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Ultimate Electronics, Inc. Form 10-Q Index

United States
Securities and Exchange Commission
Washington, D.C. 20549

FORM 10-Q

Commission file number 0-22532

ULTIMATE ELECTRONICS, INC.
(Exact name of registrant as specified in its charter)

321 West 84th Avenue, Suite A, Thornton, Colorado 80260
(Address of principal executive offices, zip code)

(303) 412-2500
(Registrant's telephone number, including area code)

        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

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

        The number of outstanding shares of common stock as of December 12, 2003 was 14,745,009.

Ultimate Electronics, Inc.
Form 10-Q
Index

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ULTIMATE ELECTRONICS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(amounts in thousands, except share and per share data)

See accompanying notes to Condensed Consolidated Financial Statements.

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ULTIMATE ELECTRONICS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(amounts in thousands, except share and per share data)

See accompanying notes to Condensed Consolidated Financial Statements.

2

ULTIMATE ELECTRONICS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(amounts in thousands)

See accompanying notes to Condensed Consolidated Financial Statements.

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ULTIMATE ELECTRONICS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

October 31, 2003

1. Significant Accounting Policies

Background

        Ultimate Electronics, Inc. is a leading specialty retailer of consumer electronics and home entertainment products located in the Rocky Mountain, Midwest and Southwest regions of the United States. The company operates 65 stores, including 54 stores in Arizona, Idaho, Illinois, Iowa, Kansas, Minnesota, Missouri, Nevada, New Mexico, Oklahoma, South Dakota, Texas and Utah under the trade name Ultimate Electronics and 11 stores in Colorado under the trade name SoundTrack. In addition, the company operates Fast Trak, Inc., an independent electronics repair company and a wholly owned subsidiary of Ultimate Electronics, Inc.

        The accompanying unaudited condensed consolidated financial statements of Ultimate Electronics, Inc. should be read in conjunction with the company's consolidated financial statements for the year ended January 31, 2003. Significant accounting policies disclosed therein have not changed except as discussed in Note 2. The company's unaudited condensed consolidated financial statements have been prepared by the company in accordance with accounting principles generally accepted in the United States for interim financial reporting and the regulations of the Securities and Exchange Commission for quarterly reporting. Accordingly, they do not include all information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the company's opinion, the financial statements include all adjustments, consisting only of normal recurring adjustments that are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods. Operating results for the three and nine month periods ended October 31, 2003 are not necessarily indicative of the results that may be expected for the year ending January 31, 2004. Seasonal fluctuations in sales of the company's products result primarily from the purchasing patterns of consumers. As is the case with many other retailers, the company's sales and profits have been greatest in the fourth quarter (which includes the holiday selling season). For further information, refer to the financial statements and footnotes thereto included in the company's Annual Report on Form 10-K for the year ended January 31, 2003 and other filings with the Securities and Exchange Commission.

Principles of Consolidation

        The unaudited condensed consolidated financial statements include the accounts of all subsidiaries. All intercompany accounts and transactions have been eliminated upon consolidation.

New Store Openings

        The company opened six new stores during the third quarter. The company opened one new store in September 2003 in Maple Grove, Minnesota, and five new stores in October 2003 (two in Austin, Texas, two in Kansas City and one in Wichita, Kansas). On November 19, 2003, the company opened its third store in the Kansas City market, for a total of seven new stores for the year.

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 reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of financial statements and the

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reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Revenue Recognition

        The company sells consumer electronics and home entertainment products, and along with the sale of this merchandise, offers and sells installation services and/or warranties, which can be purchased separately by the customer and which are separately priced off a standard price list. Revenues from non-merchandise components represent approximately 6% of the company's total sales. Revenue is recognized at the time the customer takes possession of the merchandise or such merchandise is delivered to the customer. The company recognizes revenues from services, such as home and mobile installation, home delivery and setup, and repair services, at the time the service is provided. Sales, which includes net warranty revenue, consists of gross sales less discounts, price guarantees, returns and allowances.

