##### Table of Contents



Form 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 31, 2004 Commission file number: 0-24091 Tweeter Home Entertainment Group, Inc. (Exact name of Registrant as specified in its charter)
 DELAWARE
    
    04-3417513(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer Identification No.)
 40 PEQUOT WAY
CANTON, MA 02021(Address of principal executive offices including zip code) 781-830-3000(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. þ o
 Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act). YesþNoo Indicate the number of shares outstanding of each of the registrants classes of common stock,
as of the latest practicable date. TITLE OF CLASS
    
    OUTSTANDING AT FEBRUARY 8, 2005Common Stock, $.01 par value
    
    24,579,600




---



TWEETER HOME ENTERTAINMENT GROUP, INC. AND SUBSIDIARIES INDEX PAGEPart I.
    
    FINANCIAL INFORMATIONItem 1
    
    Condensed Consolidated Financial Statements (Unaudited)Consolidated Balance
Sheets as of December 31, 2003, September 30, 2004 and December 31, 2004
    
    3Consolidated Statements of Income for the Three Months Ended December 31, 2003 and 2004
    
    4Consolidated Statements of Cash Flows for the Three Months Ended December 31, 2003 and 2004
    
    5Notes to Condensed Consolidated Financial Statements (Unaudited)
    
    6Item 2
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    11Item 3
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    14Item 4
    
    Controls and Procedures
    
    14Part II.
    
    OTHER INFORMATIONItem 1
    
    Legal Proceedings
    
    16Item 2
    
    Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity Securities
    
    16Item 3
    
    Defaults upon Senior Securities
    
    16Item 4
    
    Submission of Matters to a Vote of Security Holders
    
    16Item 5
    
    Other Information
    
    16Item 6
    
    Exhibits
    
    16EX-31.1 RULE 13A-14(A)/15D-14(A) CERTIFICATIONEX-31.2 RULE 13A-14(A)/15D-14(A) CERTIFICATIONEX-32.1 SECTION 1350 CERTIFICATIONEX-32.2 SECTION 1350 CERTIFICATION
  2




---



##### Table of Contents



Tweeter Home
Entertainment Group, Inc. and Subsidiaries 
 Consolidated Balance Sheets
 December 31,
    
    
    September 30,
    
    
    December 31,2003
    
    
    2004
    
    
    2004(Unaudited)
    
    
    
    
    
    
    (Unaudited)AssetsCurrent Assets:Cash and cash equivalents
    
    $
    2,870,933
    
    
    $
    2,801,005
    
    
    $
    2,181,540Accounts receivable, net of allowance
for doubtful accounts of $1,253,000,
$475,000, and $618,000 at December 31,
2003, September 30, 2004 , and December
31, 2004, respectively
    
    
    26,110,999
    
    
    
    17,795,922
    
    
    
    32,690,271Inventory
    
    
    145,839,912
    
    
    
    106,562,804
    
    
    
    130,276,341Deferred tax assets
    
    
    6,698,256
    
    
    
    7,801,864
    
    
    
    7,338,656Prepaid expenses and other current assets
    
    
    14,862,689
    
    
    
    17,019,121
    
    
    
    17,260,157Total current assets
    
    
    196,382,789
    
    
    
    151,980,716
    
    
    
    189,746,965Property and equipment, net
    
    
    125,131,044
    
    
    
    124,863,799
    
    
    
    126,882,908Long-term investments
    
    
    2,255,856
    
    
    
    2,304,166
    
    
    
    3,065,604Deferred tax assets
    
    
    4,147,774
    
    
    
    14,470,743
    
    
    
    11,792,841Intangible assets, net
    
    
    1,756,667
    
    
    
    1,246,667
    
    
    
    1,076,667Goodwill
    
    
    
    
    
    
    4,885,133
    
    
    
    4,885,133Other assets, net
    
    
    2,809,082
    
    
    
    1,461,909
    
    
    
    2,150,451Total
    
    $
    332,483,212
    
    
    $
    301,213,133
    
    
    $
    339,600,569Liabilities and Stockholders EquityCurrent Liabilities:Current portion of long-term
debt
    
    $
    27,701,671
    
    
    $
    3,184,274
    
    
    $
    23,686,105Current portion of deferred
consideration
    
    
    
    
    
    
    518,199
    
    
    
    505,699Accounts payable
    
    
    24,660,161
    
    
    
    41,637,673
    
    
    
    39,175,677Accrued expenses
    
    
    27,236,388
    
    
    
    28,362,551
    
    
    
    39,862,346Customer deposits
    
    
    22,819,583
    
    
    
    21,893,905
    
    
    
    24,825,349Deferred warranty
    
    
    184,942
    
    
    
    93,625
    
    
    
    70,219Total current liabilities
    
    
    102,602,745
    
    
    
    95,690,227
    
    
    
    128,125,395Long-Term Debt
    
    
    47,910,723
    
    
    
    35,001,930
    
    
    
    35,791,036Other Long-Term Liabilities:Rent related accruals
    
    
    11,081,972
    
    
    
    11,071,389
    
    
    
