Conn's Inc (CONN) 2003 Q3 法說會逐字稿

Good morning and thank you for holding. Welcome to the Conn's Inc. third quarter earnings conference call for fiscal year 2004.

My name is David and I will be your coordinator today.

During the presentation, all participants will be in a listen-only mode. If at any time during the call you require assistance, please key star, zero and a coordinator will be happy to assist you.

After the speakers' remarks, you'll be invited to participate in a question and answer session.

As a reminder, this conference is being recorded.

Your speakers today are Mr. Tommy Frank, Chairman and Chief Executive Officer of Conn's, Mr. Bill Frank, Executive Vice President and Chief Financial Officer of Conn's.

I'd like to now turn the conference over to Mr. Bill Frank. Please go ahead, sir.

Thank you, David and good morning to everyone and thank you for joining us.

By now you should have received a copy of our earnings release that was distributed after the market closed yesterday. That outlines our operational and financial results in the third quarter of fiscal year 2004. If for some reason you did not receive a copy of the release, you can download it from our Web site at www.conns.com Investor Relations.

In addition, certain financial and statistical information that will be discussed during this conference call has also been provided on that same Web site.

Finally, I must remind you that some of the statements made in this call are forward-looking statements within the meaning of the Securities and Exchange Act of 1934. These forward-looking statements represent the company's present expectations or beliefs concerning future events.

The company cautions that such statements are necessarily based on certain assumptions which are subject to risk and uncertainties which could cause actual results to differ materially from those indicated today.

These risk factors include but are not necessarily limited to the company's growth strategy and plans regarding opening new stores and entering new markets; the company's intention to update or expand existing stores; the company's estimated capital expenditures and cost related to the opening of new stores or to the update or expansion of existing stores; the company's cash flow from operations; borrowings from its revolving line of credit and proceeds from securitization to fund our operations; debt repayment and expansion, growth trends and projected sales in the home appliance and consumer electronic industry; and the company's ability to capitalize on such growth, relationships with company's key suppliers, the results of the company's litigation, interest rates, weather conditions in the company's markets, changes in the company's stock price and the actual number of shares of common stock outstanding.

Further information on these risk factors that I've enumerated is included in the company's filings with the SEC, including the company's current report on Form 8-K, which was filed last evening.

At this time, I would like to hand the call over to the host for today's call, Mr. Tommy Frank, Chairman and CEO of Conn's.

Tommy?

Well, I'd like to also thank all of you for joining and wish you a good morning. Overall, our Q3 results came in as expected. Our same store sales up 4.1% represented a return to same store sale increases that we've been accustomed to for a number of years.

As you know, Q1 and Q2 was represented or characterized by a nine-tenths of 1% decrease in same store sales. So, we were pleased to see that return of 4.1% in these same store sales.

As you look at what drove those same store sale increases, I think it's consistent with what was represented to you on the road show and that is our track concept and our betting definitely contributed to the growth of these same store sales.

If you look overall, those categories that I indicated would drive same store sales was about 28% of the same store sale increase. Additionally, we did an immense amount of promotional activities with gift cards and also heavy advertising, which aided in promoting same store sales.

As we look at overall sale increases and the components of that, certainly Dallas and Austin -- two markets for us that we had counted on heavily -- did contribute to our overall sales. If we go to Austin first, which had been a situation that had been troubling for us in Q1 and Q2. In Q3 we actually had a 33% increase in that Austin market.

Same store sales in that Austin market during Q3 was about 6.3% fiscal '04 over '03. So, we like what happened there and we're very encouraged.

In Dallas, we opened our first store in Q3 on September the 27th and we opened our second store on October the 25th in Q3. Both of those stores in that quarter performed at about 20% above our pro forma and our expectations. So, off to a very, very good start there.

As we look at the margin for the quarter, the gross profit margin was impacted somewhat by the expenditure of Dallas startup. We did not amortize or depreciate any startup costs in the Dallas market. So, we've been accustomed to absorbing that in the current operations. So, that was somewhat impacted by the -- the gross profit margin was -- by startup expenses that we incurred in carrying people and getting reading for opening those stores.

We also took some heavy margin hits in the Dallas metroplex in order to get those stores off to the great start that they did. So, if you look at margin, I think that what you'll see is that we discounted, we expensed those expenses for startup cost and we increased advertising cost.

Our credit operations remain essentially consistent with our past performance in Q3. As we look forward to Q4, I think we're off to a very, very good start. Our same store sales are, in fact, at or exceeding what we have experienced in Q3.

The margin, to the floor -- you know, there are several margins we're looking at. One is the overall margin of this company. And one margin to our retail store. The overall margin to our retail floor appears to be increasing nicely over the same quarter a year ago. And we're particularly excited about that.

Our new product categories are performing well. Our Austin market has continued to show increases and we, in fact, have opened our third store in the Dallas Fort Worth market on November the 19th of this year, which would have placed that in Q4.