        The company sells extended warranty contracts on behalf of a fully-insured unrelated party. The contracts extend beyond the normal manufacturer's warranty period, usually with terms of coverage (including the manufacturer's warranty period) between 12 and 60 months. The extended warranty contracts are administered by a third party and all performance obligations and risk of loss with respect to such contracts are the responsibility of such administrator and other parties. For extended warranty contracts entered into prior to February 1, 2000, the company recognizes revenues, net of direct selling expenses, over the term of the obligor contracts, as the company was deemed to be the obligor under the terms of its extended warranty master contract. Effective February 1, 2000, the company restructured its extended warranty master contract with the administrator such that the extended warranty contracts sold after the effective date generally qualify as non-obligor contracts. The company retains a commission, which it now recognizes as revenue from the sale of these non-obligor contracts at the time of sale to the customers.

Earnings Per Share of Common Stock

        The company reports its earnings per share amounts in accordance with Statement No. 128, "Earnings per Share" (SFAS 128). Basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share includes the dilutive effects of such equity instruments.

Stock Based Compensation

        Statement of Financial Accounting Standard No. 123, "Accounting for Stock Based Compensation" (SFAS 123), establishes accounting and reporting standards for stock based employee compensation plans, as amended. As permitted by SFAS 123, the company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related interpretations, in accounting for its employee stock options. In December 2002, the Financial Accounting Standards Board (FASB) issued Statement No. 148, "Accounting for Stock-Based Compensation—Transition and Disclosure" (SFAS 148), which amends SFAS 123 to provide alternative methods of transition to the SFAS 123 fair value method of accounting for stock-based compensation. SFAS 148 also amends the disclosure provisions of SFAS 123 and APB Opinion No. 25, "Interim

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Financial Reporting," to require disclosure in the significant accounting policies of the effects of an entity's accounting policy with respect to stock-based employee compensation on reported net income in annual and interim financial statements. The company has implemented all required disclosures of SFAS 148 in the accompanying consolidated financial statements.

        The company's pro forma information, amortizing the fair value of the options over their vesting period, is as follows:

        For a detailed description regarding the assumptions used to calculate the compensation expense noted above, refer to Note 7 in the company's Annual Report on Form 10-K for the year ended January 31, 2003.

        The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.

Inventories

        The company states merchandise inventories at the lower of cost (weighted average cost) or market. Inventories are presented net of an allowance for obsolescence of $1.6 million and $2.1 million at October 31, 2003 and January 31, 2003, respectively.

Advertising Costs

        In accordance with AICPA Statement of Position 93-7, "Reporting on Advertising Costs," all advertising costs are deferred until the first time the advertising takes place. The company reduces advertising expense with cooperative advertising from its vendors. The company's cooperative advertising from its vendors consists of three basic types: (i) market development funds of a fixed amount per period; (ii) cooperative advertising credits that are deducted from each invoice; and (iii) cooperative advertising funds that are accrued for as purchases are made and are collected either

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monthly, quarterly, semi-annually or annually. The company often provides proof of performance of advertising to its vendors. Cooperative advertising payments vary with individual programs and with individual vendors.

        As discussed in Note 2 to the company's January 31, 2003 Annual Report on Form 10-K, the company elected to adopt early, effective February 1, 2002, the provisions of EITF 02-16, "Accounting by a Customer (including a Reseller) for Certain Consideration Received from a Vendor" (EITF 02-16).

        The amounts of the company's cooperative advertising receivable at October 31, 2003 and January 31, 2003 are as follows:

        The amounts of cooperative advertising that are being netted against advertising expense for the three and nine months ended October 31, 2003 and 2002 are as follows:

2. New Accounting Pronouncements

Accounting for Asset Retirement Obligations (SFAS 143)

        In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations" (SFAS 143). SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS 143 is effective for fiscal periods beginning after June 15, 2002. The company adopted SFAS 143 on February 1, 2003. The adoption of SFAS 143 had no impact on the consolidated financial position, results of operations or cash flows of the company.

Rescission of Statements 4, 44 and 62 (SFAS 145)

        In April 2002, the FASB issued Statement 145, "Rescission of Statements 4, 44 and 62" ("SFAS 145"). SFAS 145 rescinds Statement 4, "Reporting Gains and Losses from Extinguishment of Debt", Statement 44, "Extinguishment of Debt Made to Satisfy Sinking-Fund Requirements", and Statement 62, "Accounting for Intangible Assets of Motor Carriers". SFAS 145 requires gains and losses on extinguishment of debt to be classified as either extraordinary items or in continuing operations in accordance with the provisions of APB 30. Further, any gain or loss on extinguishment of debt that was classified as an extraordinary item in prior periods presented, that does not meet the criteria in APB 30 for extraordinary item classification, is required to be reclassified to continuing operations. SFAS 145

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also amends Statement 13, "Accounting for Leases", to require certain lease modifications that have economic effects similar to sale-leaseback transactions to be accounted for in the same manner as sale-leaseback transactions. The provisions of SFAS 145 related to the recession of Statement 4 are effective for financial statements issued for fiscal years beginning after May 15, 2002. The company adopted SFAS 145 on February 1, 2003. The impact of the adoption was to reclassify a $254,000 loss on extinguishment of debt recorded on the January 31, 2001 consolidated financial statement of income from an extraordinary item to interest expense.