    11,186,122Deferred warranty
    
    
    69,488
    
    
    
    
    
    
    
    Deferred consideration
    
    
    
    
    
    
    3,030,413
    
    
    
    2,909,196Total other long-term liabilities
    
    
    11,151,460
    
    
    
    14,101,802
    
    
    
    14,095,318Total liabilities
    
    
    161,664,928
    
    
    
    144,793,959
    
    
    
    178,011,749Commitments and ContingenciesStockholders EquityPreferred stock, $.01 par value,
10,000,000 shares authorized, no shares
issued
    
    
    
    
    
    
    
    
    
    
    Common stock, $.01 par value, 60,000,000
shares authorized; 25,813,671,
26,175,965, and 26,196,193 shares issued
at December 31, 2003, September 30,
2004, and at December 31, 2004,
respectively
    
    
    258,137
    
    
    
    261,760
    
    
    
    261,962Additional paid in capital
    
    
    295,476,274
    
    
    
    304,006,333
    
    
    
    304,197,442Unearned equity compensation
    
    
    (273,318
    )
    
    
    (75,727
    )
    
    
    (31,983
    )Accumulated other comprehensive income
    
    
    7,762
    
    
    
    115,391
    
    
    
    96,902Accumulated deficit
    
    
    (122,859,966
    )
    
    
    (146,136,052
    )
    
    
    (141,194,308
    )Total
    
    
    172,608,889
    
    
    
    158,171,705
    
    
    
    163,330,015Less treasury stock: 1,730,929,
1,676,537, and 1,660,343 shares at
December 31, 2003, September 30, 2004,
and December 31, 2004, at cost,
respectively
    
    
    (1,790,605
    )
    
    
    (1,752,531
    )
    
    
    (1,741,195
    )Total stockholders equity
    
    
    170,818,284
    
    
    
    156,419,174
    
    
    
    161,588,820Total
    
    $
    332,483,212
    
    
    $
    301,213,133
    
    
    $
    339,600,569
 See notes to unaudited condensed consolidated financial statements. 3




---



##### Table of Contents



Tweeter Home
Entertainment Group, Inc. and Subsidiaries 
 Consolidated Statements of Income
(Unaudited)
 Three Months EndedDecember 31,2003
    
    
    2004Total revenue
    
    $
    250,766,631
    
    
    $
    261,974,670Cost of sales
    
    
    (155,493,377
    )
    
    
    (157,050,836
    )Gross Profit
    
    
    95,273,254
    
    
    
    104,923,834Selling expenses
    
    
    74,234,380
    
    
    
    85,323,130Corporate, general and administrative expenses
    
    
    11,762,459
    
    
    
    10,514,175Amortization of intangibles
    
    
    170,000
    
    
    
    170,000Non-cash compensation charges
    
    
    134,824
    
    
    
    43,744Income from continuing operations
    
    
    8,971,591
    
    
    
    8,872,785Interest expense
    
    
    (654,593
    )
    
    
    (543,800
    )Interest income
    
    
    225,673
    
    
    
    13,434Income from continuing operations before income taxes
    
    
    8,542,671
    
    
    
    8,342,419Income taxes
    
    
    3,417,069
    
    
    
    3,336,967Net income from continuing operations before equity
investments
    
    
    5,125,602
    
    
    
    5,005,452Income from equity investments, net of
tax
    
    
    163,366
    
    
    
    268,711Net income from continuing operations
    
    
    5,288,968
    
    
    
    5,274,163Discontinued operations:Pre-tax loss from discontinued
operations
    
    
    (302,532
    )
    
    
    (554,031
    )Income tax benefit
    
    
    (121,013
    )
    
    
    (221,612
    )Loss from discontinued operations
    
    
    (181,519
    )
    
    
    (332,419
    )NET INCOME
    
    $
    5,107,449
    
    
    $
    4,941,744Basic earnings per share:Income from continuing operations
    
    $
    0.22
    
    
    $
    0.21Loss from discontinued operations
    
    
    (0.01
    )
    
    
    (0.01
    )Net Income per share
    
    $
    0.21
    
    
    $
    0.20Diluted earnings per share:Income from continuing operations
    
    $
    0.22
    
    
    $
    0.21Loss from discontinued operations
    
    
    (0.01
    )
    
    
    (0.01
    )Net Income per share
    
    $
    0.21
    
    
    $
    0.20Weighted average shares outstanding:Basic
    
    
    23,923,099
    
    
    
    24,456,033Diluted
    
    
    24,641,583
    
    
    
    24,737,778
 See notes to unaudited condensed consolidated financial statements. 4




---



##### Table of Contents



Tweeter Home
Entertainment Group, Inc. and Subsidiaries 
 Consolidated Statements of Cash Flows
(Unaudited)
 Three Months EndedDecember 31,2003
    
    
    2004CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    5,107,449
    
    
    
    4,941,744Adjustments to reconcile net income to net cash from operating activities:Depreciation and amortization
    
    
    5,634,325
    
    
    
    6,134,969Non-cash compensation
    
    
    134,824
    
    
    