Additionally, as we look forward to the new year coming up or the next quarter, we have five additional potential sites that are soft sites for us. And we have three sites that are hard sites that we have identified for Q1, Q2 and Q3 of fiscal '05 that those stores should occur.

So, our store openings -- our new store openings in that Dallas metroplex -- appear to be on track and well within the five to six additional stores that we represented to you that we would open. As we look at the challenges that are ahead of us, certainly on an ongoing basis, day to day it's expense control without a doubt.

And the challenges also exist in cross promotional activities as we continue to drive same store sales. And as we continue to increase sales overall and enter new markets, then cross promotional and promotional activities become very, very important in achieving and maximizing gross margin profits and gross margin percents.

Additionally, challenges our advertising expense. The last challenge we have is to continue the renewed pattern of growing same store sales quarter over quarter and continue to increase our profitability.

I would now turn the program over to Bill who will give you some additional in-depth insight into our performance.

Thank you, Tommy. As everyone obviously knows, we did close the IPO on December the 1st. And as we indicated in our S-1, we used the net proceeds that we received from that to pay down all significant debt except for approximately $5.5 million of the term loan under our bank credit facility and some minor non-interest bearing loans.

We now have available for general corporate purposes, our bank credit facility revolving loan of $40 million, subject to the qualifying assets that support that loan. And an $8 million unsecured line of credit with a local bank.

For the quarter, total revenues increased $10.1 million or 9.4% from $107.3 million in 2002 to $117.4 million in 2003. This increase came from two different areas. The first one, our net sales increased $9.4 million or roughly 10%, including a same store sales increase of 4.1%.

Finance charges and others increased $0.7 million or 4.9%. We did continue to see some price deterioration in our retail sales as volume increases of $30.6 million were offset by approximately $21.2 million from lower price points. Price deterioration occurred primarily in the home audio and video and computer categories.

Our off balance sheet credit portfolio of the qualified special purpose entity increased 10.4% from October 31st, 2002 to the same date in 2003. The increase in program costs that we incurred, however, of $1.1 million for that period or roughly 32% offset the increase in interest charges that we made to our customers of about $1.0 million.

And as we had discussed with most of you, I think, during our road show, that significant increase in program costs was a result of the restructuring of our asset backed securitization program in September of '02 when we fixed the rate on $200 million in bonds. And as you will recall, that was actually about a doubling. That fixed rate was a doubling of the previous variable rate that we were enjoying.

Our gross margins, as Tommy indicated, did decrease from 40.2% in last quarter to 38.1%. Again, the result of the fixing of that interest rate on that $200 million in bonds as well as some of the other items that affected product margins that Tommy has already alluded to.

Our product margins declined from 24.7% to 22.9%. Selling, general and administrative expense increased by about $2.0 million or 6.5% from $31.4 million in 2002 to $33.4 million in 2003. As a percentage of revenue, SG&A actually decreased, however, from 29.2% to 28.5%. And that's indicative of the cost controls that Tommy has alluded to where we're attempting to gain some economies of scale.

I would also point out that our entry into the Dallas Fort Worth market resulted in our absorption of additional expenses that we estimate to be about $0.9 million for the quarter. And that kind of breaks out -- $0.4 million resulted from additional advertising costs that we incurred and $0.5 million resulted in standby sales, delivery and service personnel cost.

And while our decision not to differ these costs or startup costs resulted in a lower operating margin for the quarter, we believe it positions us very favorably for the future as we continue to grow this Dallas Fort Worth marketplace and we've eliminated the need to amortize those startup costs.

Interest expense decreased significantly $1.6 million or about 66.5% from $2.4 million in 2002 to $0.8 million in 2003. Most of this decrease results from the reclassification of amounts that previously had been recorded in other comprehensive income. The application of FAS 133 and the expiration of $30 million in interest rate swap agreements.

And I think as we mentioned to most of you on the road show, going forward we have an additional $50 million of interest rate swap agreements that expired in November of '03. So, at this point going forward, we have $20 million in interest rate swap agreements remaining.

As a result of the items that we've previously discussed, pretax income increased $1.4 million for the quarter or 21.3% from $6.8 million in 2002 to $8.3 million in 2003. Net income available for common shareholders increased $0.9 million or 23.2% from $3.8 million in 2002 to $4.7 million in 2003.

Earnings per share calculated in accordance with GAAP increased from 23 cents in 2002 to 28 cents in 2003. Tommy talked to you about our credit portfolio and the fact that it continues to perform in a consistent manner. We have placed out on our Web site some supplemental information and I'll just cover some real quick statistics that are listed in that supplemental information.

And I'm going from basically January 31st of '03 to October 31st of '03. The number of accounts remain pretty close to the same at about 285,000. Our average outstanding balance, however, increased from $303.8 million in January of '03 to $322 million at the end of October of '03.

