving
     29.2 %     23.7 %
Secondary installment
     33.2 %     27.7 %
 
12
 
At October 31, 2009, key economic assumptions and the sensitivity of the current fair value of the interests in securitized assets to immediate 10% and 20% adverse changes in those assumptions are as follows (dollars in thousands):
 
   
Primary
    
Primary
    
Secondary
  
   
Portfolio
    
Portfolio
    
Portfolio
  
   
Installment
    
Revolving
    
Installment
  
Fair value of interest in securitized assets
   $ 112,154     $ 8,668     $ 28,544  
                         
Expected weighted average life
  
1.3 years
    
1.3 years
    
1.8 years
  
                         
Net interest spread assumption
     14.4 %     14.4 %     12.5 %
Impact on fair value of 10% adverse change
   $ 3,547     $ 274     $ 1,044  
Impact on fair value of 20% adverse change
   $ 6,994     $ 541     $ 2,058  
Expected losses assumptions
     4.5 %     4.5 %     6.5 %
Impact on fair value of 10% adverse change
   $ 1,110     $ 86     $ 541  
Impact on fair value of 20% adverse change
   $ 2,211     $ 171     $ 1,075  
Projected expense assumption
     4.0 %     4.0 %     4.0 %
Impact on fair value of 10% adverse change
   $ 982     $ 76     $ 356  
Impact on fair value of 20% adverse change
   $ 1,964     $ 152     $ 711  
Discount rate assumption
     23.7 %     23.7 %     27.7 %
Impact on fair value of 10% adverse change
   $ 2,399     $ 185     $ 829  
Impact on fair value of 20% adverse change
   $ 4,683     $ 362     $ 1,612  
 
These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10% variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, the effect of the variation in a particular assumption on the fair value of the interest-only strip is calculated without changing any other assumption; in reality, changes in one factor may result in changes in another (i.e. increases in market interest rates may result in lower prepayments and increased credit losses), which might magnify or counteract the sensitivities.
 
13
 
The following tables present quantitative information about the receivables portfolios managed by the Company (in thousands):
 
   
Total Principal Amount of
    
Principal Amount Over
    
Principal Amount
  
   
Receivables
    
60 Days Past Due (1)
    
Reaged (1)
  
   
January 31,
    
October 31,
    
January 31,
    
October 31,
    
January 31,
    
October 31,
  
   
2009
    
2009
    
2009
    
2009
    
2009
    
2009
  
Primary portfolio:
                                    
            Installment
   $ 551,838     $ 556,535     $ 33,126     $ 42,694     $ 88,224     $ 88,152  
            Revolving
     38,084       36,553       2,027       2,083       2,401       1,912  
Subtotal
     589,922       593,088       35,153       44,777       90,625       90,064  
Secondary portfolio:
                                                
            Installment
     163,591       145,109       19,988       23,735       50,537       49,073  
Total receivables managed
     753,513       738,197       55,141       68,512       141,162       139,137  
Less receivables sold
     645,715       506,783       52,214       58,871       131,893       123,384  
Receivables not sold
     107,798       231,414     $ 2,927     $ 9,641     $ 9,269     $ 15,753  
Allowance for uncollectible accounts
     (3,913 )     (9,840 )                                
Allowances for promotional credit programs
     (1,588 )     (5,040 )                                
Current portion of customer accounts
                                                
receivable, net
     61,125       136,600                                  
Long-term customer accounts
                                                
receivable, net
   $ 41,172     $ 79,934                                  
                                                 
(1) Amounts are based on end of period balances and accounts could be represented in both the past due and reaged columns shown above.
  
 
               
Net Credit
                
Net Credit
  
   
Average Balances
    
Charge-offs (2)
    
Average Balances
    
Charge-offs (2)
  
   
Three Months Ended
    
Three Months Ended
    
Nine Months Ended
    
Nine Months Ended
  
   
October 31,
    
October 31,
    
October 31,
    
October 31,
  
   
2008
    
2009
    
2008
    
2009
    
2008
    
2009
    
2008
    
2009
  
 Primary portfolio:
                                                
            Installment
   $ 508,241     $ 558,195                 $ 485,951     $ 555,090              
            Revolving
     42,420       33,408                   44,375       33,614              
 Subtotal
     550,661       591,603     $ 3,849     $ 5,860       530,326       588,704     $ 10,859     $ 14,261  
 Secondary portfolio:
                                                                
            Installment
     151,783       152,705       2,098       2,236       151,883       155,003       5,179       5,840  
 Total receivables managed
     702,444       744,308       5,947       8,096       682,209       743,707       16,038       20,101  
 Less receivables sold
     644,447       553,550       5,748       6,977       653,735       575,407       15,473       18,069  
 Receivables not sold
   $ 57,997     $ 190,758     $ 199     $ 1,119     $ 28,474     $ 168,300     $ 565     $ 2,032  
                                                                 
                                                                 
(2) Amounts represent total credit charge-offs, net of recoveries, on total receivables.
                                  
 
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6.  Debt and Letters of Credit

On August 14, 2008, the Company entered into a $210 million asset-based revolving credit facility that provides funding based on a borrowing base calculation that includes accounts receivable and inventory. The facility matures in August 2011 and bears interest at LIBOR plus a spread ranging from 225 basis points to 275 basis points, based on a fixed charge coverage ratio. In addition to the fixed charge coverage ratio, the revolving credit facility includes a leverage ratio requirement, a minimum receivables cash recovery percentage requirement, a net capital expenditures limit and combined portfolio performance covenants. The Company was in compliance with the covenants at October 31, 2009. Additionally, the agreement contains cross-default provisions, such that, any default under another credit facility of the Company or its QSPE would result in a default under this agreement, and any default under this agreement would result in a default under those agreements. Based on recent declines in the economic conditions in the Company’s markets and the related impacts on its operating results, there is a reasonable likelihood that the Company could trigger the default provisions of its credit facilities beginning January 31, 2010, unless it is able to sufficiently improve operating trends, reduce the amount of debt outstanding on its balance sheet or amend the covenants contained in its and the QSPE’s credit facilities prior to January 31, 2010. Any amendment to the credit facilities would likely result in higher borrowing costs, among other potential requirements. 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 the Company’s and QSPE’s credit facilities. If the repayment of amounts owed under the Company's credit facility is accelerated, it may not have sufficient cash and liquid assets at such time to be able to immediately repay all the amounts owed under the facility. Any repayment requirement or acceleration of amounts owed could have a material adverse affect on the business operations of the Company.
 
Debt consisted of the following at the periods ended (in thousands):
 
   
January 31,
    
October 31,
  
   
2009
    
2009
  
             
             
Revolving credit facility for $210 million maturing in August 2011
   $ 62,900     $ 125,000  
Unsecured revolving line of credit for $10 million maturing in September 2009
     -       -  
Other long-term debt
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