    43,744Loss (gain) on disposal of property and equipment
    
    
    73,942
    
    
    
    (8,250
    )Provision for uncollectible accounts
    
    
    174,928
    
    
    
    157,426Tax benefit from options exercised
    
    
    50,367
    
    
    
    12,659Deferred income tax provision
    
    
    294,968
    
    
    
    3,153,436Amortization of deferred gain on sale leaseback
    
    
    (11,211
    )
    
    
    (11,211
    )Income from equity investment
    
    
    (272,276
    )
    
    
    (447,852
    )Changes in operating assets and liabilities:Increase in accounts receivable
    
    
    (8,022,363
    )
    
    
    (15,051,775
    )Increase in inventory
    
    
    (28,262,217
    )
    
    
    (23,732,070
    )Decrease (increase) in prepaid expenses and other assets
    
    
    11,378,622
    
    
    
    (1,078,764
    )(Decrease) increase in accounts payable and accrued expenses
    
    
    (3,304,261
    )
    
    
    9,011,931Increase in customer deposits
    
    
    1,650,746
    
    
    
    2,931,444Increase in deferred rent
    
    
    36,930
    
    
    
    125,944Decrease in deferred consideration
    
    
    
    
    
    
    (133,717
    )Decrease in deferred warranty
    
    
    (59,213
    )
    
    
    (23,406
    )Net cash used in operating activities
    
    
    (15,394,440
    )
    
    
    (13,973,748
    )CASH FLOWS FROM INVESTING ACTIVITIES:Purchase of property and equipment
    
    
    (4,169,786
    )
    
    
    (7,834,892
    )Proceeds from sale of property and equipment
    
    
    6,450
    
    
    
    8,250Purchase of equity investments
    
    
    
    
    
    
    (300,000
    )Distributions from equity investments
    
    
    132,326
    
    
    
    Net cash used in investing activities
    
    
    (4,031,010
    )
    
    
    (8,126,642
    )CASH FLOWS FROM FINANCING ACTIVITIES:Increase in amount due to bank
    
    
    20,379,337
    
    
    
    20,510,427Net (payments) proceeds of debt
    
    
    (398,805
    )
    
    
    780,510Proceeds from options exercised
    
    
    371,535
    
    
    
    95,284Proceeds from employee stock purchase plan
    
    
    93,867
    
    
    
    94,704Net cash provided by financing activities
    
    
    20,445,934
    
    
    
    21,480,925INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    1,020,484
    
    
    
    (619,465
    )CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
    
    
    1,850,449
    
    
    
    2,801,005CASH AND CASH EQUIVALENTS, END OF PERIOD
    
    $
    2,870,933
    
    
    
    2,181,540SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:Cash paid (received) during the period for:Interest
    
    $
    785,535
    
    
    $
    571,620Taxes
    
    $
    (7,200,671
    )
    
    $
    (61,811
    )
 See notes to unaudited condensed consolidated financial statements. 5




---



##### Table of Contents



TWEETER HOME ENTERTAINMENT GROUP, INC. AND SUBSIDIARIES 
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 1. Basis of Presentation The unaudited condensed consolidated financial statements of Tweeter Home Entertainment Group,
Inc. and its subsidiaries (Tweeter or the Company), included herein, should be read in
conjunction with the consolidated financial statements and notes thereto included in Tweeters
Annual Report on Form 10-K for the fiscal year ended September 30, 2004. 2. Accounting Policies The unaudited condensed consolidated financial statements of Tweeter have been prepared in
accordance with accounting principles generally accepted in the United States of America. In the
opinion of management, all adjustments (consisting only of normal recurring adjustments) considered
necessary for a fair presentation of the interim consolidated financial statements have been
included. Operating results for the three-month period ended December 31, 2004 are not necessarily
indicative of the results that may be expected for the fiscal year ending September 30, 2005.
Tweeter typically records its highest revenue and earnings in this first fiscal quarter. Vendor Allowances, Allowance for Bad and Doubtful Accounts Accounts receivable are primarily
due from the vendors from which the Company buys its product. The various types of accounts
receivable are for purchase rebate allowances, cooperative advertising allowances, returned
merchandise and warranty work performed by the Companys service departments. Vendor allowances are only recorded if evidence of a binding arrangement exists with the
vendor and the amounts that will be received are both probable and estimable. Evidence of an
arrangement takes different forms. Arrangements with vendors are principally evidenced by written
contracts. In the absence of written contracts, the other documentation evidencing an arrangement
are documentation received from vendors, including end-of-period settlements, vendor presentation
materials, term sheets, and emails or other forms of documentation that specify the terms and
conditions of the vendor allowance receivable. The Company only considers these forms of
documentation binding when they are consistent with historical business practices relating to a
vendor and when settlement has occurred or is reasonably assured. Cash discounts earned for timely payments of merchandise invoices are recognized in the income
statement upon the sale of the related inventory. Purchase rebate allowances and general cooperative advertising allowances are earned based on
the purchase of inventory and are recorded in accounts receivable when the inventory is purchased.
The carrying value of inventory is initially reduced by the amount of purchase and accounts payable
rebates earned, resulting in lower cost of goods sold when the inventory is sold. Certain vendor
agreements include stretch goals where the level of funds earned is dependent upon the Company
achieving certain purchase levels. These program funds are recorded as a reduction of inventory
costs when it is determined that it is likely that the Company will achieve the goal. Vendor allowances earned based on specific advertising activities and other activities are
recognized as a reduction to advertising expense as these activities are performed and only to the
extent that the cost of the activities equals or exceeds the amount of the allowances. When the Company returns merchandise to a vendor, typically because it is defective, the
Company records a receivable for the value of the merchandise returned and reduces the inventory
balance. 6