Average outstanding balances increased slightly from about $1,065.00 per account to $1,130.00 per account. The 60 day delinquency almost flat at $17 million in January of '03 and about $17.5 million in October of '03. That represents, actually, a slight decline in percentage delinquency -- 60 day percentage delinquency -- from 5.6% in January of '03 to about 5.4% in October of '03.

Our bad debt write-off and our reserve as a percentage to our outstanding balance remained very consistent at that 3.5% number that we discussed with most individuals as we walked through the road show.

At this point, David, if we could go ahead and start the Q&A session, we'd be happy to try and respond to those questions.

Thank you, sir. Ladies and gentlemen, if you have a question or comment at this time, please key star one on your touch-tone phone. To withdraw your question or if you question has already been answered, please key star two. Once again, that's star one for questions and we'll pause just a moment for the first question.

Our first question comes from Rick Nelson (ph) from Stevens, Inc. (ph) . Please go ahead, sir.

Thank you. Good morning, guys.

Good morning, Rick (ph) .

Tommy, could you provide a little more color on the Dallas entry? I know you indicated you were tracking 20% above the model. It sounds like you're coming in with some aggressive pricing in advertising and I'm curious about the bottom line performance there in Dallas relative to your expectation.

Well, good question because we have been very, very aggressive in pricing in that market. We feel like from a strategic standpoint that it's important to set the tone, if you will, of what our pricing strategy is when we first go into a market.

So, we have taken about a five to six percentage point hit on gross margin to the floor on product in that market versus the rest of the performance of our store. So, it has impacted -- the exact number I'm not going to be able to tell you and I don't know if Bill's got that information. But I would tell you that it's a significant impact on the volume that we did in those stores.

And then, additionally, if you look to the fact that we did an awful lot of advertising expense and as a percent, I believe the number that we came in at as an expense of gross advertising was almost twice the percent to retail sales volume as we normally would average.

And that was an intended type of expenditure. That's about consistent with what our expectations were. But that impacted earnings in that quarter probably in the neighborhood of 200,000 to 250,000 over and above what our normal advertising budget would be. And then I think you have to take another adjustment to your operating profit for the five to six points of product margin to the floor that we discounted.

And if memory serves me and I am really stretching now to get it, but that's probably going to be another minimum $300,000.00 to $500,000.00 ...

I think your total sales probably ...

For the quarter.

For the quarter in those two markets would have been in the 1.8 category.

OK, so about another ...

Figure somewhere around ...

Around 140?

Yes, about -- yes.

So, you can see there are some impacts there that, you know, and then you -- in addition to that I think you just cannot ignore this almost $1 million that we absorbed in expenses. We carried roughly about 100 sales people during most of that quarter to gear up for not only the two stores we got opened in that quarter, but also the third store that we opened on November the 19th, which would have been in our fourth quarter.

We carried almost 100 people and a good portion of that time we were not only carrying and training them, but we were housing them and feeding them. So, all of those had a tremendous impact. But, I would say that I think the efforts we put into it have positioned us well as far as making sure that that market was a success.

Did I answer your question, Rick (ph) ?

The expenses -- were they consistent with what you thought going into it from an advertising standpoint and the gross margin pressures?

I think they definitely were consistent. I think that as the volume probably was greater so the markdowns were greater. And one of the challenges we have in the fourth quarter is making sure that we adjust that.

And we have seen adjustments occurring, so we've seen the margins return to a more normal state in that market as we continue to progress through the fourth quarter. But I think it's consistent with what we planned to do. I don't think there's any surprises to me other than I wish that we could have achieved the same results for less cost.

I think that's always my desire is to try to get the same results and how can we do it in a more cost efficient manner.

Probably the people costs, Rick (ph) , were something that maybe we just didn't really focus on the level that we would have to carry those individuals to get the Dallas marketplace started up.

One thing we're excited about relative to people in that market is that we feel like that our assessment is that the quality of people that we've been able to attract in this initial hiring is far superior to any new market that we've ever gone into.

And I think to Bill's standpoint and probably to answer your question a little more accurately, those costs probably were greater than what we had anticipated them to be to some degree, because we probably stretched quite a bit in order to attract these better people.

One of the things that we had commented to on our road show was the fact that we don't really mind operating in a down economy because you generally can attract better people. And we think essentially that's what happened in Dallas, but it also probably cost us some additional money to get those people on board.

Thank you. Maybe some insight, too, into the fourth quarter? What you're seeing to date from a sales standpoint as well as a promotional standpoint for the company and maybe Dallas specifically?

Well, I think from the sales standpoint, as I said, I'm very, very pleased. We're off to a very, very fast start in the first, I guess, 40% of the fourth quarter I guess is about where we stand today. We're off to a very good start.

Same store sales -- we're at or above where we were at the end of Q3. We can maintain that, but it would certainly be a challenge. Our top line is growing. I think -- and those remarks are consistent for Dallas, too. We continue to be very, very excited by the results that we're getting out of the Dallas market.