Accounting for Costs Associated with Exit or Disposal Activities (SFAS 146)

        In June 2002, the FASB Issued Statement No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" (SFAS 146), which addresses the recognition, measurement, and reporting of costs that are associated with exit and disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3 (EITF 94-3), "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." Under SFAS 146, the cost associated with an exit or disposal activity is recognized in the periods in which it is incurred rather than at the date the company commits to the exit plan. This statement is effective for exit or disposal activities initiated after December 31, 2002. The adoption of SFAS 146 did not have a material impact on the consolidated financial position, results of operations or cash flows of the company.

Consolidation of Variable Interest Entities (FIN 46)

        In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46), an interpretation of Accounting Research Bulletin No. 51, to address the consolidation issues around certain types of entities, including variable interest entities ("VIE"). FIN 46 requires a VIE to be consolidated if the company's variable interest (i.e. investment in the entity) will absorb a majority of the entity's expected losses and/or residual returns if they occur. The consolidation requirements of FIN 46 were originally applicable to the company effective August 1, 2003. On September 17, 2003, the FASB issued a limited deferral of FIN 46 to public companies until the end of the first interim or annual period ending after December 15, 2003, provided certain conditions are met. The company has reviewed the provisions of FIN 46 and does not expect its implementation to have any material impact on the financial position, results of operations or cash flows of the company.

Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity (SFAS 150)

        In May 2003, the FASB issued Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" (SFAS 150). SFAS 150 establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. SFAS 150 generally requires liability classification for financial instruments that represent, or are indexed to, an obligation to buy back the issuer's shares, regardless whether the instrument is settled on a net-cash or gross physical basis. This includes mandatorily redeemable equity instruments, written options that give the counterparty the right to require the issuer to buy back shares, and forward contracts that require the issuer to purchase shares. Additionally, SFAS 150 requires liability classification for obligations that can be settled in

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shares and meet certain additional criteria. SFAS 150 is effective immediately to instruments entered into or modified after May 31, 2003 and to all other instruments that exist as of the beginning of the first interim financial reporting period beginning after June 15, 2003. The implementation of the provisions of SFAS 150 did not have any material impact on the financial position, results of operations or cash flows of the company.

3. Contingencies

        In re Ultimate Electronics, Inc. Securities Litigation.    On April 7, 2003, Howard Fisher filed a complaint against the company and three of its officers and directors in the United States District Court for the District of Colorado. The complaint is a purported class action lawsuit on behalf of purchasers of the company's common stock during the period between March 13, 2002 and August 8, 2002. As initially filed, the complaint sought damages for alleged violations of Section 11 of the Securities Act of 1933, as amended (the "Securities Act"), Section 10(b) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), Rule 10b-5 promulgated under the Exchange Act, and Section 20(a) of the Exchange Act. On May 30, 2003, the company moved to dismiss all claims asserted in the complaint. The Alaska Electrical Pension Fund ("AEPF"), which had been appointed as the lead plaintiff to represent the putative plaintiff class, responded to the company's Motion to Dismiss by filing an amended complaint on August 11, 2003. In the amended complaint, AEPF asserts claims against the company and all of the company's directors during the relevant period for alleged violations of Sections 11, 12(a)(2) and 15 of the Securities Act. AEPF asserts that the prospectus, dated April 30, 2002, for the company's 2002 public offering of common stock failed to disclose material facts that were required to be disclosed and contained false and misleading statements. The amended complaint seeks to recover unspecified monetary damages, an award of rescission or rescissory damages and an award of attorneys' fees, costs and prejudgment and post-judgment interest. On September 11, 2003, the company moved to dismiss all claims asserted by AEPF in the amended complaint. The company believes the lawsuit is without merit and intends to defend the matter vigorously.