---



##### Table of Contents



The Company sells products that come with a manufacturers warranty, but the Company has
service centers that repair products. When the Company repairs products that are still under
manufacturers warranty, the vendor reimburses the Company for the parts and the technicians
labor. Once the product is repaired, the Company establishes a receivable for the amounts due from
the vendor and records service revenue. AdvertisingGross advertising, including electronic media, newspaper, buyers guides and
direct mailings, are expensed when released. For the three months ended December 31, 2003 and 2004
gross advertising was $15.9 million and $19.7 million, respectively. Cooperative advertising, for
specific advertising activities received from vendors, offsetting our gross advertising expense,
amounted to $1.2 million and $7,000 for the three months ended December 31, 2003 and 2004,
respectively, resulting in net advertising of $14.7 million and $19.7 million for the three months
ended December 31, 2003 and 2004, respectively. Stock-based compensation Statement of Financial Accounting Standards (SFAS) No. 123,
Accounting for Stock-Based Compensation, addresses the financial accounting and reporting
standards for stock or other equity-based compensation arrangements. The Company accounts for stock
based compensation to employees using the intrinsic method. The Company provides disclosures based
on the fair value as permitted by SFAS No. 123. Stock or other equity-based compensation for
non-employees must be accounted for under the fair value-based method as required by SFAS No. 123
and EITF No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling, Goods or Services, and other related interpretations.
Under this method, the equity-based instrument is valued at either the fair value of the
consideration received or the equity instrument issued on the date of grant. The resulting
compensation cost is recognized and charged to operations over the service period, which is usually
the vesting period. For purposes of determining the disclosures required by SFAS No. 123, the fair value of each
stock option granted in the three months ended December 31, 2003 and December 31, 2004 under the
Companys stock option plan was estimated on the date of grant using the Black-Scholes
option-pricing model. Key assumptions used to apply this pricing model were as follows: Three Months EndedDecember 31,2003
    
    
    2004Risk free interest rate
    
    
    3.46
    %
    
    
    3.35
    %Expected life of options grants
    
    
    7.2
    
    
    
    10.0Expected volatility of underlying stock
    
    
    87.53
    %
    
    
    83.21
    %
 Had compensation cost for the Companys stock option plans been determined using the fair
value method, pro forma net income and pro forma diluted earnings per share would have been: Three Months EndedDecember 31,2003
    
    
    2004Net income as reported
    
    $
    5,107,449
    
    
    $
    4,941,744Total stock-based employee
compensation expense recorded, net of
related -tax effects
    
    
    80,894
    
    
    
    26,246Total stock-based employee
compensation expense determined under
fair value based method for all
awards, net of related tax effects
    
    
    (1,616,034
    )
    
    
    (1,182,487
    )Pro forma net income
    
    $
    3,572,309
    
    
    $
    3,785,503Earnings per share:Basic  as reported
    
    $
    0.21
    
    
    $
    0.20Basic  pro forma
    
    $
    0.15
    
    
    $
    0.15Diluted  as reported
    
    $
    0.21
    
    
    $
    0.20Diluted  pro forma
    
    $
    0.14
    
    
    $
    0.15
 7




---



##### Table of Contents



See Note 8 for discussion of SFAS No. 123R, Share-Based Payment. 3. Earnings per Share The weighted average shares used in computing basic and diluted net income per share are
presented in the table below. Options and warrants are not included in the earnings per share
calculation when the exercise price is greater than the average market price for the period. The
number of options and warrants excluded in each period is reflected in the table. Three Months EndedDecember 31,2003
    
    
    2004Basic Earnings Per Share:Numerator:Net income from continuing operations
    
    $
    5,288,968
    
    
    $
    5,274,163Denominator:Weighted average common shares outstanding
    
    
    23,923,099
    
    
    
    24,456,033Basic earnings per share
    
    $
    0.22
    
    
    $
    0.21Diluted Earnings Per Share:Numerator:
    
    $
    5,288,968
    
    
    $
    5,274,163Denominator:Weighted average shares outstanding
    
    
    23,923,099
    
    
    
    24,456,033Potential common stock outstanding
    
    
    718,484
    
    
    
    281,755Total
    
    
    24,641,583
    
    
    
    24,737,788Diluted earnings per share
    
    $
    0.22
    
    
    $
    0.21Anti dilutive options and warrants not included
in earnings per share calculation
    
    
    3,088,814
    
    
    
