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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
( X ) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended January 31, 2004
Commission File No.0-25464
DOLLAR TREE STORES, INC.
(Exact name of registrant as specified in its charter)
Virginia 54-1387365
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
500 Volvo Parkway, Chesapeake, VA 23320
(Address of principal executive offices)
Registrant's telephone number, including area code: (757) 321-5000
Securities Registered Pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
None None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock (par value $.01 per share)
(Title of Class)
Indicate by check mark whether 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 (X) No ( )
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. (X)
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes (X) No ( )
The aggregate market value of Common Stock held by non-affiliates of the
Registrant on August 2, 2003, was $4,208,274,759 based on a $36.67 average of
the high and low sales prices for the Common Stock on such date. For purposes of
this computation, all executive officers and directors have been deemed to be
affiliates. Such determination should not be deemed to be an admission that such
executive officers and directors are, in fact, affiliates of the Registrant.
On April 5, 2004, there were 113,593,263 shares of the Registrant's Common
Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The information regarding securities authorized for issuance under equity
compensation plans called for in Item 5 of Part II and the information called
for in Items 10, 11, 12, 13 and 14 of Part III are incorporated by reference to
the definitive Proxy Statement for the Annual Meeting of Stockholders of the
Company to be held June 17, 2004, which will be filed with the Securities and
Exchange Commission not later than April 29, 2004.
DOLLAR TREE STORES, INC.
TABLE OF CONTENTS
Page
----
PART I
Item 1. BUSINESS..................................................... 5
Item 2. PROPERTIES................................................... 9
Item 3. LEGAL PROCEEDINGS............................................ 10
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......... 10
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS........................................ 10
Item 6. SELECTED FINANCIAL DATA..................................... 11
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS........................ 13
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK... 24
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................. 25
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE........................ 50
Item 9A. CONTROLS AND PROCEDURES...................................... 50
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT........... 51
Item 11. EXECUTIVE COMPENSATION....................................... 51
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS............. 51
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............... 51
Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES....................... 51
PART IV
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K................................................ 51
SIGNATURES................................................... 53
2
A WARNING ABOUT FORWARD LOOKING STATEMENTS: This document contains
"forward-looking statements" as that term is used in the Private Securities
Litigation Reform Act of 1995. Forward-looking statements address future events,
developments and results. They include statements preceded by, followed by or
including words such as "believe," "anticipate," "expect," "intend," "plan,"
"view" "target" or "estimate." For example, our forward-looking statements
include statements regarding:
o our anticipated sales, including comparable store net sales, net sales
growth and earnings growth;
o our growth plans, including our plans to add, expand or relocate
stores, our anticipated square footage increase, and our ability to
renew leases at existing store locations;
o the average size of our stores to be added in 2004 and beyond;
o the net sales per square foot, net sales and operating income
attributable to smaller and larger stores and store-level cash payback
periods;
o the possible effect of inflation and other economic changes on our
costs and profitability, including the possible effect of future
changes in shipping rates, domestic and foreign freight costs, fuel
costs, minimum wage rates and wage and benefit costs;
o our cash needs, including our ability to fund our future capital
expenditures and working capital requirements;
o our gross profit margin, earnings, inventory levels and ability to
leverage selling, general and administrative costs;
o our seasonal sales patterns including those relating to the length of the
holiday selling seasons;
o changes in our merchandise mix and the effect on gross profit margin and
sales;
o the capabilities of our inventory supply chain technology, planned labor
management system and other new systems;
o the future reliability of, and cost associated with, our sources of
supply, particularly imported goods such as those sourced from China;
o the capacity, performance and cost of our existing and planned
distribution centers, including opening and expansion schedules;
o our expectations regarding competition and growth in our retail sector;
o costs of pending and possible future legal claims;
o management's estimates associated with our critical accounting policies,
including inventory valuation, accrued expenses, and income taxes;
o the adequacy of our internal financial reporting controls;
o the possible effect on our financial results of changes in generally
accepted accounting principles relating to accounting for stock-based
compensation;
You should assume that the information appearing in this annual report is
accurate only as of the date it was issued. Our business, financial condition,
results of operations and prospects may have changed since that date.
For a discussion of the risks, uncertainties and assumptions that could
affect our future events, developments or results, you should carefully review
the risk factors described below, as well as "Management's Discussion and
Analysis of Financial Condition and Results of Operations" beginning on page 13.
Our risk factors include:
o The outbreak of war and other national and international events, such
as terrorism, could lead to disruptions in the economy. Adverse
economic conditions, such as reduced consumer confidence and spending,
could significantly reduce our sales. Bad weather could also prevent us
from meeting our sales and operating forecasts.
o Our profitability is vulnerable to future increases in operating and
merchandise costs including shipping rates, freight costs, fuel costs,
wage levels, inflation, competition and other adverse economic factors
because we sell goods at the fixed $1.00 price point.
3
o We could fail to meet our goals for opening, expanding or relocating
stores on a timely basis, which would cause our sales to suffer. We may
not anticipate all the challenges that our expanding operations will
impose and, as a result, we may not meet our targets for opening new
stores and expanding profitability. In addition, new or expanded stores
will cause sales at nearby stores to suffer, and we could have
difficulties profitably renewing or replacing expiring leases.
o We realize a disproportionately larger amount of our sales and net
income during the Christmas and Easter seasons. If for any reason our
sales were below expectations during the Christmas and Easter selling
seasons, our operating results could suffer materially.
o Our sales and profits could be reduced by increases in competition,
especially because there are no significant economic barriers for
others to enter our retail segment.
o The performance of our distribution system is critical to our
operations. We must expand or replace existing distribution centers and
build new ones in a timely manner or we will not meet our growth plans.
Unforeseen disruptions or costs in operating and expanding our systems,
including our receiving and distribution systems, could harm our sales
and profitability.
o Our merchandise mix relies heavily on imported goods. An increase in
the cost or disruption of the flow of these goods may significantly
decrease our sales and profits because any transition to alternative
sources may not occur in time to meet our demands. In addition,
products from alternative sources may also be of lesser quality and
more expensive than those we currently import.
o Disruptions in the availability of quality, low-cost merchandise in
sufficient quantities to maintain our growth may reduce our sales and
profits.
Our forward-looking statements could be wrong in light of these and other
risks, uncertainties and assumptions. The future events, developments or results
described in this report could turn out to be materially different. We have no
obligation to publicly update or revise our forward-looking statements after the
date of this annual report and you should not expect us to do so.
Investors should also be aware that while we do, from time to time,
communicate with securities analysts and others, we do not, by policy,
selectively disclose to them any material nonpublic information or other
confidential commercial information. Accordingly, shareholders should not assume
that we agree with any statement or report issued by any analyst regardless of
the content of the statement or report. We generally do not issue financial
forecasts or projections and we do not, by policy, confirm those issued by
others. Thus, to the extent that reports issued by securities analysts contain
any projections, forecasts or opinions, such reports are not our responsibility.
- --------------------------------------------------------------------------------
INTRODUCTORY NOTE: Unless otherwise stated, references to "we," "our" and
"Dollar Tree" generally refer to Dollar Tree Stores, Inc. and its direct and
indirect subsidiaries on a consolidated basis. Unless specifically indicated
otherwise, any reference to "2003" or "fiscal 2003" relates to as of or for the
year ended January 31, 2004 and any reference to "2004" or "fiscal 2004" relates
to as of or for the year ended January 29, 2005. Any references to "2002" and
"2001" or "fiscal 2002" and "fiscal 2001" relate to as of or for the years ended
December 31, 2002 and 2001, respectively.
- --------------------------------------------------------------------------------
AVAILABLE INFORMATION
Our annual reports on Form 10-K, quarterly reports on Form 10-Q, Current
reports on Form 8-K and amendments to those reports filed or furnished pursuant
to Section 13(a) or 15(d) of the Securities Exchange Act are available free of
charge on our web site at www.dollartree.com as soon as reasonably practicable
after electronic filing of such reports with the SEC.
4
PART I
Item 1. BUSINESS
Overview
Since our founding in 1986, we have become the leading operator of discount
variety stores offering merchandise at the fixed price of $1.00. We believe the
variety and quality of products we sell for $1.00 sets us apart from our
competitors. At January 31, 2004, we operated 2,513 single-price point stores
under the names of Dollar Tree, Greenbacks, Dollar Express, Dollar Bills, Only
One Dollar, and Only $One.
Since 1986, we have evolved from opening primarily mall-based stores
ranging between 1,500 and 2,500 selling square feet to opening primarily strip
shopping center-based stores averaging 10,000 to 15,000 selling square feet. In
the past five years, we gradually increased the average size of our stores as we
improved our merchandise offerings and service to our customers. At December 31,
1998, we operated 1,285 stores in 31 states; at January 31, 2004, we operated
2,513 stores in 47 states. Over the same time period, our selling square footage
increased from approximately 4.9 million square feet in December 1998 to 16.9
million square feet in January 2004. Our store growth since 1998 has resulted
from opening new stores and completing mergers and acquisitions. We centrally
manage our store and distribution operations from our corporate headquarters in
Chesapeake, Virginia.
Change in Fiscal Year End
In January 2003, we changed our fiscal year end to a retail fiscal year
ending on the Saturday closest to January 31.
Business Strategy
Value Merchandise Offering. We strive to exceed our customers' expectations
of the variety and quality of products that they can purchase for $1.00 by
offering items that we believe typically sell for higher prices elsewhere. We
buy approximately 60% of our merchandise domestically and directly import the
remaining 40%. Our domestic purchases include closeouts. We believe our mix of
imported and domestic merchandise affords our buyers flexibility that allows
them to consistently exceed the customer's expectation. In addition, direct
relationships with manufacturers permit us to select from a broad range of
products, and customize packaging, product sizes and package quantities that
meet our customers' needs.
Mix of Basic Variety and Seasonal Merchandise. We maintain a balanced
selection of products within traditional variety store categories. We offer a
wide selection of everyday basic products and we supplement these basic,
everyday items with seasonal and closeout merchandise. We attempt to keep
certain basic consumable merchandise in our stores continuously to establish our
stores as a destination. Closeout merchandise is purchased opportunistically and
represents less than 10% of our purchases. National, regional and private-label
brands have become a bigger part of our merchandise mix.