You know, we've got this third store open now in Dallas and all three of those stores are performing extremely well. We've got good leadership out there. We planned well. We learned a lot from our entry into Austin and we've been able to capitalize on some of the mistakes that we made there. And we just feel very excited about that.

Now, I forgot the second part of that question that you asked?

About promotional environment?

Yes, I think that that's an area that's been very challenging to us. I think that at the beginning of the fourth quarter that I was not very comfortable with the amount of promotional activities we were doing, so an adjustment has been in order there. And we continue to assess whether the amount of cross -- of promotional activity that we're doing is yielding the kind of results that we want.

They’re certainly yielding the results at the top line. And I guess the challenge is, at what point do you stop? Do you pull back the top line a little in order to control the costs with promotional activities? So, that's in a process of analysis and adjustment that we are currently going through. And it definitely has the ability to impact operating margins very dramatically.

So, it's a big cost in our business is promotional activities. And with the Dallas market still having to spend a disproportionate amount of advertising dollars as a percent to the retail volume versus our ongoing operations then that puts an additional strain on it.

And you know, the decision becomes a very subjective decision about, you know, are you going to get the volume and create the impact that you want and make sure that your foothold is strong enough in that market to succeed?

Are you going to try to squeeze that a little bit and maximize earnings so to say and get some sort term results when you know that you're better off establishing who you are and what you want to be and going there with a dominant attitude so you can dominate the market as opposed to going in there and dilly dallying around so to speak, which is really what we did in Austin.

We really took a strategy of sort of going through the backdoor and not being highly visible and not putting the investment in dollars and so forth to create the awareness level. And it's taken a long, long time and I think in the end it's been a whole lot more expensive to do it that way.

And while we were doing it, short term profits were looking good. So, our strategy has been entirely different as we've entered this Dallas market and it -- in my opinion it's definitely the proper approach to do because we're dominating those geographical areas that we have these stores in. Our dominance is very, very good there and we're very excited about what's occurring.

Thank you very much.

You're welcome. Thank you, Rick (ph) .

Thank you. And our next question comes from Zack Shaffron (ph) from Waddell & Reed. Please go ahead, sir.

Good morning. Two questions, gentlemen. First, can you talk specifically about gift cards? What impact that's had on sales? That sort of thing.

And then secondly, could you provide some insight into particular products? What's selling well? What's not selling well and if there's anything that you're having trouble getting?

Thank you, Zack (ph) . Yes, we'll attempt to answer it. And Bill, you jump in if you want to help. I don't know that we can nail down the impact that gift cards has had to the degree that I might like to answer the question.

But I will tell you this, that the gift cards have had a tremendous impact on increasing that top line. It's also had a tremendous impact on reducing margins. And we're still attempting to quantify that.

And one of the reasons it's difficult to quantify for you is because the gift card venture is a fairly new venture for us and I suspect in reality while we've had gift cards for about a year, we've probably really learned -- our learning curve has probably increased dramatically in the past 90 days.

And probably one of the reasons that it's a little difficult for us to get a handle on the exact impact is that we probably issued our first gift cards with too long of an expiration date on them. And we've probably been a little bit liberal in honoring those expiration dates.

So, the gift cards have had a tremendous impact on both the top line and the expense line and it's one of the challenges in this quarter that we're focusing on to adjust that so that we maximize the impact to the top line while at the same time making sure that the cost efficiency drops out.

The program is a good program to have. I think that we're in the early stages of learning how to maximize the potential value that that process has for enhancing our business. What was his second question, Bill?

Products.

Oh, yes. We aren't having any problems getting them and what's going. I'll tell you, Zack (ph) , across the board the volume has been up. As we look at each product category and then we drill down, we don't really see any deterioration in any product category. It's just really been a nice thing that it's across the board.

Our appliance business as we look at it is up. Our electronics business is up. As you drill down into each one of those, washer business is up, laundry is up, refrigeration is up. As you drill down into electronics, the big screen thing that we talked to you about on our road show. We're still struggling somewhat with price deterioration. Units are still up. Overall volume's up.

And the new product that we're so excited about that we talked to you about on the road show, which was DLP -- Direct Like Projection -- versus the traditional or conventional projection television, which is -- and it's about halfway between -- the product is characterized by, in my mind, being about halfway in appearance between traditional protection and what's that? Plasma television in thickness and the quality is tremendous, this DLP.

That's been the only one that we've been somewhat disappointed in availability. And that availability is somewhat limited to a couple of manufacturers. Other than that, really, really have not experienced any product shortages.

We did a pretty darn good job of forecasting our needs. And generally, if you forecast correctly then, generally, that does not become an issue and we've not seen it.

Just so I'm clear, the DLP's tough to get because the sales are so good, or?

I think there's -- from my understanding and it's only with a couple of manufacturers and one in particular that's a well known brand. But I think that's a fair statement or assessment. But we've got enough to sell, but we probably don't have it in a brand we'd like to have.

Great. Thank you.

Thank you, Zack (ph) .