    5,049,659Price range of anti dilutive options and warrants
    
    $
    8.500 to $32.125
    
    
    $
    6.900 to $32.125
 4. Comprehensive Income Comprehensive income for the three months ended December 31, 2003 and December 31, 2004 was as
follows: Three Months EndedDecember 31,2003
    
    
    2004Net income
    
    $
    5,107,449
    
    
    $
    4,941,744Change in fair value of long-term investments (net of tax)
    
    
    6,632
    
    
    
    (2,968
    )Change in fair value of interest rate forward contract (net of tax)
    
    
    17,061
    
    
    
    (15,521
    )Comprehensive income
    
    $
    5,131,142
    
    
    $
    4,923,255
 5. Intangible Assets and Goodwill Acquired amortizable intangible assets are as follows: As of September 30, 2004
    
    
    As of December 31, 2004Gross Carrying
    
    
    Accumulated
    
    
    Gross Carrying
    
    
    AccumulatedAmount
    
    
    Amortization
    
    
    Amount
    
    
    AmortizationNon compete agreements and tradenames
    
    $
    3,400,000
    
    
    $
    2,153,333
    
    
    $
    3,400,000
    
    
    $
    2,323,333
 8




---



##### Table of Contents



For the three months ended December 31, 2003 and 2004, the aggregate amortization expense was
$170,000 in each period. For the full fiscal year 2005, the amortization expense is estimated to be
approximately $680,000 and for fiscal year 2006, the amortization expense is estimated to be
approximately $567,000. Goodwill On July 1, 2004, the Company acquired 100% of the outstanding common stock of Sumarc
Electronics Incorporated d/b/a NOW! AudioVideo (NOW!). The results of operations have been included
in the consolidated financial statements since that date. NOW! is a full service specialty retailer
of consumer electronics products with five North Carolina-based stores and one Tennessee-based
store. This acquisition was consummated for a number of reasons, including the compatibility of
NOW! with Tweeters existing go to market strategy, the protection of growing markets in North
Carolina and Tennessee, expected efficiencies of a combined infrastructure and the timing of the
acquisition (i.e., prior to the fiscal 2004 holiday selling season). The aggregate purchase price, including acquisition costs, was $5,031,746, which included the
issuance of 133,824 shares of common stock valued at $752,091 and cash of $4,279,655. The following
table provides a preliminary allocation of the purchase price and is subject to refinement and
finalization as additional information becomes available. Current assets
    
    $
    2,780,174Property and equipment
    
    
    1,039,778Goodwill
    
    
    4,885,133Total assets acquired
    
    
    8,705,085Current liabilities
    
    
    1,645,156Assumed debt
    
    
    2,028,183Total liabilities assumed
    
    
    3,673,339Total purchase price
    
    $
    5,031,746
 6. Related-Party Transactions Tweeter has a 25% ownership interest in Tivoli Audio, LLC, a manufacturer of consumer
electronic products. The Company accounts for this investment in Tivoli under the equity method of
accounting, recognizing the Companys share of Tivolis income or loss in the Companys statement
of income. For the three months ended December 31, 2003 and December 31, 2004, the Company
purchased approximately $459,000 and $693,000, respectively, of product from Tivoli. Distributions
received from Tivoli amounted to $132,000 for the three months ended December 31, 2003. There were
no distributions received for the three months ended December 31, 2004. Amounts payable to Tivoli
were $14,000 and $15,100 at December 31, 2003 and 2004, respectively. On December 31, 2004, Tweeter made an initial investment of $300,000 in Sapphire Audio, LLC, a
manufacturer of consumer electronic products, to obtain a 25% ownership interest. This investment
is being accounted for under the equity method of accounting. 7. Reclassifications Certain 2003 reclassifications have been made to conform to the 2004 presentation. 8. New Accounting Pronouncements In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123
(revised 2004), Share-Based Payment(SFAS No. 123R), which requires the recognition of the cost
of employee services received in exchange for an award of equity instruments in the financial
statements and measurement based on the grant-date fair value of the award. It also requires the
cost to be recognized over the period during which an employee is required to provide service in
exchange for the award (presumptively the vesting period). SFAS No. 123R replaces 9




---



##### Table of Contents



SFAS No. 123 and supersedes APB Opinion No. 25, and its related interpretations. SFAS No. 123R
is effective for periods beginning after June 15, 2005. The Company will adopt SFAS No. 123R on
July 1, 2005, as required. The Company is in the process of determining which transition method it
will adopt. Adoption of SFAS No. 123R will not effect Tweeters cash flow or financial position, but it
will reduce reported net income and earning per share because Tweeter currently uses the intrinsic
value method as permitted by Opinion No. 25. Accordingly, no compensation expense is currently
recognized for share purchase rights granted under the Companys employee stock option and employee
stock purchase plans. Specifically, adopting SFAS No. 123R will result in Tweeter recording
compensation cost for employee stock options and employee share purchase rights. The Company is evaluating the impact of the adoption of this standard. On December 16, 2004, the FASB issued Statement No. 153, Exchanges of Nonmonetary Assets, an
amendment of ABP Opinion No. 29.Statement No. 153 addresses the measurement of exchanges of
nonmonetary assets and redefines the scope of transactions that should be measured based on the
fair value of the assets exchanged. Statement 153 is effective for nonmonetary asset exchanges
occurring in fiscal periods beginning after June 15, 2005. The Company does not believe adoption of
Statement No. 153 will have a material effect on its consolidation financial position, results of
operations or cash flows. 10