Our merchandise mix consists of:
o consumable merchandise, which includes candy and food, health and beauty
care, and housewares such as paper, plastics and household chemicals;
o variety merchandise, which includes toys, durable housewares, gifts,
party goods, greeting cards, hardware, and other items; and
o seasonal goods such as Easter, summer toys, lawn and garden, Halloween
and Christmas merchandise.
Our larger stores, which appeal to a broader demographic mix, carry more
consumable merchandise than smaller stores. As a result, consumable merchandise
has grown as a percentage of purchases and sales. Our larger stores also allow
us to increase our seasonal offering and presentation resulting in increasing
our seasonal purchases as a percentage of our total purchases. The following
table shows the percentage of purchases of each major product group for the
years ended January 31, 2004 and December 31, 2002:
January 31, December 31,
Merchandise Type 2004 2002
---------------- ---- ----
Variety categories 49.5% 50.6%
Consumable 41.2% 40.5%
Seasonal 9.3% 8.9%
Convenient Locations and Store Size. We primarily focus on opening new
stores in strip shopping centers anchored by mass merchandisers, whose target
customers we believe to be similar to ours, and in neighborhood centers anchored
by large grocery retailers. Our stores have proven successful in
5
metropolitan areas, mid-sized cities and small towns. The range of our store
sizes allows us to target a particular location with a store that best suits
that market and takes advantage of available real estate opportunities. Our
stores are attractively designed and create an inviting atmosphere for shoppers
by using bright lighting, vibrant colors, uniform decorative signs and
background music. We enhance the store design with attractive merchandise
displays. We believe this design attracts new and repeat customers and enhances
our image as both a destination and impulse store.
For more information on retail locations and retail store leases, see
"Properties" on page 9.
Profitable Stores with Strong Cash Flow. We maintain a disciplined,
cost-sensitive approach to store site selection in order to minimize the initial
capital investment required and maximize our potential to generate high
operating margins and strong cash flows. We believe that our stores have a
relatively small shopping radius, which allows us to profitably concentrate
multiple stores in a single market. Our ability to open new stores is dependent
upon, among other factors, locating suitable sites and negotiating favorable
lease terms.
On a cash basis, our stores have historically experienced a payback period
of approximately 12 to 15 months and we expect this trend to continue. Following
is a reconciliation of our operating income margin, as determined under
generally accepted accounting principles, to the store-level cash operating
income margin for all stores combined.
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Corporate operating
income margin 10.5% 10.9% 10.3% 12.0% 13.0%
Add freight, distribution
costs, corporate overhead
and depreciation 11.8% 11.5% 12.7% 12.0% 11.2%
----- ----- ----- ----- -----
Store-level cash operating
income margin 22.3% 22.4% 23.0% 24.0% 24.2%
===== ===== ===== ===== =====
During the past five years, we have maintained our store-level cash operating
income margins in the 22.3% to 24.2% range. Store-level cash operating income
margin represents the operating results of our stores based on revenues and
costs that are directly associated with the individual stores, excluding
depreciation. This measure excludes several components of our corporate
operating margin as calculated in accordance with generally accepted accounting
principles because these components are not directly associated with or
allocable to the individual stores. Management believes that this measure is
important in evaluating our performance because the measure is used by
management and investors to evaluate the performance of the stores in relation
to one another and in relation to industry peers and benchmarks. Stores whose
first full year of operations was 2003 had average store-level cash operating
income margin of approximately 22.5%, which was slightly lower than the 22.7%
average for all stores with a full year's operations in fiscal 2003.
Our older, smaller stores continue to generate significant store-level
operating income and operating cash flows and have some of the highest operating
margins among our stores; however, the increased size of our newer stores allows
us to offer a wider selection of products, including more basic consumable
merchandise, thereby making them more attractive as a destination store.
The strong cash flows generated by our stores allow us to grow primarily
using internally generated funds. Over the past five years, cash flows from
operating activities have exceeded capital expenditures.
For more information on our results of operations, see "Management's
Discussion and Analysis - Results of Operations" on page 15. For more
information on seasonality of sales, see "Management's Discussion and Analysis -
Seasonality and Quarterly Fluctuations" on page 22.
Cost Control. We believe that substantial buying power at the $1.00 price
point contributes to our successful purchasing strategy, which includes
disciplined, targeted merchandise margin goals by category. We believe our
disciplined buying and quality merchandise help to minimize markdowns. We buy
products on an order-by-order basis and have no material long-term purchase
contracts or other assurances of continued product supply or guaranteed product
cost. No vendor accounted for more than 10% of total merchandise purchased in
any of the past five years.
During 2002, we upgraded our supply chain systems and identified other
processes that could be improved using technology. These new systems continue to
provide us with valuable sales information to assist our buyers and improve
merchandise allocation to our stores. Controlling our inventory levels will
result in more efficient distribution and store operations.
Payroll and related costs are a significant component of our selling,
general and administrative costs. Accordingly, we believe that more efficient
use of labor hours in our stores could increase our profitability. In an effort
to optimize hours worked in our stores, we expect to roll out a new labor
management and scheduling system during fiscal 2004.
6
Information Systems. We believe that investments in appropriate technology
help us to increase sales and control costs. In 2002, we implemented a new
inventory management system. Our new system has allowed us to improve the
efficiency of our supply chain, improve merchandise flow and control
distribution and store operating costs.
In 2003, we piloted our automatic replenishment system. This system
automatically reorders key items, based on actual store level sales. In 2004, we
expect to roll out this system to additional stores and merchandise categories.
At January 31, 2004, we operated point-of-sale systems in 1,855 stores and
we expect to install point-of-sale systems in virtually all remaining stores
that will benefit from it by the end of fiscal 2004. Point-of-sale data allows
us to track sales by merchandise category and geographic region as well as
assists in planning for future purchases of inventory. We believe that this
information will allow us to ship the appropriate product to the correct store
at the proper time.
Corporate Culture and Values. We believe that honesty and integrity, doing
the right things for the right reasons, and treating people fairly and with
respect are core values within our corporate culture. We believe that running a
business, and certainly a public company, carries with it a responsibility to be
beyond reproach when making operational and financial decisions. Our management
team visits and shops our stores like every customer; we have an open door
policy to all our associates; and ideas and individuality are encouraged. We
have standards for store displays, merchandise presentation, and store
operations. Our distribution centers are operated based on objective measures of
performance and everyone in our store support center is available to help
associates in the stores and distribution centers get their jobs done.
Our disclosure committee, headed by our corporate controller, meets at
least quarterly and identifies and monitors our internal financial reporting
controls and ensures that our public filings contain discussions about the risks
our business faces. We believe that we have the controls in place to be able to
certify our financial statements. Additionally, we have complied with the
updated listing requirements for the Nasdaq Stock Market.
Growth Strategy
Store Openings and Square Footage Growth. The primary factors contributing
to our net sales growth have been new store openings, an active store expansion
and remodel program and selective mergers and acquisitions. From 1999 to 2003,
net sales increased at a compound annual growth rate of 20.0% and operating
income increased at a compound annual growth rate of 13.6%. We expect that the
substantial majority of our future sales growth will come primarily from new
store openings and secondarily from our store expansion and remodeling program.
The following table shows the total selling square footage of our stores
and the selling square footage per new store opened over the last five years. We
began opening larger stores after the acquisition of 98 Cent Clearance Center in
1998. Our growth and productivity statistics will be reported based on selling
square footage prospectively because our management believes the use of selling
square footage yields a more accurate measure of store productivity. The selling
square footage statistics for 1999 through 2000 are estimates based on the
relationship of selling to gross square footage.
Average Selling
Average Selling Square Footage
Square Footage Per New Store
Year Number of Stores Per Store Opened
---------- ---------------- ---------------- ----------------
1999 1,507 4,055 4,765
2000 1,729 4,520 6,240
2001 1,975 5,130 7,070
2002 2,263 5,763 7,783
2003 2,513 6,716 9,948
We expect to increase our selling square footage in the future by opening
new stores in underserved markets and strategically increasing our presence in
our existing markets via new store openings and store expansions (expansions
include store relocations). In fiscal 2004 and beyond, we plan to predominantly
open stores that are approximately 10,000 to 15,000 selling square feet and we
believe this size range allows us to achieve our objectives in the markets in
which we plan to expand. At January 31, 2004, 356 of our stores, totaling 28.3%
of our selling square footage, were 10,000 selling square feet or larger.
In addition to new store openings, we plan to continue our store expansion
program to increase our net sales per store and take advantage of market
opportunities. We target stores for expansion based on the current sales per
selling square foot and changes in market opportunities. Stores targeted for
expansion are generally less than 4,000 selling square feet in size. Store
expansions generally increase the existing store size by approximately 6,000 to
10,000 selling square feet.
7
Since 1995, we have added a total of 471 stores through four mergers and
several small acquisitions. Our acquisition strategy has been to target
companies with a similar single price point concept that have shown success in
operations or provide a strategic advantage. We evaluate potential acquisition
opportunities in our retail sector as they become available.
Merchandising and Distribution. Expanding our customer base is important to
our growth plans. We plan to continue to stock our new stores with the
ever-changing merchandise that our current customers have come to appreciate. In
addition, we are opening larger stores that contain more basic consumable
merchandise to attract new customers. Consumable merchandise typically leads to
more frequent return trips to our stores resulting in increased sales. The
presentation and display of merchandise in our stores are critical to
communicating value to our customers and creating a more exciting shopping
experience. We believe our approach to visual merchandising results in high
store traffic, high sales volume and an environment that encourages impulse
purchases.
A strong and efficient distribution network is key to our ability to grow
and to maintain a low-cost operating structure. We currently operate nine
distribution centers and plan to open a replacement distribution center for our
Chicago distribution center in mid-year 2004. These distribution centers in
total will be capable of supporting approximately $4.5 billion in annual sales.
We expect to continue to add distribution capacity to support our store opening
plans, with the aim of remaining approximately one year ahead of our
distribution needs. New distribution sites are strategically located to reduce
stem miles, maintain flexibility and improve efficiency in our store service
areas.