Thank you, sir. And our next question from Richard Kim (ph) from Kensington Management Group. Please go ahead, sir.

Hi, good morning. One of the questions I had was why is it -- I guess this is sort of a philosophy question -- I would think you would have to be less promotional price-wise, because a lot of your customers are using your financing.

And it just seems to me that if they didn't have financing elsewhere, they'll come to you. So, why do you have to be so price promotional?

Well, OK. And I'm glad you bring it up and I'm just going to revert back to, again, to the statements that we made on the road show is that we don't profile customers. We can't tell you what our customer looks like.

If you walk out on the street in the city that you live in and everybody you pass by, that's the customer that we want. Whether they're most financially affluent customer to the most credit needy customer.

So, when you say that we don't have to be price sensitive or you take that assumption ...

No, I'm just asking. I'm not ...

Yes, I understand. And I'm just saying that when you make the assumption that you don't have to be price sensitive, I don't think it's a fair assumption because people are very, very astute and knowledgeable about the price of products.

And when they spend $300.00, $400.00, $500.00, or $600.00, they don't generally just walk into a store and lay that money down. Only about 20% of our credit business -- and remember, our credit business is about 56% of our total business on a monthly basis and only about 20% of that 56% is what we would call sub-prime credit or less than 20%.

And you know, from the standpoint of ethics and treating people right and good business and trying to build a return relationship with people, you can't charge one person one thing and another person another thing just because their credit doesn't happen to meet a certain criteria.

So -- and you have to be competitive in the marketplace with what Lowe's does, with what Sears does, with what Best Buy or Circuit. So we have got to, you know, we can't hold an umbrella over everybody else's prices. We did that for about two decades prior to the 10 years that our new management team came in 10 years ago. We tried that approach.

And yes, you create a lot of percentage of gross margin at the top line, but in doing that you don't grow your company, you don't grow your volume. And so, what you have to do in order to make that operating margin fall out, you've got to make sure you've got enough dollar sales at the top line and that you control expenses.

And you know, it's a good question. And if you work from the assumption that our business is totally driven by sub-prime credit, you know, that's one thing. But our business is not. And just from an ethical standpoint, if we make an offer to one person, from an ethical standpoint, my philosophy is that we have to make it to everyone.

No, I wasn't suggesting that. I was just thinking that the person who is coming to you is probably more interested in credit than say, going to Best Buy.

And that is correct in a percentage of our situation. And what is that percentage? Today it's about 17% of 56% of the sales that we generate. So, you know, if you take a theoretical of 1,000 and that 56, that's 560. And 17% of 560 is what? A hundred -- I'm doing all that in my head -- or 140 or something like that.

So, out of the 1,000 it's only about, you know, out of the 1,000 I think it's a 15% portion of your business that that group is coming here. And the rest of the time people are coming here because of why? Because number one, they know they're going to get the pricing that they can get anywhere else. And that we're going to give them the added value of delivery and service and flexible in-house credit and a professional sales force.

So, it's all of those things together. It's a rather complex matrix of items that causes our business to work. I hope I'm getting it a little closer Richard (ph) to helping you understand.

Yes, you are. Do maintenance contracts still run about 8% of sales?

They dropped a little bit in -- was it Q3?

[Inaudible] .

Yes, it dropped a little bit in that third quarter. Part of it was impacted by when you go into a new market like Dallas it was impacted a little bit by that because the percentage of penetration is a little bit lower.

That's a product that takes a high skill level for someone. It's almost an intangible until someone needs it. And it takes a higher skill level to sell that. We do see that as a percent of sales improving in Dallas, but it did drop a little bit.

And that also, when that drops, does impact our gross profit margin dollars.

Yes, right, right. When you say dropped a little bit, are we talking 50 basis points? Or what are we talking?

I'm sorry. Tell him, Bill.

I think we went from about 8% down to about 7.3%.

Wow. And you would -- not putting words in your mouth, would you expect that to start rising again?

Well -- our expectations are that we're going to try to make it rise again. Because as the experience of our people in Dallas grows and they sell these sophisticated, complex electronic products then the attachment rate gets greater.

We think we're doing our customers a disservice if we don't. I don't look for it -- I think that the fairest statement would be that it's probably going to stay around the 7.5 level. You know, we brought that down from a traditional pace of about 10%, which we had paced for many, many years on purpose to about seven point to about 8%. And we covered that on the road show. And we just felt like we were putting too much emphasis on the product.

OK. Final question. Back to that gentleman's question about what's is selling and what is selling well. Computers. How much of your business is computers?

Yes, it's about 4%. And it really is not a significant part of the business. Although I would tell you that the emphasis that Tommy has placed on the track area, we have seen that number in dollars go up. But it's still a very small part of our overall sales.

OK. Because one is reading that computers are hot and they're, you know, personal computers are really selling well.