---



##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTION Tweeter Home Entertainment Group, Inc. (Tweeter or the Company) is a specialty retailer of
mid- to high-end audio and video consumer electronics products. Tweeter currently operates 175
stores under the Tweeter, HiFi Buys, Sound Advice, Electronic Interiors, Showcase Home
Entertainment and Hillcrest names in the New England, Mid-Atlantic, Southeast, Texas, Southern
California, Chicago, Florida and Phoenix markets. RESULTS OF OPERATIONS THREE MONTHS ENDED DECEMBER 31, 2004 AS COMPARED TO THREE MONTHS ENDED DECEMBER 31, 2003 Total Revenue.Total revenue includes delivered merchandise, labor, net commissions on service
contracts sold, completed service center work orders, insurance replacement and corporate sales.
Total revenue from continuing operations increased $11.2 million, or 4.5%, to $262.0 million for
the three months ended December 31, 2004 from $250.8 million for the three months ended December
31, 2003. Comparable store sales increased $3.8 million or 1.6%. Comparable store sales is a term
we use to compare the year-over-year sales performance of our stores. A store is included in the
comparable store sales base after it is in operation for 12 full months. An acquired store is
included after 12 full months from the date of acquisition. Remodeled or relocated stores are
excluded from the comparable store base until they have competed 12 full months of operation from
the date the remodeling was completed or the store re-opened after relocation. In addition to the
comparable store sales increase, $4.8 million of sales were generated from new and relocated
stores that have not been opened for a twelve-month period and are therefore not yet includable in
the comparable store sales base. Our corporate sales/insurance replacement sales decreased by $2.3
million, while our home install labor increased $3.5 million and our service sales increased $1.0
million. For the quarter ended December 31, 2004, flat panel television sales grew to 23.4% of
total sales compared to 18.9% for the quarter ended December 31, 2003. For the quarter ended
December 31, 2004, plasma televisions represented 68.5% of the flat panel categorys dollars and
49.4% of the units sold. Home installation labor revenue grew to 4.0% of revenues during the
quarter ended December 31, 2004 from 2.7% during the quarter ended December 31, 2003. Cost of Sales and Gross Profit.Cost of sales includes merchandise costs, net delivery costs,
distribution costs, home installation labor costs, purchase discount and vendor allowances. Cost of
sales increased $1.6 million, or 1.0%, to $157.1 million for the three months ended December 31,
2004 from $155.5 million for the three months ended December 31, 2003. Gross profit increased $9.7
million, or 10.1%, to $104.9 million for the three months ended December 31, 2004 from $95.3
million for the three months ended December 31, 2003. The gross margin percentage increased 210
basis points to 40.1% for the three months ended December 31, 2004 from 38.0% for the three months
ended December 31, 2003. Overall margins, excluding distribution and labor costs, increased by 225
basis points, while labor costs increased by 23 basis points. Selling Expenses.Selling expenses include the compensation of store personnel and store
specific support functions, occupancy costs, store level depreciation, advertising, pre-opening
expenses and credit card fees. Selling expenses increased $11.1 million, or 14.9%, to $85.3 million
for the three months ended December 31, 2004 from $74.2 million for the three months ended December
31, 2003. As a percentage of revenue, selling expenses increased to 32.6% for the three months
ended December 31, 2004 from 29.6% for the three months ended December 31, 2003. The increase in
selling expenses as a percent of revenue is mainly due to a 170 basis point increase in gross
advertising expense due to the implementation of a new advertising strategy. In addition there was
a 40 basis point increase in store level fringe benefit costs. Credit card fees increased by 20
basis points and depreciation was 10 basis points higher than last year as well. 11