Our stores receive approximately 96% of their inventory from our
distribution centers via contract carriers. The remaining store inventory,
primarily perishable consumable items and other vendor-maintained display items,
are delivered directly to our stores from vendors. For more information on our
distribution center network, see "Properties" below.
Competition
The retail industry is highly competitive and we expect competition to
increase in the future. The value discount retail sector currently represents
approximately 10% of the $300 billion discount retail market and appears to be
the fastest growing sector. Our value discount retail competitors include Family
Dollar, Dollar General, 99 Cents Only and Big Lots. The principal methods of
competition include convenience and the quality of merchandise offered to the
customer. Though we are a fixed-price point retailer, we also compete with mass
merchandisers, such as Wal-Mart and Target, and regional discount retailers. In
addition, several mass merchandisers and grocery store chains are now testing
"dollar store" concepts in their stores, which will increase competition. Our
sales and profits could be reduced by increases in competition, especially
because there are no significant economic barriers for others to enter our
retail sector.
Trademarks
We are the owners of federal service mark registrations for "Dollar Tree,"
the "Dollar Tree" logo, "1 Dollar Tree" together with the related design, and
"One Price...One Dollar." A small number of our stores operate under the name
"Only One Dollar," for which we have not obtained a service mark registration.
We also own a concurrent use registration for "Dollar Bill$" and the related
logo. During 1997, we acquired the rights to use trade names previously owned by
Everything's A Dollar, a former competitor in the $1.00 price point industry.
Several trade names were included in the purchase, including the marks
"Everything's $1.00 We Mean Everything," and "Everything's $1.00," the
registration of which is pending. With the acquisition of Dollar Express, we
became the owner of the service marks "Dollar Express" and "Dollar Expres$." We
became the owners of the "Greenbacks All A Dollar" and "All A Dollar" service
marks, with the acquisition of Greenbacks. We have applied for federal trademark
registrations for various private labels that we use to market some of our
product lines.
Employees
We employed approximately 9,600 full-time and 19,100 part-time associates
on January 31, 2004. The number of part-time associates fluctuates depending on
seasonal needs. We consider our relationship with our associates to be good, and
we have not experienced significant interruptions of operations due to labor
disagreements. None of our employees is subject to collective bargaining
agreements.
8
Item 2. PROPERTIES
Stores
As of January 31, 2004, we operated 2,513 stores in 47 states as detailed
below:
Alabama.................68 Maine....................3 Oklahoma.................35
Arizona.................28 Maryland................72 Oregon...................49
Arkansas................33 Massachusetts...........22 Pennsylvania............171
California.............160 Michigan................95 Rhode Island..............8
Colorado................16 Minnesota...............25 South Carolina...........63
Connecticut.............17 Mississippi.............44 South Dakota..............2
Delaware................15 Missouri................53 Tennessee................77
Florida................184 Montana..................1 Texas...................141
Georgia................117 Nebraska.................8 Utah.....................24
Idaho....................8 Nevada..................17 Vermont...................4
Illinois................96 New Hampshire...........10 Virginia................123
Indiana.................68 New Jersey..............56 Washington...............30
Iowa....................17 New Mexico...............9 West Virginia............26
Kansas..................21 New York...............116 Wisconsin................51
Kentucky................52 North Carolina.........130 Wyoming...................1
Louisiana...............44 Ohio...................103
We currently lease our stores and expect to continue to lease new stores as
we expand. Our leases typically provide for a short initial lease term
(generally five years) with options to extend. We believe this leasing strategy
enhances our flexibility to pursue various expansion opportunities resulting
from changing market conditions.
As current leases expire, we believe that we will be able to obtain lease
renewals, if desired, for present store locations, or to obtain leases for
equivalent or better locations in the same general area. To date, we have not
experienced significant difficulty in either renewing leases for existing
locations or securing leases for suitable locations for new stores. From time to
time we may not comply with certain provisions of our store operating leases. We
maintain good relations with our landlords and believe that violation of these
lease provisions, if any, will not have a material effect on our operations.
Distribution Centers
The following table includes information about the distribution centers
that we currently operate. By mid-year 2004, we are planning to replace our
Chicago distribution center with a newly constructed automated 1.2 million
square foot distribution center located in Joliet, Illinois. Once our Joliet
facility is operational, we believe our distribution center network will be
capable of supporting a total of approximately $4.5 billion in annual sales.
Size in
Location Own/Lease Lease Expires Square Feet
------------------ -------------- -------------- -------------
Chesapeake, Virginia Own N/A 400,000
Olive Branch, Mississippi Own N/A 425,000
June 2005, with
Chicago, Illinois Lease options to renew 250,000
Stockton, California Own N/A 525,000
Briar Creek, Pennsylvania Own N/A 603,000
Savannah, Georgia Own N/A 603,000
Marietta, Oklahoma Own N/A 603,000
Salt Lake City, Utah Lease August 2005 252,000
Ridgefield, Washington Own N/A 665,000
In February 2004, we opened our newly built distribution center in
Ridgefield, Washington. This distribution center is a 665,000 square foot
facility that can be expanded in the future to accommodate our growth needs. In
addition to our distribution centers noted above, during the past several years
we have used off-site facilities to accommodate limited quantities of seasonal
merchandise.
Four of our distribution centers were financed through a variable interest
entity, which we included in our consolidated financial statements effective
January 1, 2003. The variable interest entity owned these distribution center
assets and carried the debt used to finance them. Terms of the debt, among other
things, required the maintenance of certain specified financial ratios,
restricted the payment of certain distributions and limited certain types of
debt we could incur. In March 2004, we refinanced the debt related to the
variable interest entity (see Note 14 in the Notes to Consolidated Financial
Statements on page 50).
With the exception of our Chicago, Salt Lake City and Ridgefield
facilities, each of our distribution centers contains advanced materials
handling technologies, including an automated
9
conveyor and sorting system, radio-frequency inventory tracking equipment and
specialized information systems.
We have a former distribution center for which we are liable for future
rents. The lease on this facility expires in September 2005. We will continue to
make every effort to sublease this facility. The lease on our Chicago
distribution center expires in June 2005. We are making an effort to find a
tenant to sublease the facility when we vacate it later this year to move to our
new facility in Joliet; however, if we are unable to locate a suitable tenant,
we would have to record a charge for our future obligations under this lease of
approximately $1.0 million.
For more information on financing of our distribution centers, see
"Management's Discussion and Analysis - Funding Requirements" on page 19. For
more information on our liability for future rents and related costs, see
"Management's Discussion and Analysis - Inflation and Other Economic Factors" on
page 23.
Item 3. LEGAL PROCEEDINGS
From time to time, we are defendants in ordinary, routine litigation and
proceedings incidental to our business, including allegations regarding:
o employment related matters;
o product safety matters, including product recalls by the Consumer
Products Safety Commission;
o personal injury claims; and
o the infringement of the intellectual property rights of others.
We have been sued in California by several employees and in Alabama by a
salaried store manager and a former store manager who allege, among other
things, that they should have been classified as non-exempt employees and,
therefore, should have received overtime compensation. The suits also request
that the California state court certify the case as a class action on behalf of
all store managers, assistant managers and merchandise managers in our
California stores and request that the Alabama Federal Court certify the case as
a collective action under the Fair Labor Standards Act on behalf of all salaried
managers in all of our stores. We were also sued in California on November 3,
2003 by a former store manager who alleges that certain employees should have
received meal period breaks and paid rest periods. As in the other California
lawsuit, he also alleges that he and other salaried managers should have been
classified as non-exempt employees and, therefore, should have received overtime
compensation. The suit also requests that the California state court certify the
case as a class action. We will vigorously defend ourselves in all these
matters.
We do not believe that any of these matters will individually, or in the
aggregate, have a material adverse affect on our business or financial
condition.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of our 2003 fiscal year.
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock has been traded on The Nasdaq Stock Market(R) under the
symbol "DLTR" since our initial public offering on March 6, 1995. The following
table gives the high and low sales prices of our common stock as reported by
Nasdaq for the periods indicated.
High Low
Fiscal year ended February 1, 2003:
First Quarter........................................ $ 38.62 $ 28.65
Second Quarter....................................... 41.00 26.26
Third Quarter........................................ 31.00 19.08
Fourth Quarter....................................... 30.59 21.22
Fiscal year ended January 31, 2004:
First Quarter........................................ $ 22.39 $ 17.40
Second Quarter....................................... 33.81 20.13
Third Quarter........................................ 39.75 32.51
Fourth Quarter....................................... 38.74 27.36
10
On April 5, 2004, the last reported sale price for our common stock, as
quoted by Nasdaq, was $31.18 per share. As of April 5, 2004, we had
approximately 605 shareholders of record.
The following chart presents our repurchase activity for the fourth quarter
of 2003.
ISSUER PURCHASES OF EQUITY SECURITIES(1)
Approximate
dollar value
Total number of shares that
of shares may yet be
purchased as purchased under
Total number Average part of publicly the plans or
of shares price paid announced plans programs
Period purchased per share or programs (in thousands)
------ ------------- ------------- ------------------- ------------------
November 2 to November 29, 2003.............. -- $ -- -- $ 200,000
November 30, 2003 to January 3, 2004......... 890,400 $ 29.52 890,400 $ 173,700
January 4 to January 31, 2004................ 395,000 $ 31.31 395,000 $ 161,300
--------- ---------
Total..................................... 1,285,400 $ 30.07 1,285,400 $ 161,300
========= =========
(1) In November 2002, our Board of Directors authorized the repurchase of up to $200 million of
our common stock.
We anticipate that substantially all of our income in the foreseeable
future will be retained for the development and expansion of our business, the
repayment of indebtedness and, as authorized by our Board of Directors, the
repurchase of stock. Management does not anticipate paying dividends on our
common stock in the foreseeable future. In addition, our credit facilities
contain financial covenants that restrict our ability to pay cash dividends.
Item 6. SELECTED FINANCIAL DATA
(Amounts in thousands, except per share data, number of stores
data and net sales per selling square foot data)
The following table presents a summary of our selected financial data for
the fiscal year ended January 31, 2004 and the calendar years ended December 31,
2002, 2001, 2000 and 1999. The selected income statement and balance sheet data
have been derived from our consolidated financial statements that have been
audited by our independent auditors. This information should be read in
conjunction with the consolidated financial statements and related notes,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our financial information found elsewhere in this report. As
required by pooling-of-interests accounting, the financial information and
operating data of Dollar Tree and our past merger partners, Dollar Express, Only
$One and 98 Cent Clearance Center, have been combined and restated as of the
beginning of the earliest period presented.