Yes, and we're seeing increases in it, but as our overall business went up as a percent to the total volume, you know, it stayed relatively the same. I think we probably -- and you know what? We probably ought to qualify that to this extent -- that's part of the increases in that track that I told you about is that computer sales volume.

I think what we don't have is what percentage of that track increases was there. We tracked that number and our sales volume in computers was up and I don't recall what it was right off hand.

But the track sales themselves were up 20% quarter over quarter and I would just on a qualified basis tell you that some portion of that -- a good portion of that 20% would have been due to the computer business simply because of the size of the ticket versus some of the other items that are represented in the track. So you're right. It has helped us, yes.

Right. And I do have one final question and that is, is bad debt expense. Is that tracking at about -- I think you used at the road show you said about 3.5%?

Yes, as we look at the off balance sheet portfolio in total, it continues to be about 3.5%. And I think one of the things that we indicated on the road show is that we work very hard to actually manage to that number.

And again, I would refer you to the supplemental data that we put out on the Web site. It actually gives you a comparison of the annualized bad debt write off percent at January 31st, '03; July 31st, '03 and October 31st, '03. And it's 3.5% very consistent.

Right. Great. All right, hey, thank you.

Thank you for your questions.

Thank you. And our next question comes from Frank Brown (ph) from Suntrust Robinson Humphrey. Please go ahead, sir.

Good morning, gentlemen. I'd like to go back to the gross margin if I could. You know, the track concept. You said that's about a quarter of the comp gain. And I was just curious, you know, how the gross margin shakes out on those products relative to say, the average?

It's somewhat lower to the floor. And I think you have to look at when you talk about gross margin -- and Bill, you jump in with me -- I think you have to look at two components of gross margin.

You look at the overall gross margin of the company with all of the financing and maintenance agreement and everything inclusive. And then you can differentiate between the product itself. And the product within that track.

So, to your point, it is impacting. It is driving down that total gross margin. The gross margin in that track looks like it's around 12 -- 11% to 12%. Somewhere in that neighborhood to our retail floor versus maybe three or four percentage points higher on some of the other products we sell.

And that floor percentage that he's referring to, Frank (ph) , includes our internal load. So, to convert that to the number that we told you at 22.9% for the product for the quarter, the track area would be somewhere in the 18% level.

I would also suggest to you that one of the things that we discussed on the road show was the implementation of our basement service maintenance agreement product that's not yet off the ground. As that product is introduced, it will focus more in that track area.

Appliances and smaller electronics. And we would hope to see some of that SMA sales increase as a result of that. And hopefully, impact that margin positively.

OK. And just a clarification, Tommy. In your remarks earlier I thought I heard you say that the margin to the floor was increasing nicely in the third quarter as opposed to the product margins in the press release. Did I misunderstand that?

I think you probably did misunderstand it. What I said was or intended to say if I didn't, was that the margins to the floor are increasing nicely in Q4.

OK. And one thing also I wanted to ask you about is the credit penetration in Dallas. I know it's very early to make any, you know, kind of assessment of how that's going to run. But do you have any insight into how the credit penetration on that business has been so far?

You know what? I don't even think we had that.

I don't have it at my fingertips.

It's a little early, but I can make this general statement about credit penetration: it's going to vary from store to store as we open these stores. It will definitely depend on the demographics of the area that we place those stores in. So, you're going to get some variance from store to store.

But when you look at the market as a whole, when you just take the entire metroplex, including Fort Worth, our expectations are that it shouldn't deviate very much from the norm that we've been experiencing overall in our company.

Within geographical segments of the city you're going to get wide fluctuations. And I think it's almost too early even if we had numbers to give you. These three stores are in such different demographic mixes that I think it would be almost too early to really draw any firm conclusion or accurate conclusion about what that penetration really is.

OK, that's fair enough. In your comments about the promotional environment, I was a little unclear. Were you talking about being more promotional, really, in the Dallas Fort Worth market in terms of entrance? Or were you talking across the system as a whole of, you know, balancing being more promotional versus balancing the comp versus the gross margin kind of discussion?

Both. Both.

OK.

But I do think I was talking about both, and then I was also making the point that Dallas was even accelerated more than what we had been accelerating in our other business.

OK. And just following along. On the gift cards, is there anyway you can quantify the impact on sales from that link? And I was a little unclear what the negative gross margin impact on that business would be?

I think it's one of the areas we are really just now getting into beginning to do deep analysis on. And I think it best if we could just generalize. And I don't think it'd be fair to give you the kind of generalizations that we're working with at this point.

We know what we're working on. What we can tell you is, is that we know the gift cards have the ability to impact the top line dramatically. What we're working on is, how can we improve the ratio of the cost of those gift cards to the improvement in top line?

And I just don't -- Bill, unless you have some hard data ...

No, I think it's a good analysis. And all I could probably give you would be some data in the most recent month of November as we begin to analyze the operations there. We know that the percentage of gift cards used to the sales generated was higher than we wanted to see it.