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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

        Some statements contained in this Quarterly Report on Form 10-Q are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Such statements include statements relating to, among other things:

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the resolution of performance issues with respect to our new management information system;



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our growth strategy and plans regarding opening new stores and relocating, expanding or remodeling existing stores;



•

total estimated capital expenditures and primary cash requirements;



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estimated capital expenditures and costs related to the opening of new stores and the relocation, expansion or remodeling of existing stores;



•

the sufficiency of our cash flows from operations and availability under our revolving line of credit to fund our operations, debt repayment and anticipated expansion;



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the timing of the completion of the mortgaging of our Thornton, Colorado facility;



•

available sources of financing;



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the impact of inflation;



•

the reliability of the Black-Scholes option valuation model;



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the effects of the holiday selling season;



•

the impact of new accounting pronouncements; and



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our belief that the complaint filed on April 7, 2003 and amended August 11, 2003 in a purported securities class action lawsuit is without merit and our intention to defend it vigorously.

        These forward-looking statements are subject to numerous risks, uncertainties and assumptions, including local, regional and national economic conditions; store traffic; comparable store sales and the success of new stores; terrorist acts and acts of war; the availability of new products; competition in our targeted markets; the availability of adequate financial resources; the timing of new store openings; weather conditions in our markets; our relationships with suppliers and vendors; the mix of consumer electronic merchandise sold in our stores; performance issues with our new management information system; and other factors discussed in our Annual Report on Form 10-K for the fiscal year ended January 31, 2003. We disclaim any obligation to update forward-looking statements, whether as a result of new information, future events or otherwise.

Results of Operations

        During the third quarter ended October 31, 2003, we converted to a new management information system. We experienced unexpected issues during the conversion, which we believe negatively impacted our sales, gross margins, selling, general and administrative expense and net loss. These issues included, among others, lack of visibility into our inventory, interruptions in distribution and delays in processing service repairs. While we have resolved many of these issues, we continue to experience gaps in the expected performance of the system. We continue to allocate significant resources to resolve these remaining performance issues.

        Sales.    Sales for the three months ended October 31, 2003 decreased 10% to $159.7 million from $177.8 million for the three months ended October 31, 2002. Sales for the nine months ended October 31, 2003 increased 2% to $469.6 million from $462.0 million for the nine months ended October 31, 2002. Sales of comparable stores were down 12% and 10% for the three and nine months ended October 31, 2003, respectively. Comparable store sales represent the percentage sales change

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from the same period in the prior year for stores open at least 13 months and exclude (i) sales for stores recently relocated and expanded until 13 months after completion and (ii) sales for stores in new markets until 13 months after 75% of the initial number of stores planned for the market have opened. As of October 31, 2003, 47 of the 64 stores we had open were considered comparable stores. Sales during the three and nine month periods ended October 31, 2003, were negatively impacted by weak store traffic, the issues related to the conversion to our new management information system and our exiting from the computer category.

        Gross Profit.    Gross profit for the three months ended October 31, 2003 decreased 12% to $53.0 million (33.2% of sales) from $60.5 million (34.0% of sales) for the three months ended October 31, 2002. Gross profit margins for the three months ended October 31, 2003, were negatively impacted by the decrease in sales compared to the prior year, our exiting from the computer category and the shortfall in revenues from our repair service business associated with the conversion to our new management information system during the quarter. Gross profit for the nine months ended October 31, 2003 increased 1% to $156.1 million (33.2% of sales) from $155.2 million (33.6% of sales) for the nine months ended October 31, 2002. Gross profit margins for the nine months ended October 31, 2003 were negatively impacted primarily due to the same reasons discussed above.

        Selling, General and Administrative Expenses.    Selling, general and administrative expenses for the three months ended October 31, 2003 were $62.9 million (39.4% of sales) compared to $59.8 million (33.6% of sales) for the three months ended October 31, 2002. Fixed expenses such as occupancy, depreciation and payroll increased as a percentage of sales by approximately 4.3% compared to the third quarter of the prior year due to lower than anticipated sales for the quarter as well as the costs associated with new stores. As a percentage of sales, training and other costs associated with the implementation of our new management information system increased 90 basis points, net advertising expenses increased 58 basis points and insurance costs increased 36 basis points. Selling, general and administrative expenses for the nine months ended October 31, 2003 were $171.2 million (36.4% of sales) compared to $153.9 million (33.3% of sales) for the nine months ended October 31, 2002. Fixed expenses such as occupancy, depreciation and payroll increased as a percentage of sales by 2.9% compared to the first nine months of the prior year due to lower than anticipated sales for the nine months as well as the costs associated with new stores. As a percentage of sales, training and other costs associated with the implementation of our new management information system increased 31 basis points and insurance costs increased 37 basis points for the nine months ended October 31, 2003. The above increases in expenses as a percentage of sales for the nine months were partially offset by a decrease in preopening expense of 48 basis points due to fewer store openings in the current year.