For 2000, operating income was reduced by $4,366, and net income was
reduced by $3,134 for charges related to the Dollar Express merger. For 1999,
operating income was reduced by $1,050, and net income was reduced by $792, for
charges related to the Only $One merger.
Dollar Express and Only $One were treated as S corporations for federal and
state income tax purposes through February 4, 1999 and June 29, 1999,
respectively. As a result, their income was taxable to their shareholders
through those dates. Accordingly, our pro forma net income available to common
shareholders and the related per share data reflects the pro forma increase in
our C corporation federal and state income tax expense, which would have
occurred had these companies been taxed as C corporations for the entire periods
presented. Pro forma C corporation income taxes were $505 in 1999.
In our merger with Dollar Express in May 2000, the outstanding preferred
stock of Dollar Express was converted to common stock. Pro forma diluted net
income per common share would have been $0.96 for the year ended December 31,
1999 if the conversion of preferred stock had taken place on February 5, 1999,
the date when the preferred stock was originally issued. This calculation gives
effect to an adjustment that increases net income available to common
shareholders by $7,409 to eliminate the charge for accrued preferred stock
dividends and accretion of preferred stock and warrants for the year ended
December 31, 1999. In addition, if the conversion had taken place on February 5,
1999, the weighted average number of common shares and dilutive potential common
shares outstanding would have increased by 2,795,000 shares for the year ended
December 31, 1999.
In 1999, store-level cash operating income margin excludes stores acquired
through our merger in 2000, because store-level data for the acquired stores was
not available. A reconciliation of store-level cash operating income margin to
operating income margin is presented in "Profitable Stores with Strong Cash
Flow" on page 6.
11
Comparable store net sales compare net sales for stores open throughout
each of the two periods being compared, including expanded stores. Net sales per
store and net sales per selling square foot are calculated for stores open
throughout the period presented.
Year Ended Year Ended December 31,
January 31, -----------------------------------------------------
2004 2002 2001 2000 1999
---- ---- ---- ---- ----
Income Statement Data:
Net sales...................................... $2,799,872 $2,329,188 $1,987,271 $1,688,105 $1,351,820
Gross profit................................... 1,012,820 847,956 715,957 623,589 497,253
Selling, general and administrative
expenses.................................... 719,223 594,035 512,092 420,553 321,657
Operating income............................... 293,597 253,921 203,865 203,036 175,596
Net income..................................... 177,583 154,647 123,081 121,622 106,577
Net income available to common
shareholders................................ 177,583 154,647 123,081 120,209 99,550
Pro forma net income available to
common shareholders......................... 177,583 154,647 123,081 120,209 99,045
Margin Data (as a percentage of net sales):
Gross profit................................... 36.2% 36.4% 36.0% 36.9% 36.8%
Selling, general and administrative
expenses.................................... 25.7% 25.5% 25.7% 24.9% 23.8%
Operating income............................... 10.5% 10.9% 10.3% 12.0% 13.0%
Net income..................................... 6.3% 6.6% 6.2% 7.2% 7.9%
Net income available to common
shareholders................................ 6.3% 6.6% 6.2% 7.1% 7.4%
Pro forma net income available to
common shareholders......................... 6.3% 6.6% 6.2% 7.1% 7.3%
Per Share Data:
Diluted net income available to
common shareholders......................... $ 1.54 $ 1.35 $ 1.09 $ 1.08 $ 0.92
Diluted net income per
common share percent change................. 14.1% 23.9% 0.9% 17.4% 21.1%
Pro forma diluted net income per
common share................................ $ 1.54 $ 1.35 $ 1.09 $ 1.08 $ 0.92
Pro forma diluted net income per
common share annual growth.................. 14.1% 23.9% 0.9% 17.4% 29.6%
As of As of December 31,
January 31, ----------------------------------------------------
2004 2002 2001 2000 1999
---- ---- ---- ---- ----
Balance Sheet Data:
Cash and short-term investments................ $ 168,685 $ 335,972 $ 236,653 $ 181,166 $ 181,587
Working capital................................ 457,467 509,629 360,757 303,209 226,707
Total assets................................... 1,480,306 1,116,377 902,048 746,859 611,233
Total debt..................................... 185,151 54,429 62,371 71,730 108,773
Mandatorily redeemable preferred
stock....................................... -- -- -- -- 35,171
Shareholders' equity........................... 1,014,522 855,404 651,736 518,658 316,238
Year Ended Year Ended December 31,
January 31, -----------------------------------------------------
2004 2002 2001 2000 1999
---- ---- ---- ---- ----
Selected Operating Data:
Number of stores open at
end of period............................... 2,513 2,263 1,975 1,729 1,507
Gross square footage at end of period.......... 21,416 16,527 12,791 9,832 7,638
Selling square footage at end of period........ 16,878 13,042 10,129 7,818 6,113
Selling square footage annual growth........... 27.5% 28.8% 29.6% 27.9% 25.6%
Net sales annual growth........................ 18.7% 17.2% 17.7% 24.9% 26.9%
Comparable store net sales increase............ 2.9% 1.0% 0.1% 5.7% 5.0%
Net sales per selling square foot.............. $ 180 $ 199 $ 217 $ 238 $ 245
Net sales per store............................ $ 1,134 $ 1,083 $ 1,043 $ 1,014 $ 939
12
Year Ended Year Ended December 31,
January 31, -----------------------------------------------------
2004 2002 2001 2000 1999
---- ---- ---- ---- ----
Selected Financial Ratios:
Return on assets............................... 13.7% 15.3% 14.9% 17.9% 20.3%
Return on equity............................... 19.0% 20.5% 21.0% 29.1% 36.8%
Store-level cash operating income margin....... 22.3% 22.4% 23.0% 24.0% 24.2%
Inventory turns................................ 3.7 4.5 4.6 4.7 4.9
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
In Management's Discussion and Analysis, we explain the general financial
condition and the results of operations for our company, including:
o what factors affect our business;
o what our earnings and costs were in 2003 and 2002;
o why those earnings and costs were different from the year before;
o how all of this affects our overall financial condition;
o what our expenditures for capital projects were in 2003 and what we
expect them to be in 2004; and
o where funds will come from to pay for future expenditures.
As you read Management's Discussion and Analysis, please refer to our
consolidated financial statements, included in Item 8 of this Form 10-K, which
present the results of operations for the fiscal year ended January 31, 2004,
the one-month period ended February 1, 2003, and the calendar years ended
December 31, 2002 and 2001. In Management's Discussion and Analysis, we analyze
and explain the annual changes in some specific line items in the consolidated
financial statements for the fiscal year 2003 compared to the comparable fiscal
year 2002, the one-month period ended February 1, 2003 compared to the one-month
period ended January 31, 2002 and the calendar year 2002 compared to calendar
year 2001.
Key Events and Recent Developments
Several key events have had or are expected to have a significant effect on
our results of operations. You should keep in mind that:
o In March 2004, we entered into a five-year $450.0 million Revolving
Credit Facility. We used availability under this facility to repay the
$142.6 million of variable rate debt related to our variable interest
entity. This facility also replaced the $150.0 million Revolving Credit
Facility.
o In January 2004, we completed construction on our Ridgefield,
Washington distribution center, which is a 665,000 square foot facility
that can be expanded in the future to accommodate our growth needs. We
began shipping merchandise from this distribution center in February
2004.
o In June 2003, we completed our acquisition of Greenbacks, Inc., based
in Salt Lake City, Utah. Greenbacks operated 100 stores in 10 western
states and an expandable 252,000 square foot distribution center in
Salt Lake City. We accounted for this acquisition under the purchase
method of accounting and as a result, Greenbacks is included in our
results since the date of acquisition, June 29, 2003.
o In May 2003, we began construction on a new distribution center in
Joliet, Illinois. The Joliet distribution center will be a fully
automated 1.2 million square foot facility and will replace our
existing Chicago distribution center. It is scheduled to open by
mid-year 2004.
o In February 2003, we opened a new 603,000 square foot automated
distribution center in Marietta, Oklahoma.
o In January 2003, we changed our fiscal year from a calendar year to a
retail fiscal year ending on the Saturday closest to January 31. Our
first fiscal year reported is fiscal 2003. Fiscal 2003 is the period
beginning February 2, 2003 and ending January 31, 2004.
13
Overview
Our net sales are derived from the sale of merchandise. Two major factors
tend to affect our net sales trends. First is our success at opening new stores
or adding new stores through mergers or acquisitions. Second, sales vary at our
existing stores from one year to the next. We refer to this change as a change
in comparable store net sales, because we compare only those stores that are
open throughout both of the periods being compared. We include sales from stores
expanded during the year in the calculation of comparable store net sales, which
has the effect of increasing our comparable store net sales. The term 'expanded'
also includes stores that are relocated. In fiscal 2003, we increased our
selling square footage by 27.5%. Of this 3.6 million selling square foot
increase, approximately 0.9 million was added by expanding existing stores. In
fiscal 2004, we plan to increase our selling square footage by approximately
20%.
Most retailers have the ability to increase their merchandise prices or
alter the mix of their merchandise to favor higher-priced items in order to
increase their comparable store net sales. As a fixed-price point retailer, we
do not have the ability to raise our prices. Generally, our comparable store net
sales will increase only if we sell more merchandise.
We expect the substantial majority of our future net sales growth to come
from square footage growth resulting from new store openings and expansion of
existing stores. We expect the average size of new stores opened in fiscal 2004
to be approximately 10,000 selling square feet per store. In fiscal 2004 and
beyond, we plan to predominantly open stores that are approximately 10,000 to
15,000 selling square feet. We believe this size range allows us to achieve our
objectives in the markets in which we plan to expand. Larger stores take longer
to negotiate, build out and open and generally have lower net sales per square
foot than our smaller stores. While our newer, larger stores have lower sales
per square foot than older, smaller stores, they generate higher sales and
operating income per store and create an improved shopping environment that
invites customers to shop longer and buy more. When our larger stores become the
majority of our store base, which we expect to occur by the end of 2005, we
believe our net sales per square foot will begin to rise.