And I think some of it involves maybe some cross promotional programs where Tommy's in the process of trying to redefine how those programs relate to one another so that we don't really offer the gift card and then turn around and provide a discount on top of that.

And so, it is an area that we're beginning to look at very hard. And I think as the rest of this quarter unfolds, I think we will see some improvements in terms of that relationship of gift cards as a percentage to new sales generated.

When I think of a gift card I think of, you know, I pay $50.00 to a retailer and they give me a card for $50.00. The retailer puts it in deferred revenue. Is that the way this is working? Or how I am?

Is he asking an accounting question or a promotional?

He's asking an accounting.

Well, both, actually, because I don't see where it's a discounted sale? It seems like it's dollar for dollar.

Well, let me just tell you about the promotional side and then Bill can tell you about the accounting side.

We used the gift card in a mailer in a direct mail activity. We physically send the gift card with an expiration date and a letter inviting people to come in and apply that gift card towards a purchase of some value.

But really, the gift card, once you send it out there -- and this is part of the challenge that we have in administering the program. Once you send that gift card out there they really can bring it in to buy anything they want.

So, that's basically like a percent off kind of card?

Well, it's not. And that’s when the difference or that's when the challenge comes in. That if you sent a coupon out and said we're going to give you $25.00 off on the purchase of -- but when you send that gift card out, that's like sending a $20.00 bill in the mail is what you've just done. And that creates traffic in that store and it creates excitement. It creates the buying frenzy that you need to keep your retail business being driven.

But there is a difference between a gift card and a coupon or a discount off. And Bill, why don't you tell him about the accounting side.

Just from the accounting side, the cost is recognized as a cost or actually as a revenue reduction at the point of sale. And as Tommy said, it's like we gave somebody a $20.00 and as it is used, it is removed from the revenue line. And that's how we're able to track that percentage that we were talking about. The relationship of the gift card to the sale generated.

And at this point, I would tell you it's still a very insignificant number relative to our total sales. It's certainly something that we're looking at very hard to make certain that it doesn't get out of whack.

OK. Is there anyway you can tell us the increase year to year and the number of mailings associated with that?

Oh, it's dramatic, Frank (ph) . As I say, this is a new process for us. We essentially started about 12 months ago and it has grown and grown and grown each and every month. And I would say, the last 90 days -- really even the last 60 days -- we increased that promotional activity dramatically in that area.

I don't have any numbers, but I can tell you, it's almost a 45 degree line upwards!

I could give you some usage in terms of dollars for roughly the nine months ended October 31st. We probably went from about 350,000 last year to over $3 million this year. So, as Tommy said, it's a dramatic increase.

Tenfold.

Yes, tenfold. And so we're looking at it very closely to make certain that what we're giving away in the form of free dollars is generating the level of sales and that we're getting a higher margin on those sales.

Just shifting gears. Last question. On the TV category, can you tell me -- do you have any sense of how many DLP's you could have sold if you had adequate supply: And I'm curious about what you see as the plasma and LCD ramp at this point? In terms of customer demand.

OK, the first question was how could we have sold? Well, I think it's really hard to say because, you know, maybe we got the sale or maybe someone just decided to wait. I think there are two issues when you look at the sale of DLP.

One is the availability with the best known brand in the world. And the second one is the price point is still a little bit high. It probably still needs to drop 20% to 30%, which in today's world that's not a huge amount of drop for the life cycle of an electronics product.

So, there are really two issues. And I don't know, maybe we would have done 10% more or 5% more if we could have had the supply we wanted. The LCD business is a very, very competitive business. A lot of catalogue houses. Very, very thin margins there. But the plasma business in this -- the plasma business is being enjoyed at a greater rate than other geographical parts of our country and we're particularly enjoying it right now.

We've invested heavily in the display and in the stocking of the product and the merchandising of it. And we do feel like it's an area we have to play. And we have not achieved the kind of results we would like to achieve at this point. And I would limit my remarks to our experiences because I don't think that anything I would say relative to the industry itself -- I'm not sure it'd be very accurate.

All right. Fair enough. Thank you very much.

Thank you, Frank (ph) .

Thank you. And our final question comes from Robert Strauss (ph) from Greenville Capital Management (ph) . Please go ahead, sir.

Hey, guys. Just a couple of quick housekeeping questions. One's related to some of the promotional activity in Dallas. Did you incorporate any what I would call finance, you know, related initiatives for the customer to come in -- i.e., open up in-house credit here and you get 10% off in this area? Something used of that nature in your promotional activity for Dallas? And if it hasn't been, is it something that will be since that would be an additional type just a one time hit to bring the customer in, you know, lock hold to them?

And then you used to run, I guess, financed sales used to be about or floor (ph) product sales using the in-house credit using about 60% to 65% of your business. Do you forsee a return to that in helping, you know, bolster same store sales over the next couple or three, four quarters?

And the final question would just be pure housekeeping. What was technically your comp base for the October quarter? How many stores?