---



##### Table of Contents



Corporate, General and Administrative Expenses.Corporate, general and administrative expenses
include the costs of the finance, information systems, merchandising, marketing, human resources
and training departments, related support functions and executive officers. Corporate, general and
administrative expenses decreased 10.6% or $1.3 million to $10.5 million for the three months ended
December 31, 2004 from $11.8 million for the three months ended December 31, 2003. As a percentage
of total revenue, corporate general and administrative expenses decreased to 4.0% for the three
months ended December 31, 2004 from 4.7% for the three months ended December 31, 2003. This was
mainly due to a 30 basis point decrease in professional fees, mostly due to higher payments to
outside consultants in the prior year. Administrative compensation costs also decreased by 20 basis
points. Amortization of Intangibles.Amortization of intangibles was $170,000 for the three months
ended December 31, 2004 and December 31, 2003. Interest Expense.Interest expense decreased to $544,000 for the three months ended December
31, 2004 compared to $655,000 for the three months ended December 31, 2003. This decrease is due to
the reduced borrowings on our revolving credit facility during the three months ended December 31,
2004 compared to the balances borrowed during the three months ended December 31, 2003. Borrowings
were decreased as a result of lower inventory levels. Interest Income.Interest income decreased to $13,000 for the three months ended December 31,
2004 compared to $226,000 for the three months ended December 31, 2003. In fiscal 2004, we received
interest income from our suppliers on pre-payments made to secure inventory purchases. No
prepayments were made in fiscal 2005. Income from Equity Investment.Income from equity investment increased to $448,000 for the
three months ended December 31, 2004 from $272,000 for the year ended December 31, 2003. Income Taxes.The effective tax rate for the three months ended December 31, 2004 and December
31, 2003 was 40.0%. Discontinued Operations.In the fourth quarter of fiscal 2004, we closed, sold or committed
to close eight stores. We completed the store closures by December 31, 2004. The decision to exit
these stores was to allow us to focus on our core operating strategy. In accordance with our
accounting policy and Statements of Financial Accounting Standards (SFAS) No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets, we classified the operating results of these
stores as discontinued operations in the accompanying consolidated statements of operations. Prior
year information has been reclassified to conform to current year presentation. Revenues from the
closed stores, included in pre-tax loss from discontinued operations, amounted to $4,473,120 and
$485,212 for the three months ended December 31, 2003 and 2004, respectively. Seasonality.Tweeters operations, in common with other retailers, are subject to seasonal
influences. Historically, Tweeter has realized more of its revenue and net earnings in this first
fiscal quarter, which includes the holiday season, than in any other fiscal quarter. The net
earnings of any interim quarter are seasonally disproportionate to net sales since certain selling
expenses and administrative expenses are relatively fixed during the year. Therefore, interim
results should not be relied upon as indicative of results for the entire fiscal year. BALANCE SHEET COMPARISON: DECEMBER 31, 2004 AS COMPARED TO SEPTEMBER 30, 2004 Inventory. Total inventory increased during the three months ended December 31, 2004 compared
to September 30, 2004 by $23.7 million. The increase is attributable to additional video
merchandise, which was high in demand and short in supply, brought in during the December quarter
in anticipation of January sales, which historically has been a strong video month. Accounts receivable.Total accounts receivable increased by $14.9 million during the three
months ended December 31, 2004 compared to September 30, 2004. The increase was primarily
attributable to monies due from vendors for allowances that were higher as a result of the increase
in purchases for the quarter. In addition, credit card receivables increased due to the higher
sales volume in the quarter. 12




---



##### Table of Contents



Current portion of long-term debt.Current portion of long-term debt increased by $20.5
million during the three months ended December 31, 2004 compared to September 30, 2004. The
increase is a result of the timing of accounts payable checks clearing the bank. Accrued expenses.Total accrued expenses increased $11.5 million during the three months ended
December 31, 2004 compared to September 30, 2004. This is a result of an increase in advertising
related accruals. LIQUIDITY AND CAPITAL RESOURCES Net cash used in operating activities was $14.0 million for the three months ended December
31, 2004 compared to net cash used of $15.4 million for the three months ended December 31, 2003.
Cash used in operating activities for the three months ended December 31, 2004 was primarily the
result of an increase in inventory of $23.7 million and an increase in accounts receivable of $15.1
million. This was offset by net income of $4.9 million, an increase in accounts payable and
accrued expenses of $9.0 million, and an increase in customer deposits of $2.9 million. The
adjustments to reconcile net income to net cash from operating activities consisted primarily of
$6.1 million for depreciation and amortization and $3.2 million related to deferred income tax
provision, as well as other minor items. At December 31, 2004, working capital was $61.6 million, compared to $56.3 million at
September 30, 2004. The ratio of current assets to current liabilities was 1.48 to 1 at December
31, 2004 and 1.59 to 1 at September 30, 2004. The decrease was primarily the result of higher
inventory levels at December 31, 2004. Net cash used in investing activities for the three months ended December 31, 2004 consisted
primarily of capital expenditures of $7.8 million, primarily used for the building of new stores
and displays. Net cash provided by financing activities during the three months ended December 31, 2004 was
$21.5 million, which was primarily due to an increase in current portion of long-term debt of $20.5
million. This increase was due to the timing and clearing of outstanding checks. The Company currently has a $90 million line of credit that will expire on April 1, 2008.
Under the agreement the availability under the credit facility is based on a borrowing base tied to
a percentage of eligible inventory, receivables and real estate. The interest rate on the facility
ranged from 1.75% to 2.25% over LIBOR provided the Company commits the loan balances for a period
of thirty days or more, or 0% to .25% over the prime rate. The line is secured by substantially all
of the assets of the Company and its subsidiaries and contains various covenants and restrictions,
including that: (i) the Company cannot create, incur, assume or permit additional indebtedness,
(ii) the Company cannot create, incur, assume or permit any lien on any property or asset, (iii)
the Company cannot merge or consolidate with any other person or permit any other person to merge
or consolidate with the Company, (iv) the Company cannot purchase, hold or acquire any investment
in any other person except those specifically permitted, (v) the Company cannot sell, transfer,
lease, or otherwise dispose of any asset except permitted exceptions, and (vi) the Company cannot
declare or make any restricted payments. The borrowers under the credit facility are subsidiaries
of the Company, and the Company is the guarantor of any amounts borrowed. In addition, there is a
commitment fee for the unused portion of the line of .300%. Our weighted average interest rate on
outstanding borrowings under this credit facility for the three months ended December 31, 2004 and
December 31, 2003 was approximately 4.4%, and 3.6%, respectively. The Company is required to have
$6.0 million on reserve when computing the available borrowing base. The administrative
availability block under the agreement is presently at $7.5 million. As of December 31, 2004, the Company had $38.4 million available under this revolving credit
facility and $35.8 million outstanding. The Company believes that its existing cash, together with cash generated by operations and
available borrowings under its credit facility, will be sufficient to finance its working capital
and capital expenditure requirements for at least the next twelve months. Furthermore, due to the
seasonality of its business, our working 13