Our plans for fiscal 2004 operations anticipate comparable store net sales
increases of slightly positive to 3%, net sales in the $3.2 to $3.3 billion
range and earnings increases of at least 14%. We continue to expect annual gross
margin, as a percentage of net sales, to be between 36.0% and 36.5%. We also
expect to experience pressure on our gross profit margins in future years as we
refine our merchandise mix to include a higher proportion of consumable
merchandise, which typically carries a lower gross profit margin, open larger
stores and continue to absorb higher costs.
We must control our merchandise costs, inventory levels and our general and
administrative expenses. Increases in these expenses could negatively impact our
operating results because we cannot pass on increased expenses to our customers
by increasing our merchandise price above the $1.00 price point.
We plan to continue to improve operating expenses, other than depreciation,
as a percentage of net sales; however, we expect our depreciation expense to
increase by more than 20 basis points in 2004 compared to 2003. As a result, we
believe that maintaining our operating margin in 2004 will be a challenge.
Depreciation expense is expected to increase as a result of our continued
investments in opening larger stores and in technology assets, such as
point-of-sale systems, particularly as we convert existing stores to
point-of-sale. As these assets become fully depreciated, we expect a decrease in
our depreciation expense, as a percentage of net sales, beginning in 2006.
We expect a shift in the seasonality of our earnings in 2004. Compared to
2003, we expect a smaller portion of our total annual earnings to be realized in
the first quarter of 2004 while we believe a larger portion will be realized in
the fourth quarter of 2004. This shift is primarily due to the nine-day shorter
Easter selling season and two additional selling days between Thanksgiving and
Christmas in 2004 compared to 2003.
14
Results of Operations
The following table expresses items from our statements of operations, as a
percentage of net sales:
Year Month Year Month
Ended Ended Ended Ended Year ended
January 31, February 1, January 31 December 31,
----------- ----------------- ---------- -------------
2004 2003 2003 2002 2002 2001
---- ---- ---- ---- ---- ----
Net sales.................................... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales................................ 63.8 70.9 63.8 69.3 63.6 64.0
----- ----- ----- ------ ----- -----
Gross profit........................... 36.2 29.1 36.2 30.7 36.4 36.0
Selling, general and administrative
expenses.................................. 25.7 34.3 25.7 32.1 25.5 25.7
----- ----- ----- ------ ----- -----
Operating income (loss)................ 10.5 (5.2) 10.5 (1.4) 10.9 10.3
Interest income.............................. 0.1 0.2 0.1 0.4 0.2 0.2
Interest expense............................. (0.3) (0.5) (0.2) (0.3) (0.2) (0.3)
Changes in fair value of non-hedging
interest rate swaps....................... -- 0.2 -- -- (0.1) (0.1)
----- ----- ----- ------ ----- -----
Income (loss) before income taxes...... 10.3 (5.3) 10.4 (1.3) 10.8 10.1
Provision for income taxes................... (4.0) 2.0 (4.0) 0.5 (4.2) (3.9)
----- ----- ----- ------ ----- -----
Net income (loss) before cumulative
effect of a change in accounting
principle............................ 6.3 (3.3) 6.4 (0.8) 6.6 6.2
Cumulative effect of a change, in
accounting principle, net of tax
benefit................................... -- (3.3) (0.2) -- -- --
----- ----- ----- ------ ----- -----
Net income (loss)...................... 6.3% (6.6)% 6.2% (0.8)% 6.6% 6.2%
===== ===== ===== ====== ===== =====
Fiscal year ended January 31, 2004 compared to fiscal year ended February 1,
2003
The following table is presented to compare statements of operations
amounts for the fiscal year ended January 31, 2004 to the fiscal year ended
February 1, 2003. Amounts for the fiscal year ended February 1, 2003 are not
included in the Consolidated Statements of Operations on page 28.
Year ended
----------
January 31, February 1,
2004 2003
---------- ---------
(in thousands)
Net sales.................................... $ 2,799,872 $ 2,357,836
Cost of sales................................ 1,787,052 1,503,612
----------- -----------
Gross profit........................... 1,012,820 854,224
Selling, general and administrative
expenses.................................. 719,223 606,836
----------- -----------
Operating income....................... 293,597 247,388
Interest income.............................. 2,648 3,445
Interest expense............................. (8,382) (4,812)
Changes in fair value of non-hedging
interest rate swaps....................... 889 (1,297)
----------- -----------
Income before income taxes............. 288,752 244,724
Provision for income taxes................... 111,169 94,220
----------- -----------
Income before cumulative
effect of a change in accounting
principle............................ 177,583 150,504
Cumulative effect of a change in
accounting principle, net of tax
benefit................................... -- (5,285)
----------- -----------
Net income............................. $ 177,583 $ 145,219
=========== ===========
15
Net Sales. Net sales increased 18.7% in 2003 compared to 2002. We attribute
this $442.0 million increase in net sales primarily to new and acquired stores
in 2003 and 2002 which are not included in our comparable store net sales
calculation and to a comparable store net sales increase of 2.9% in 2003.
Comparable store net sales are positively affected by our expanded and relocated
stores which we include in the calculation, and, to a lesser extent, are
negatively affected when we open new stores or expand stores near existing
stores. Our comparable store net sales increase was due to our expanded and
relocated stores. Net sales in our larger, newer stores, particularly the 10,000
to 15,000 square foot stores, have been stronger than those in our smaller,
older stores.
The following table summarizes the components of the changes in our store
size and count for fiscal years ended January 31, 2004 and February 1, 2003.
Fiscal years ended January 31, 2004 February 1, 2003
---------------- ----------------
New stores 183 314
Acquired stores (Greenbacks) 100 0
Expanded or relocated stores 124 110
Closed stores (42) (36)
Of the 3.6 million selling square foot increase in 2003, approximately 0.9
million selling square feet was added by expanding existing stores.
Gross Profit. Gross profit margin was 36.2% in 2003 and 2002. An
approximate 20 basis point decrease in markdowns was offset by an approximate 20
basis point increase in occupancy costs. Our improved markdowns are primarily
due to better seasonal sell-through, use of point-of-sale data to better manage
the buying process and better allocate merchandise across store classes through
use of our supply chain systems. Our increase in occupancy costs was primarily
attributed to the loss of leverage as a result of two fewer selling days in 2003
compared to 2002 and increased occupancy rates in our smaller stores which
generally experience lower comparable store net sales. In addition, during 2003,
gross profit margin was affected by approximately $3.8 million of additional
non-cash depreciation expense in cost of sales associated with the adoption of
FASB Interpretation 46 Consolidation of Variable Interest Entities. By adopting
FIN 46, four of our distribution centers, previously accounted for as operating
leases, were consolidated in our financial statements effective January 1, 2003.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses, as a percentage of net sales, remained unchanged at
25.7% in 2003. Increased depreciation expense of approximately 50 basis points
was primarily offset by a decrease of approximately 40 basis points in
payroll-related and store operating expenses. The increase in depreciation
expense was associated with our larger new and expanded stores and the continued
installation of our point-of-sale systems and other technology assets. Continued
improvements in store-level labor productivity and store supply expenses were
the primary drivers to our lower payroll-related and store operating expenses,
as a percentage of net sales.
Operating Income. Due to the reasons discussed above, operating income
margin was consistent at 10.5% for 2003 and 2002.
Interest Income and Expense. Interest income, as a percentage of net sales,
was consistent at 0.1% in 2003 and 2002. Interest expense increased $3.6 million
primarily due to the consolidation of our variable interest entity effective
January 1, 2003.
Income Taxes. Our effective tax rate was 38.5% in 2003 and 2002.
16
Month Ended February 1, 2003 Compared to Month Ended January 31, 2002
The following table is presented to compare statements of operations
amounts for the fiscal month ended February 1, 2003 to the fiscal month ended
January 31, 2002. Amounts for the fiscal month ended January 31, 2002 are not
included in the Consolidated Statements of Operations on page 28.
Month ended
-----------
February 1, January 31,
2003 2002
---- ----
(in thousands)
Net sales..................................... $ 160,789 $ 132,141
Cost of sales................................. 113,980 91,600
----------- -----------
Gross profit............................ 46,809 40,541
Selling, general and administrative
expenses................................... 55,237 42,436
----------- -----------
Operating loss.......................... (8,428) (1,895)
Interest income............................... 389 470
Interest expense.............................. (719) (427)
Changes in fair value of non-hedging
interest rate swaps........................ 239 68
----------- -----------
Loss before income taxes................ (8,519) (1,784)
Provision for income taxes.................... (3,279) (687)
----------- -----------
Loss before cumulative
effect of a change in accounting
principle............................. (5,240) (1,097)
Cumulative effect of a change in
accounting principle, net of tax
benefit.................................... (5,285) --
----------- -----------
Net loss................................ $ (10,525) $ (1,097)
=========== ===========
Net Sales. Net sales for the month ended February 1, 2003 increased 21.7%
compared to the month ended January 31, 2002. This increase was primarily due to
increased sales in our new and expanded stores and one additional selling day in
the month ended February 1, 2003 compared to the month ended January 31, 2002.
These increases were slightly offset by a 5.1% decrease in comparable store net
sales.
Gross Profit. Gross profit margin decreased 160 basis points in the month
ended February 1, 2003 compared to the month ended January 31, 2002, primarily
due to a change in our merchandise mix toward lower margin merchandise.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses, as a percentage of net sales, increased 2.3% primarily
as a result of a 100 basis point increase in payroll-related costs and a 40
basis point increase in depreciation costs.
Cumulative Effect of a Change in Accounting Principle. The cumulative
effect of a change in accounting principle represents, net of tax, the effect of
consolidation of our variable interest entity in accordance with the
implementation of FIN 46 effective January 1, 2003. The variable interest entity
holds the assets and related debt of four of our distribution centers.
Calendar Year 2002 Compared to Calendar Year 2001
Net Sales. Net sales increased 17.2% in 2002 compared to 2001. We attribute
this $341.9 million increase in net sales primarily to our new stores opened in
2002 and 2001 which are not included in our comparable store net sales increase,
and to a comparable store net sales increase of 1.0% in 2002. Comparable store
net sales are positively affected by our expanded and relocated stores, which we
include in the calculation, and, to a lesser extent, are negatively affected
when we open new stores or expand stores near existing stores.