        Income (Loss) from Operations.    As a result of the foregoing, we recorded a loss from operations of $9.9 million (6.2% of sales) for the three months ended October 31, 2003 compared to income from operations of $0.7 million (0.4% of sales) for the three months ended October 31, 2002. We recorded a loss from operations of $15.1 million (3.2% of sales) for the nine months ended October 31, 2003 compared to income from operations of $1.4 million (0.3% of sales) for the nine months ended October 31, 2002.

        Interest Income.    We recorded no interest income for the three and nine months ended October 31, 2003. We recorded interest income of $32,000 and $118,000 for the three and nine months ended October 31, 2002, respectively. We used a portion of the proceeds from our May 6, 2002 public offering to repay approximately $61.7 million then outstanding under our revolving line of credit.

        Interest Expense.    We recorded interest expense of $105,000 for the three months ended October 31, 2003, compared to interest expense of $47,000 for the three months ended October 31, 2002, primarily due to higher average amounts outstanding on our revolving line of credit during the third quarter of the current year. Additionally, we ceased capitalization of interest on our new management information system following its implementation during the third quarter of the current

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year, which also contributed to higher interest expense. We recorded interest expense of $194,000 for the nine months ended October 31, 2003, compared to interest expense of $287,000 for the nine months ended October 31, 2002, respectively, primarily due to higher average amounts outstanding on our revolving line of credit during the first quarter of the prior fiscal year (before the completion of our public offering).

        Income Taxes.    Our effective tax rate was 38.0% for the three and nine month periods ended October 31, 2003 and October 31, 2002.

        Cumulative Effect of Change in Accounting Principle.    Upon adoption of EITF 02-16, we changed our accounting principle with respect to recording cooperative advertising allowances effective retroactively as of the beginning of fiscal 2003. As a result, we recorded a non-cash charge of $1.6 million, net of income tax, in the first quarter of fiscal 2003 for the cumulative effect of the change in accounting principle on fiscal years prior to fiscal 2003.

        Net Loss.    Our net loss was $6.2 million and $9.5 million for the three and nine months ended October 31, 2003, respectively, compared to net income of $422,000 and a net loss of $848,000 for the three and nine months ended October 31, 2002, respectively, for the reasons described above.

Liquidity and Capital Resources

        Historically, our primary sources of liquidity for funding expansion and growth have been net cash from operations, revolving credit lines, term debt and issuances of common stock. Our primary cash requirements are related to expenditures for new store openings, the relocation and/or remodeling of existing store locations, inventory build-up prior to the holiday selling season and information technology systems. Expenditures for new store openings include leasehold improvements, fixtures and equipment, additional inventory requirements, preopening expenses and selling, general and administrative expenses. We currently operate a total of 65 stores in 14 states.

        Net cash used in operating activities was $23.9 million for the nine months ended October 31, 2003, compared to net cash used in operating activities of $23.3 million for the nine months ended October 31, 2002, primarily related to the increase in inventory levels from January 2003 to October 2003 compared to January 2002 to October 2002, and partially offset by increased Accounts Payable and Accrued Liabilities levels compared to the prior year. In addition, our net loss increased from $0.8 million for the nine months ended October 31, 2002 to $9.5 million for the nine months ended October 2003, which increase was offset by an increase in depreciation and amortization expense and changes in operating assets and liabilities.

        Net cash used in investing activities was $30.1 million for the nine months ended October 31, 2003, compared to net cash used in investing activities of $42.5 million for the nine months ended October 31, 2002, primarily due to fewer new store openings in the current year and the completion of the implementation of our new management information system in September 2003.