---



##### Table of Contents



capital needs are significantly higher in the fiscal third and fourth quarters and there is
the possibility that this could cause unforeseen capital constraints in the future. Within our
credit facility, there is an option during our peak holiday season buying periods to have more
availability on our credit line to meet these needs. FORWARD-LOOKING STATEMENTS Certain statements contained in this Quarterly Report on Form 10-Q, including, without
limitation, statements containing the words expects, anticipates, believes and words of
similar import, constitute forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. These forward-looking statements are subject to various
risks and uncertainties, including Company growth and acquisitions, dependence on key personnel,
the need for additional financing, competition and seasonal fluctuations, and those referred to in
the Companys Annual Report on Form 10-K filed on December 14, 2004, that could cause actual future
results and events to differ materially from those currently anticipated. Readers are cautioned not
to place undue reliance on these forward-looking statements. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The principle market risk inherent in our financial instruments and in our financial position
is the potential for loss arising from adverse changes in interest rates. We do not enter into
financial instruments for trading purposes. At December 31, 2004, the Company had $35.8 million of variable rate borrowings outstanding
under its revolving credit agreements, which approximates fair value. A hypothetical 10% adverse
change in interest rates for this variable rate debt would have an approximate $188,000 annual
impact on the Companys earnings and cash flows. On July 14, 2003, the Company entered into an interest rate swap that fixes the interest rate
on up to $35 million of libor-based borrowings under the revolving term bank loan at 1.69%, plus
the applicable margin, for the period from January 1, 2004 to December 31, 2004. The interest rate
swap has been designated as a cash flow hedge. The effective portion of the gain or loss on the
derivative instrument is reclassified into earnings in the same period or periods during which the
hedged transaction affects earnings. The ineffective portion of the derivative instrument is
recognized in current earnings during the period of change. For the quarter ended December 31 2004,
we recorded $28,226 of interest income in the statement of income with respect to this instrument.
There was no expense or income recorded for the quarter ended December 31, 2003 with respect to
this instrument. The instrument expired on December 31, 2004. 
 ITEM 4. CONTROLS AND PROCEDURES Our chief executive officer and chief financial officer, after evaluating the effectiveness of
our disclosure controls and procedures (as defined in the Securities Exchange Act of 1934 Rules
13a-15(e) and 15d-15(e)) as of the end of the period covered by this quarterly report (the
Evaluation Date), have concluded that as of the Evaluation Date our disclosure controls and
procedures were effective and designed to ensure that material information relating to Tweeter
would be made known to them by others within the company. During the period covered by this
quarterly report, there were no changes in our internal control over financial reporting that have
materially affected, or are reasonably likely to materially affect, our internal control over
financial reporting, except for the following: In connection with its audit procedures for the year ended September 30, 2004, Deloitte &
Touche LLP, our independent auditors, advised our Audit Committee and management that controls
relating to the accumulation of financial information within spreadsheets were not sufficient,
resulting in a material weakness under standards established by the American Institute of Certified
Public Accountants. Deloitte & Touche reported that it had deemed our monitoring controls over the
use of spreadsheets in the financial reporting process to be ineffective, because these controls
did not detect the errors in a timely fashion. The errors were isolated to the fourth quarter of 14




---



##### Table of Contents



fiscal 2004 and did not affect prior periods. We reviewed and re-evaluated our monitoring
controls over the use of spreadsheets, and implemented formalized procedures and subjected the data
to more rigorous management review. 15




---



##### Table of Contents



PART II. OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS None 
 ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS, AND ISSUER PURCHASES OF EQUITY 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 None 
 ITEM 6. EXHIBITS 31.1
    
    Rule 13a-14(a)/15d-14(a) Certifications.31.2
    
    Rule 13a-14(a)/15d-14(a) Certifications.32.1
    
    Section 1350 Certifications.32.2
    
    Section 1350 Certifications.
 16




---



##### Table of Contents



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. TWEETER HOME ENTERTAINMENT GROUP, INC.By: /s/ Joseph McGuireJoseph McGuire,
Senior Vice-President and Chief Financial Officer
 Date: February 9, 2005 17