We opened 318 new stores and closed 30 stores during 2002, compared to 276
new stores opened and 30 stores closed in 2001. During 2002, we opened larger
stores than originally planned, which required us to shift our store openings to
later in the third quarter and shift some store openings into the fourth
quarter. We added 28.8% to our selling square footage in 2002 compared to 29.6%
in 2001. Of the 2.9 million in selling square footage increase in 2002,
approximately 0.5 million selling square feet was added by expanding 111
existing stores.
17
Gross Profit. Gross profit margin increased to 36.4% in 2002 compared to
36.0% in 2001. This increase in gross profit margin in 2002 was primarily due to
a 50 basis point improvement in inventory shrink. This improvement is primarily
attributed to lower shrink in our Dollar Express stores and our Philadelphia
distribution network and adjustments to our distribution center shrink in
connection with our supply chain management system implementation. In addition,
merchandise costs increased 50 basis points, but this increase was offset by a
50 basis point improvement in freight costs. The increase in our merchandise
costs resulted from a change in our merchandise mix toward lower margin
merchandise as we increased the sales of these items in our newer, larger
stores. Negotiation of favorable import and domestic freight rates coupled with
better management of routing of our merchandise shipments during 2002 compared
to 2001 led to the improvements in our freight costs.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased as a percentage of net sales to 25.5% compared
to 25.7% in 2001. This decrease is primarily the result of savings achieved from
our implementation of various expense-management initiatives, particularly with
regard to payroll-related expenses, partially offset by an increase in
depreciation and amortization expense. Our payroll-related expenses decreased 60
basis points in 2002 compared to 2001, while our depreciation and amortization
increased 30 basis points for the same period. The increase in depreciation
expense resulted primarily from increased depreciation costs associated with our
square footage growth and increased depreciation costs resulting from the
continued rollout of our point-of-sale systems. In addition, effective January
1, 2002, we ceased amortization of goodwill in accordance with the provisions of
Statement of Financial Accounting Standards (SFAS) No. 142 Goodwill and Other
Intangible Assets. We recorded approximately $2.0 million of goodwill
amortization in 2001.
Operating Income. Due to the reasons discussed above, operating income
increased to $253.9 million in 2002 from $203.9 million in 2001 and increased
as a percentage of net sales to 10.9% from 10.3%.
Interest Income and Expense. Interest income in 2002 was consistent with
2001. Decreased interest rates throughout 2002 were offset by increased levels
of cash and cash equivalents. Interest expense decreased $0.9 million in 2002
compared to 2001 due to repayments of our long-term debt and a decrease in
interest on our capitalized leases. We benefited slightly from the decrease in
variable interest rates in 2002; however, this benefit was partially offset as a
result of the interest rate swaps in effect during 2002.
Income Taxes. Our effective tax rate was 38.5% in 2002 and 2001.
Liquidity and Capital Resources
Our business requires capital to open new stores, expand our distribution
network and operate existing stores. Our working capital requirements for
existing stores are seasonal and usually reach their peak in September and
October. Historically, we have satisfied our seasonal working capital
requirements for existing stores and have funded our store opening and expansion
programs from internally generated funds and seasonal borrowings under our
credit facilities.
The following table compares cash-related information for the years ended
January 31, 2004, December 31, 2002 and 2001:
Year Ended Year Ended December 31,
January 31, -----------------------
2004 2002 2001
---- ---- ----
(in millions)
Net cash provided by (used in):
Operating activities............... $ 234.3 $ 206.9 $ 178.7
Investing activities............... (267.4) (173.8) (121.5)
Financing activities............... (35.5) 22.5 (1.8)
The $27.4 million increase in cash provided by operating activities in 2003
was due primarily to increased profitability before non-cash depreciation and
amortization expense. Non-cash depreciation expense was primarily attributed to
our square footage growth in 2003 and our continued installation of our point-
of-sale systems and other technology assets. These increases were partially
offset by the timing and volume of domestic merchandise receipts in January
2004 compared to December 2002. Our outstanding payable days were approximately
30 days in both periods.
Cash used in investing activities is generally expended to open new stores
and to expand or relocate existing stores. The $93.6 million increase in 2003
compared to 2002 was primarily due to the following:
o we acquired Greenbacks for approximately $100 million;
o we internally financed the construction of our distribution centers in
2003; and
18
o we increased the number of point-of-sale installations as well as
invested in additional technology assets.
These increases were partially offset by $63.5 million in proceeds from net
sales of our short-term investments.
The $58.0 million increase in cash used in financing activities in fiscal
year 2003 compared with calendar year 2002 was primarily the result of the
following:
o We paid approximately $38.0 million in the fourth quarter of 2003 to
repurchase shares under a $200 million authorization granted by our
Board of Directors in November 2002.
o We received $10.3 million less cash pursuant to stock-based
compensation plans in 2003 compared to 2002 because of a decrease
in the amount of stock option exercises, which we believe resulted
from the decreased stock price in 2003 compared to 2002.
At January 31, 2004, our long-term borrowings were $167.6 million and our
capital lease commitments were $20.3 million. We had $150.0 million available
through a revolving credit facility. We also have a $125.0 million Letter of
Credit Reimbursement and Security Agreement, under which approximately $67.0
million was committed to letters of credit issued for routine purchases of
imported merchandise.
In March 2004, we entered into a five-year $450.0 million Revolving Credit
Facility. This facility bears interest at LIBOR, plus 0.475% spread. We used
availability under this facility to repay $142.6 million of variable rate debt
related to our variable interest entity and to invest in certain money market
securities. As of April 1, 2004, we had $200.0 million available under this
facility. This facility replaced the $150.0 million Revolving Credit Facility.
Funding Requirements
Overview
In 2003, the average investment per new store, including capital
expenditures, initial inventory and pre-opening costs, was approximately
$442,000. We expect our cash needs for opening new stores and expanding existing
stores in fiscal 2004 to total approximately $178.0 million, which includes
approximately $129.5 million for capital expenditures and $48.5 million for
initial inventory and pre-opening costs. Our total planned capital expenditures
for fiscal 2004 are approximately $199.0 million, including planned expenditures
for new and expanded stores, new and relocated distribution centers and
investments in technology. We believe that we can adequately fund our working
capital requirements and planned capital expenditures for the next few years
from net cash provided by operations and borrowings under our existing credit
facilities, including the new facility entered into in March 2004. We believe
that we will be able to obtain adequate funding to construct our new
distribution centers.
The following tables summarize our material contractual obligations,
including both on- and off-balance sheet arrangements, and our commitments (in
millions):
Contractual Obligations Total 2004 2005 2006 2007 2008 Thereafter
----------------------- ----- ---- ---- ---- ---- ---- ----------
Lease Financing
Operating lease obligations $801.0 $186.9 $169.7 $138.7 $107.1 $71.5 $127.1
Capital lease obligations 20.3 6.8 8.0 5.3 0.1 0.1 --
(primarily sale-leaseback)
Long-term Borrowings
Variable interest entity 142.6 -- -- 142.6 -- -- --
Long-term debt(including 25.0 25.0 -- -- -- -- --
current portion)
Total obligations $988.9 $218.7 $177.7 $286.6 $107.2 $71.6 $127.1
19
Expiring Expiring Expiring Expiring Expiring
Commitments Total in 2004 in 2005 in 2006 in 2007 in 2008 Thereafter
----------- ----- ------- ------- ------- ------- ------- ----------
Unsecured revolving credit $ -- $ -- $ -- $ -- $ -- $ -- $ --
facility
Letters of credit and bonds 114.6 114.6 -- -- -- -- --
Freight contracts 29.7 3.7 7.2 18.8 -- -- --
Technology assets 24.1 24.1 -- -- -- -- --
Total commitments $168.4 $142.4 $7.2 $ 18.8 $ -- $ -- $ --
Lease Financing
Operating Lease Obligations. Amounts presented are as of December 31, 2003
for leases signed prior to that date. In addition, amounts presented have been
updated for new leases entered into during the month of January 2004. Our
operating lease obligations are primarily for payments under noncancelable store
leases. The commitment includes amounts for leases that were signed prior to
January 31, 2004 for stores that were not yet open on January 31, 2004.
Capital Lease Obligations (primarily sale-leaseback). In September 1999, we
sold certain retail store leasehold improvements to an unrelated third party and
leased them back for seven years. We have an option to repurchase the leasehold
improvements in September 2004 and September 2006 at amounts approximating their
fair market values at the time the option is exercised. The transaction is
treated as a financing arrangement for financial accounting purposes. The total
amount of the lease obligation is $23.4 million. We are required to make monthly
lease payments of $438,000 in the first five years and $638,000 in the sixth and
seventh years. As a result of the transaction, we received net cash of $20.9
million and an $8.1 million 11.0% note receivable, which matures in September
2006. The amount of the repurchase option under the lease will equal the amount
outstanding under the note receivable in September 2006.
Long-Term Borrowings
Variable Interest Entity. In March 2001, we entered into an operating
lease, known as a synthetic lease, to finance the construction of several of our
distribution centers. At December 31, 2002, approximately $154.5 million of the
$165.0 million facility was committed to the Stockton, Savannah, Briar Creek and
Marietta facilities. Because we accounted for this transaction as an operating
lease prior to January 1, 2003, the related fixed assets and lease liabilities
were not included in our balance sheets and payments under the lease were
included in rent expense prior to this date.
In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46. After evaluating this new standard, our Board of
Directors and management determined that we would maintain the existing terms of
the facility and include the variable interest entity in our consolidated
financial statements effective January 1, 2003. As a result of the
implementation, the distribution center assets, the financing-related costs and
the debt incurred by the variable interest entity to purchase and construct the
assets are included on our balance sheets for periods after January 1, 2003.
Interest is payable monthly and the principal amount is payable upon maturity of
the debt in March 2006. The debt, among other things, requires the maintenance
of certain specified financial ratios, restricts the payment of certain
distributions and prohibits the incurrence of certain new indebtedness.
In March 2004, we repaid this debt with borrowings from the $450.0 million
Revolving Credit Facility.