OK, you've got the last two. And when you answer that one about the credit penetration, tell him all the different ways we measure it. I think, too, sometimes we confuse people the way we talk.

I'm going to take the first one for you, Robert (ph) .

OK, thanks.

Bill's going to take the next two. Yes, we did do the financing promotional activities and we did everything. We did 10% off to -- we tried to tailor the credit promotion to the demographics of the area the store's in.

And within the store area themselves and then we would try to even further segment that demographic and coordinate our financial related promotional activities to the segment that's most appropriate. And so, we did 12 months cash option or 12 months no interest. We did 10% off. We did some sub-prime credit promotion. We did gift cards in that.

So, we did all of those things and it does work. It's obvious it works and we will continue to be active in that area. And we will continue to refine it so that we don't waste dollars in attracting that business in that we get the maximum efficiency out of the cost that we spend to do it. Because after all, there are very large costs associated with all of that promotional activity on this credit based product.

So, yes. We did all of that and we'll continue to do it. And then if I answered that, then I'm going to turn it over to Bill.

Well, quickly, is my assumption correct that if especially with your core customers, you know, in your areas where you're geographically located today, if you were to capture that customer, you have that additional service levels and delivery levels and you get them in there and it really locks that customer in for say the next couple of three years or possibly even longer. Is that a correct assumption?

Yes. In fact, that is exactly our viewpoint is that if you will experience one favorable transaction with us from the time you enter the store and you're greeted by a professional sales counselor to the time that we handle that credit transaction properly for you to the time that our professional delivery team arrives in your home, sweeps under the refrigerator, mops the floor. Shows you how to operate it. Wipes the product clean. And then when something goes wrong with that product, we send our own -- we don't subcontract the delivery out and we don't subcontract the service call out.

And when it breaks -- and these complicated products break today -- and then you have the experience of dealing with the service call and the salesman calling you back up to see if you're happy. And we send you a note to see if you're happy with the service.

All of that tends to build that relationship and that's really what we're trying to do is we're attempting to build a relationship that creates a potential stream of income over the lifetime of that consumer. So that when they need the products that we sell, that they'll come back to our store first and give us a chance to serve those needs. That ...

That certainly removes some of the price sensitivity that all of us as consumers will look for.

Well, I'm going to go back to what -- and I believe it was Zack (ph) , but I'm not sure who asked the question, you know, is that price sensitivity important? You have to do all that and we still have to be price competitive.

I will tell you that even in our community that we live in, the people that we have known our entire lives. They'll give us credit for all of that, but we have to be price competitive with everyone else out there. You cannot be $10.00 or $20.00 higher.

They'll give you -- we get credit for those extra things we do, but they'll also take that credit away very, very quickly if you're not price competitive. We cannot -- price sensitivity is important. But we differentiate ourselves from those companies that just say price, price, price because we do all these added value things for the consumer.

And I think that's where the differentiation comes from is that you have to be there at the price point and now how do you differentiate yourself? Once you're at the price point how can you differentiate yourself from the other masses out there? And that's how we do it.

But I think your assumptions are very correct in everything else that you've asked me about.

Thanks.

Robert (ph) , good morning to you. It's nice to hear from you again. I guess I would respond to your question about credit penetration by first saying I don't have an exact percentage at my fingertips.

Sure.

But I would tell you that it's a number that we monitor very frequently in our executive committee meetings. And as we mentioned to you on the road show, we had kind of self inflicted some pain on ourselves and had seen an unintentional decline in that penetration. And then we obviously put the programs in place to correct that.

Since then, we have seen a return of that credit penetration to the level that we were enjoying before in the low 60% area.

Good.

And certainly, as we move forward and learn more about the types of things you guys are interested in we'll try to incorporate that information in future calls for you. You asked a third question and I'm sorry, I did not get it down?

The comp base of stores in the October quarter? You know, when you're measuring your same store sales.

How we were measuring it? Is that what you're asking?

Well, how many stores were technically in the comp base? You know, was it 30? Was it 35?

I think it actually was if you pull out Dallas it would have been -- we were at 44 so it would probably be right at 40.

OK.

[Inaudible] . Round Rock, I think.

Yes, that was it was.

OK. Thanks, guys.

Thank you, Robert (ph) . Good to hear from you.

You too, guys. Good luck.

Thank you. And now I'd like to turn the call back to you gentlemen for some closing comments.

Well, I think the only closing comment I would have is that we're going to continue to operate our business with a lot of focus on driving the top line, a lot of focus on serving customers' needs, a lot of focus on taking out costs that are unnecessary and continuing to fine tune it. And continue to be competitive out there and create as much value as we possibly can for everyone, including the consumer who's most important to all of us.

So, we thank all of you for your time today, for your interest and for your continued support relative to our company and your ownership position. I have no further comments. Thank you all, bye.

Thank you, sir. Thank you, ladies and gentlemen, today for your participation. This concludes your conference call. You may now disconnect. Good day.