        Through the nine months ended October 31, 2003 we incurred capital expenditures of $30.1 million. Total capital expenditures for fiscal 2004 are expected to be approximately $35 million. We opened seven new stores in fiscal 2004. We also remodeled our two Las Vegas stores, our Tulsa, Oklahoma store and our Minnetonka, Minnesota store. In addition, we relocated and expanded our Rochester, Minnesota store in March 2003. During fiscal 2005, we plan to open two new stores and to relocate and expand one or two additional stores. We plan to evaluate potential remodels at the beginning of next year. The cost of new stores is anticipated to average approximately $3.3 million per store during fiscal 2005, which amount includes leasehold improvements, fixtures and equipment, inventory (net of payables) and preopening expenses. Leasehold improvements and fixtures and equipment are expected to average approximately $2.2 million per store, depending on tenant allowances. The inventory requirement for each new store is expected to average approximately

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$1.5 million, approximately $750,000 of which will be financed through trade credits from our vendors. Preopening expenses for new stores are expected to average approximately $350,000, and include costs for advertising prior to opening and recruitment and training of new employees. If we relocate existing stores, preopening costs are expected to average $150,000 and will be higher if we are required to terminate existing store leases prior to their maturity. We completed the implementation of our new management information system in the third quarter of fiscal 2004, incurring total capital expenditures for the project of approximately $27 million.

        Net cash provided by financing activities was $52.3 million for the nine months ended October 31, 2003 compared to net cash provided by financing activities of $66.1 million for the nine months ended October 31, 2002. Net cash provided by financing activities for the nine months ended October 31, 2003 was primarily the result of borrowings under our revolving line of credit. Net cash provided by financing activities for the nine months ended October 31, 2002 was primarily the result of the net proceeds we received from our May 6, 2002 offering, partially offset by the repayment of our revolving line of credit.

        We currently have an $80 million credit agreement with Wells Fargo Retail Finance, LLC, which expires in September 2004. At October 31, 2003, amounts payable under our revolving line of credit have been classified in the accompanying consolidated balance sheet as current. We are currently negotiating a renewal of our credit agreement. Borrowings under this revolving line of credit are limited to the lesser of (i) $80 million or (ii) 75% of eligible inventory plus the lesser of 75% of eligible accounts receivable and $2.5 million. Amounts borrowed bear interest, payable monthly, based on a blend of (i) LIBOR plus 1.75% to 2.25% and (ii) Wells Fargo Bank's prime rate minus 0.375%. Our weighted average interest rate was 3.5% at October 31, 2003. Inventories, bank accounts, accounts receivable, equipment, intangibles, negotiable instruments, investment property, intellectual property and equity interests in our subsidiaries secure the borrowings. The facility includes negative covenants that restrict our ability to incur indebtedness, create liens, enter into mergers and consolidations, pay dividends, repurchase our capital stock, issue guarantees, sell or otherwise dispose of assets and engage in transactions with affiliates without the written consent of the bank. The facility also contains covenants regulating our gross margins, inventory levels, tangible net worth and capital expenditures. As of October 31, 2003, we had a borrowing base of approximately $80.0 million, of which approximately $59.9 million was outstanding, and we were in compliance with all borrowing covenants.

        To provide additional liquidity and financial flexibility, we are in the process of mortgaging our Thornton, Colorado facility, which we expect to complete during the fourth quarter of fiscal 2004.

        We believe that our cash flows from operations and availability under our revolving line of credit, assuming we renew our revolving line of credit prior to its expiration in September 2004, will be sufficient to fund our operations, debt repayment and anticipated expansion through fiscal 2005. To fund the capital requirements for our anticipated expansion plans beyond that time, we may be required to seek additional financing, which could include an increase in our revolving line of credit or additional debt or equity financings. We may not be able to obtain such funds on favorable terms, if at all.

Impact of Inflation

        We believe that inflation has not had a significant effect on our results of operations during the three most recent fiscal years. We cannot predict whether inflation will have an impact on our results of operations in the future.

Seasonality

        Our business is affected by seasonal consumer buying patterns. As is the case with many other retailers, our sales and profits have been greatest in our fourth quarter (which includes the holiday

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selling season). Due to the importance of the holiday selling season, any factors negatively impacting the holiday selling season could have a material adverse impact on our financial condition and results of operations.

Item 3. Qualitative and Quantitative Disclosures about Market Risk

        The following discusses our exposure to market risks related to changes in interest rates and other general market risks. All of our investment and financing decisions are supervised or managed by our executive officers. All of our merchandise inventory purchases are denominated in U.S. dollars.