For more information on the variable interest entity, see Notes 6 and 14 of
the Consolidated Financial Statements in Item 8 of this Form 10-K.
Revenue Bond Financing. In May 1998, we entered into an agreement with the
Mississippi Business Finance Corporation under which it issued $19.0 million of
variable-rate demand revenue bonds. We borrowed the proceeds from the bonds to
finance the acquisition, construction and installation of land, buildings,
machinery and equipment for our distribution facility in Olive Branch,
Mississippi. At January 31, 2004, the balance outstanding on the bonds was $19.0
million. We begin repayment of the principal amount of the bonds in June 2006,
with a portion maturing each June 1 until the final portion matures in June
2018. The bonds do not have a prepayment penalty as long as the interest rate
remains variable. The bonds contain a demand provision and, therefore,
outstanding amounts are classified as current liabilities. We pay interest
monthly based on a variable interest rate, which was 1.12% at January 31, 2004.
The bonds are secured by a $19.3 million letter of credit issued by one of our
existing lending banks. The letter of credit is renewable annually. The letter
of credit and reimbursement agreement requires that we maintain specified
financial ratios and restricts our ability to pay cash dividends.
Debt Securities. In April 1997, we issued $30.0 million of 7.29% unsecured
senior notes, proceeds from which indirectly financed a portion of our
Chesapeake distribution center and corporate headquarters. We pay interest on
the notes semiannually on April 30 and October 30 each
20
year and we have been paying principal in equal annual installments of $6.0
million since April 30, 2000. We will make the final payment on April 30, 2004.
The note holders have the right to require us to prepay the notes in full
without premium upon a change of control or upon specified asset dispositions
or other transactions we may make. The note agreements prohibit specified
mergers and consolidations in which our company is not the surviving company,
require that we maintain specified financial ratios, require that the notes
rank on par with other debt and limit the amount of debt we can incur. In the
event of default or a prepayment at our option, we must pay a penalty to the
note holder.
Commitments
Unsecured Revolving Credit Facility. Effective May 30, 2003, we
entered into a $150.0 million revolving credit facility. This facility bears
interest at LIBOR, plus a spread. The revolving credit facility, among other
things, requires the maintenance of certain distributions and prohibits the
incurrence of certain new indebtedness. There was no amount outstanding on this
facility at January 31, 2004.
See a discussion of our new $450.0 million credit facility entered into in
March 2004 in "Liquidity and Capital Resources" on page 18.
Letters of Credit and Bonds. Effective March 12, 2001, we entered into a
Letter of Credit Reimbursement and Security Agreement, which provides $125.0
million for letters of credit, which are generally issued for the routine
purchase of imported merchandise. Approximately $67.0 million was committed to
letters of credit at January 31, 2004. We also have letters of credit or surety
bonds outstanding for our revenue bond financing, our high-deductible insurance
program and utility payments at our stores.
Freight Contracts. We have contracted outbound freight services from
various carriers with contracts expiring through January 2007. The total amount
of these commitments is approximately $29.7 million.
Technology Assets. We have commitments totaling approximately $24.1 million
to purchase store technology assets for our stores during 2004.
Derivative Financial Instruments
We are party to four interest rate swaps, which allow us to manage the risk
associated with interest rate fluctuations on the demand revenue bonds and a
portion of our variable rate, variable interest entity debt. The swaps are based
on notional amounts of $19.0 million, $10.0 million, $5.0 million and $25.0
million. Under the $19.0 million, $10.0 million and $5.0 million agreements, as
amended, we pay interest to the banks that provided the swaps at a fixed rate.
In exchange, the financial institution pays us at variable-interest rates, which
are similar to the rates on the demand revenue bonds and our variable-rate
operating leases. The variable-interest rates on the interest rate swaps are set
monthly. No payments are made by either party under the swaps for monthly
periods with an established interest rate greater than a predetermined rate (the
knock-out rate). The swaps may be canceled by the bank or us and settled for the
fair value of the swap as determined by market rates.
The $25.0 million interest rate swap agreement is used to manage the risk
associated with interest rate fluctuations on a portion of our variable interest
entity debt. Under this agreement, we pay interest to a financial institution at
a fixed rate of 5.43%. In exchange, the financial institution pays us at a
variable-interest rate, which approximates the floating rate on the debt,
excluding the credit spread. The interest rate on the swap is subject to
adjustment monthly. The swap is effective through March 2006, but it may be
canceled by the bank or us and settled for the fair value of the swap as
determined by market rates.
Because of the knock-out provision in the $19.0 million, $10.0 million and
$5.0 million interest rate swaps, changes in the fair value of those swaps are
recorded in earnings. Changes in fair value on our $25.0 million interest rate
swap are recorded as a component of "accumulated other comprehensive income" in
the consolidated balance sheets because the swap qualifies for hedge accounting
treatment in accordance with Statement of Financial Accounting Standards No.
133, as amended by Statement of Financial Accounting Standards No. 138. The
amounts recorded in accumulated other comprehensive income are subsequently
reclassified into earnings in the same period in which the related interest
affects earnings.
In March 2004, we repaid the variable interest entity debt with borrowings
from our $450.0 million Revolving Credit Facility. The $25.0 million, $10.0
million and $5.0 million interest rate swaps designated to the variable interest
rate debt were redesignated to our borrowings under the $450.0 million Revolving
Credit Facility. This redesignation does not effect the accounting method used
for the individual interest rate swaps.
For more information on the interest rate swaps, see "Quantitative and
Qualitative Disclosures About Market Risk - Interest Rate Risk" on page 24.
21
Critical Accounting Policies
The preparation of financial statements requires the use of estimates.
Certain of our estimates require a high level of judgment and have the potential
to have a material effect on the financial statements if actual results vary
significantly from those estimates. Following is a discussion of the estimates
that we consider critical.
Inventory Valuation
As discussed in Note 1 to the Consolidated Financial Statements,
inventories at the distribution centers are stated at the lower of cost or
market with cost determined on a weighted-average basis. Cost is assigned to
store inventories using the retail inventory method on a weighted-average basis.
Under the retail inventory method, the valuation of inventories at cost and the
resulting gross margins are computed by applying a calculated cost-to-retail
ratio to the retail value of inventories. The retail inventory method is an
averaging method that has been widely used in the retail industry and results in
valuing inventories at lower of cost or market when markdowns are taken as a
reduction of the retail value of inventories on a timely basis.
Inventory valuation methods require certain significant management
estimates and judgments, including estimates of merchandise markdowns and
shrink, which significantly affect the ending inventory valuation at cost as
well as the resulting gross margins. The averaging required in applying the
retail inventory method and the estimates of shrink and markdowns could, under
certain circumstances, result in costs not being recorded in the proper period.
We estimate our markdown reserve based on the consideration of a variety of
factors, including but not limited to quantities of slow moving or carryover
seasonal merchandise on hand, historical markdown statistics and future
merchandising plans. The accuracy of our estimates can be affected by many
factors, some of which are outside of our control, including changes in economic
conditions and consumer buying trends. Historically, we have not experienced
significant differences in our estimates of markdowns compared with actual
results.
Our accrual for shrink is based on the actual historical shrink results of
our most recent physical inventories adjusted, if necessary, for current
economic conditions. These estimates are compared to actual results as physical
inventory counts are taken and reconciled to the general ledger. The majority of
our counts are taken between January and May of each year; therefore, the shrink
accrual recorded at January 31, 2004 is based on estimated shrink for most of
2003, including the fourth quarter. We have not experienced significant
fluctuations in historical shrink rates in our Dollar Tree stores. However, we
have sometimes experienced higher than typical shrink in acquired stores in the
year following an acquisition, as was experienced in the former Dollar Express
distribution facilities and stores in 2001. We periodically adjust our shrink
estimates to address these factors as they become apparent.
Our management believes that our application of the retail inventory method
results in an inventory valuation that reasonably approximates cost and results
in carrying inventory at the lower of cost or market.
Accrued Expenses
On a monthly basis, we estimate certain material expenses in an effort to
record those expenses in the period incurred. Our most material estimates relate
to domestic freight, insurance-related expenses, certain store level operating
expenses, such as property taxes and utilities, and other expenses. Our freight
and store-level operating expenses are estimated based on current activity and
historical results. Our workers' compensation and general liability insurance
accruals are recorded based on actuarial valuation methods performed by
third-party actuaries. These actuarial valuations are estimates based on
historical loss development factors. Other expenses are estimated and recorded
in the periods that management becomes aware of them. The related accruals are
adjusted as management's estimates change. Differences in management's estimates
and assumptions could result in an accrual materially different from the
calculated accrual. Our experience has been that some of our estimates are too
high and others are too low. Historically, the net total of these differences
has not had a material effect on our financial condition or results of
operations.
Income Taxes
On a quarterly basis, we estimate our required tax liability and assess the
recoverability of our deferred tax assets. Our taxes payable are estimated based
on enacted tax rates, including estimated tax rates in states where our store
base is growing applied to the income expected to be taxed currently. Management
assesses the realizability of our deferred tax assets based on the availability
of carrybacks of future deductible amounts and management's projections for
future taxable income. We cannot guarantee that we will generate income in
future years. Historically, we have not experienced significant differences in
our estimates of our tax accrual.
Seasonality and Quarterly Fluctuations
We experience seasonal fluctuations in our net sales, comparable store net
sales, operating income and net income and expect this trend to continue. Our
results of operations may also fluctuate significantly as a result of a variety
of factors, including:
22
o shifts in the timing of certain holidays, especially Easter;
o the timing of new store openings;
o the net sales contributed by new stores;
o changes in our merchandise mix; and
o competition.
Our highest sales periods are the Christmas and Easter seasons. Easter was
observed on March 31, 2002, April 20, 2003 and will be observed on April 11,
2004. We generally realize a disproportionate amount of our net sales and a
substantial majority of our operating and net income during the fourth quarter.
In anticipation of increased sales activity during these months, we purchase
substantial amounts of inventory and hire a significant number of temporary
employees to supplement our permanent store staff. Our operating results,
particularly operating and net income, could suffer if our net sales were below
seasonal norms during the fourth quarter or during the Easter season for any
reason, including merchandise delivery delays due to receiving or distribution
problems.