        Cash and Cash Equivalents.    As of October 31, 2003, we had $0.9 million in cash and cash equivalents, which was not restricted and in various non-interest bearing accounts. We consider all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.

        Outstanding Debt of the Company.    We are exposed to market risk due to changes in U.S. interest rates. We do not engage in financial transactions for trading or speculative purposes. We have an $80 million revolving line of credit. Amounts borrowed under the $80 million revolving line of credit bear interest based on a blend of (i) LIBOR plus 1.75% to 2.25% and (ii) Wells Fargo Bank's prime rate minus 0.375%. Borrowings under this credit facility were $59.9 million as of October 31, 2003. An increase in the interest rate on our revolving line of credit of 36 basis points (a 10% change from the bank's reference rate as of October 31, 2003) would have no material effect on our operating results. We have not hedged against interest rate changes.

Item 4. Controls and Procedures

        During the 90-day period prior to the filing date of this report, an evaluation was performed under the supervision and with the participation of our management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures in providing reasonable assurance (based on our management's evaluation of the costs and benefits of possible controls and procedures) that we are able to record, process, summarize and report the information required in our quarterly and annual reports under the Exchange Act. The Chief Executive Officer and Chief Financial Officer have concluded that the evaluation has provided them with reasonable assurance that our disclosure controls and procedures are effective.

        During the third quarter ended October 31, 2003, we converted to a new management information system. As previously discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations," we experienced unexpected issues during the conversion. No changes occurred in the company's internal controls concerning financial reporting during the quarter ended October 31, 2003, that have materially affected, or are reasonably likely to materially affect, the company's internal controls over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

        In re Ultimate Electronics, Inc. Securities Litigation.    On April 7, 2003, Howard Fisher filed a complaint against the company and three of its officers and directors in the United States District Court for the District of Colorado. The complaint is a purported class action lawsuit on behalf of purchasers of the company's common stock during the period between March 13, 2002 and August 8, 2002. As initially filed, the complaint sought damages for alleged violations of Section 11 of the Securities Act, Section 10(b) of the Exchange Act, Rule 10b-5 promulgated under the Exchange Act, and Section 20(a) of the Exchange Act. On May 30, 2003, the company moved to dismiss all claims asserted in the complaint. The Alaska Electrical Pension Fund ("AEPF"), which had been appointed as the lead plaintiff to represent the putative plaintiff class, responded to the company's Motion to Dismiss by filing an amended complaint on August 11, 2003. In the amended complaint, AEPF asserts claims against the company and all of the company's directors during the relevant period for alleged violations of Sections 11, 12(a)(2) and 15 of the Securities Act. AEPF asserts that the prospectus, dated April 30, 2002, for the company's 2002 public offering of common stock failed to disclose material facts that were required to be disclosed and contained false and misleading statements. The amended complaint seeks to recover unspecified monetary damages, an award of rescission or rescissory damages and an award of attorneys' fees, costs and prejudgment and post-judgment interest. On September 11, 2003, the company moved to dismiss all claims asserted by AEPF in the amended complaint. The company believes the lawsuit is without merit and intends to defend the matter vigorously.

Item 2. Changes in Securities.

        None.

Item 3. Defaults upon Senior Securities.

        None.

Item 4. Submission of Matters to a Vote of Security Holders.

        None.

Item 5. Other Information.

        On December 15, 2003, the company announced it had appointed the company's president and chief operating officer, David J. Workman, as president and chief executive officer, effective upon the retirement of J. Edward McEntire, its chief executive officer, at year end. The company also announced that Mr. McEntire will resign from its board of directors and that the size of its board will be reduced from nine members to eight members upon his resignation.

Item 6. Exhibits and Reports on Form 8-K.

(a)

Exhibits:



10.1

Letter of Amendment to Second Amended and Restated Loan and Security Agreement, dated August 28, 2003



31.1

Certification under Section 302 of the Sarbanes-Oxley Act of 2002



31.2

Certification under Section 302 of the Sarbanes-Oxley Act of 2002



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Certifications under Section 906 of the Sarbanes-Oxley Act of 2002



(b)

Reports on Form 8-K:

On August 12, 2003, the company filed a Current Report on Form 8-K disclosing its sales results for the second fiscal quarter of 2003.

On August 28, 2003, the company filed a Current Report on Form 8-K disclosing its operating results for the second fiscal quarter 2003.

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SIGNATURES

        Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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EXHIBIT INDEX

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