Our unaudited results of operations for the eight most recent quarters are
shown in a table in Footnote 13 of the Consolidated Financial Statements in Item
8 of this Form 10-K.
Inflation and Other Economic Factors
Our ability to provide quality merchandise at a fixed price and on a
profitable basis may be subject to economic factors and influences that we
cannot control. National or international events, including war or terrorism,
could lead to disruptions in economies in the United States or in foreign
countries where we purchase much of our merchandise. These and other factors
could increase our merchandise costs and other costs that are critical to our
operations, such as shipping and wage rates. Consumer spending could also
decline because of economic pressures.
Shipping Costs. In the past, we have experienced annual increases of as
much as 33% in our trans-Pacific shipping rates due primarily to rate increases
imposed by the trans-Pacific shipping cartel. Currently, trans-Pacific shipping
rates are negotiated with individual freight lines and are subject to
fluctuation based on supply and demand for containers and current fuel costs. As
a result, our trans-Pacific shipping costs in fiscal 2004 may increase by $5.0
million or more compared with fiscal 2003 when we renegotiate our import
shipping rates effective May 2004. We can give no assurances as to the amount of
the increase, as we are in the early stages of our negotiations.
Because of rising fuel costs in 2004, we could experience increases in
mileage costs as charged by our domestic contract carriers compared with past
years. However, we do not expect these increases, if any, to have a material
effect on our results of operations, in part, because the opening of two new
distribution centers in 2004 is expected to reduce the average distance between
our distribution centers and the stores that they service.
Minimum Wage. Although our average hourly wage rate is significantly higher
than the federal minimum wage, an increase in the mandated minimum wage could
significantly increase our payroll costs. In prior years, proposals increasing
the federal minimum wage by $1.00 per hour have narrowly failed to pass both
houses of Congress. However, if the federal minimum wage were to increase by
$1.00 per hour, we believe that our annual payroll expenses would increase by
approximately 40 basis points, unless we realize offsetting cost reductions.
Leases for Replaced Distribution Centers. We are liable for rent and
pass-through costs under a lease for a now-closed distribution center whose
lease expires in September 2005. We have recorded charges for these future
obligations considering current market conditions and probable sublease income
and do not anticipate recording additional charges under this lease. The lease
on our Chicago distribution center expires in June 2005. We are making an effort
to find a tenant to sublease the facility when we vacate it later this year to
move to our new facility in Joliet; however, if we are unable to locate a
suitable tenant, we would have to record a charge for our future obligations
under this lease of approximately $1.0 million.
Unless offsetting cost savings are realized, adverse economic factors,
including inflation in operating costs, could harm our financial condition and
results of operations.
Potential Future Accounting Pronouncements
In March 2004, the Financial Accounting Standards Board issued an exposure
draft addressing the accounting for stock-based compensation. A final standard
is expected by the end of 2004. Proposed changes to the existing rules require
companies to recognize compensation expense for stock option grants. When the
new rules are enacted, we expect our results of operations to be materially
adversely affected; however, our cash flow and the underlying economics of our
financial condition are not expected to be materially affected. We will continue
to monitor the development of the new standard and review our stock-based
compensation plans accordingly.
23
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to various types of market risk in the normal course of our
business, including the impact of interest rate changes and foreign currency
rate fluctuations. We may enter into interest rate swaps to manage exposure to
interest rate changes, and we may employ other risk management strategies,
including the use of foreign currency forward contracts. We do not enter into
derivative instruments for any purpose other than cash flow hedging purposes and
we do not hold derivative instruments for trading purposes.
Interest Rate Risk
We have financial instruments that are subject to interest rate risk,
consisting of debt and lease obligations issued at variable and fixed rates.
Based on amounts outstanding on our fixed rate debt obligations at January 31,
2004, we do not consider our exposure to interest rate risk to be material.
We use variable-rate debt to finance certain of our operations and capital
improvements. These obligations expose us to variability in interest payments
due to changes in interest rates. If interest rates increase, interest expense
increases. Conversely, if interest rates decrease, interest expense also
decreases. We believe it is beneficial to limit the variability of our interest
payments.
To meet this objective, we entered into derivative instruments in the form
of interest rate swaps to manage fluctuations in cash flows resulting from
changes in the variable-interest rates on the obligations. The interest rate
swaps reduce the interest rate exposure on these variable-rate obligations.
Under the interest rate swap, we pay the bank at a fixed-rate and receive
variable-interest at a rate approximating the variable-rate on the obligation,
thereby creating the economic equivalent of a fixed-rate obligation. Under the
$19.0 million, $10.0 million and $5.0 million interest rate swaps, no payments
are made by parties under the swaps for monthly periods in which the
variable-interest rate is greater than the predetermined knock-out rate.
The following table summarizes the financial terms of our interest rate
swap agreements and the fair value of each interest rate swap at January 31,
2004:
Hedging Receive Pay Knock-out Fair
Instrument Variable Fixed Rate Expiration Value
---------- -------- ----- ---- ---------- -----
$19.0 million LIBOR 4.88% 7.75% 4/1/09 ($1.7 million)
interest rate swap
$10.0 million LIBOR 6.45% 7.41% 6/2/04 ($0.2 million)
interest rate swap
$5.0 million LIBOR 5.83% 7.41% 6/2/04 ($0.1 million)
interest rate swap
$25.0 million LIBOR 5.43% N/A 3/12/06 ($1.8 million)
interest rate swap
Hypothetically, a 1% change in interest rates results in approximately a $0.6
million change in the amount paid or received under the terms of the interest
rate swap agreements on an annual basis. Due to many factors, management is not
able to predict the changes in fair value of our interest rate swaps. The fair
values are the estimated amounts we would pay or receive to terminate the
agreements as of the reporting date. These fair values are obtained from an
outside financial institution.
24
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements Page
----
Independent Auditors' Report............................................ 26
Consolidated Balance Sheets as of January 31, 2004, February 1, 2003
and December 31, 2002............................................... 27
Consolidated Statements of Operations for the year ended January 31,
2004, the month ended February 1, 2003 and the years ended
December 31, 2002 and 2001 ......................................... 28
Consolidated Statements of Shareholders' Equity and Comprehensive
Income (Loss)for the year ended January 31, 2004, the month ended
February 1, 2003 and the years ended December 31, 2002 and 2001..... 29
Consolidated Statements of Cash Flows for the year ended January 31,
2004 and the month ended February 1, 2003
and the years ended December 31, 2002 and 2001...................... 30
Notes to Consolidated Financial Statements.............................. 32
25
INDEPENDENT AUDITOR'S REPORT
The Board of Directors and Shareholders
Dollar Tree Stores, Inc.:
We have audited the accompanying consolidated balance sheets of Dollar Tree
Stores, Inc. and subsidiaries (the Company) as of January 31, 2004, February 1,
2003 and December 31, 2002, and the related consolidated statements of
operations, shareholders' equity and comprehensive income (loss), and cash flows
for the year ended January 31, 2004, the one-month period ended February 1, 2003
and for each of the years in the two-year period ended December 31, 2002. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Dollar Tree
Stores, Inc. and subsidiaries as of January 31, 2004, February 1, 2003 and
December 31, 2002, and the results of their operations and their cash flows for
the year ended January 31, 2004, the one-month period ended February 1, 2003 and
for each of the years in the two-year period ended December 31, 2002, in
conformity with accounting principles generally accepted in the United States of
America.
Effective January 1, 2002, the Company implemented Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets, as well as
Statement of Financial Accounting Standards No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, as described in Note 1.
Effective January 1, 2003, the Company implemented the provisions of
Financial Accounting Standards Board Interpretation 46, Consolidation of
Variable Interest Entities, as described in Note 6.
/s/ KPMG LLP
Norfolk, Virginia
February 23, 2004
26
DOLLAR TREE STORES, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
January 31, February 1, December 31,
2004 2003 2002
---- ---- ----
(In thousands, except share data)
ASSETS
Current assets:
Cash and cash equivalents.................................... $ 168,685 $ 237,302 $ 292,192
Short-term investments....................................... -- 63,525 43,780
Merchandise inventories...................................... 525,643 438,439 357,665
Deferred tax asset (Note 4).................................. 11,716 14,333 10,409
Prepaid expenses and other current assets.................... 16,525 15,783 12,094
--------- --------- ---------
Total current assets..................................... 722,569 769,382 716,140
Property and equipment, net (Notes 5, 6, 7 and 8)................. 613,214 477,947 344,322
Intangibles, net (Notes 2 and 7).................................. 123,738 41,351 41,418
Other assets, net (Notes 3 and 6)................................. 20,785 15,559 14,497
--------- --------- ---------
TOTAL ASSETS............................................. $ 1,480,306 $ 1,304,239 $ 1,116,377
========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt (Note 8)................... $ 25,000 $ 25,000 $ 25,000
Current installments of obligations under capital
leases (Note 7)............................................ 5,324 5,811 5,782
Accounts payable............................................. 114,972 137,668 59,451
Other current liabilities (Note 7)........................... 82,771 75,033 88,237
Income taxes payable......................................... 37,035 23,548 28,041
--------- --------- ---------
Total current liabilities................................ 265,102 267,060 206,511
Long-term debt, excluding current portion (Notes 6 and 8)......... 142,568 146,628 6,000
Obligations under capital leases, excluding
current installments (Note 7).................................. 12,259 17,283 17,647
Deferred tax liability (Note 4)................................... 29,717 11,685 9,899
Other liabilities (Notes 9 and 11)................................ 16,138 15,764 20,916
--------- --------- ---------
Total liabilities........................................ 465,784 458,420 260,973
--------- --------- ---------
Shareholders' equity (Notes 9, 10 and 12):
Common stock, par value $0.01. 300,000,000 shares authorized,
114,083,768 shares issued and outstanding at January 31,
2004; 114,231,314 shares issued and outstanding at
February 1, 2003; and 114,186,569 shares issued and
outstanding at December 31, 2002........................... 1,141 1,142 1,142
Additional paid-in capital................................... 208,870 218,106 217,267
Accumulated other comprehensive loss......................... (970) (1,277) (1,373)
Unearned compensation........................................ (62) (112) (117)
Retained earnings............................................ 805,543 627,960 638,485
---------- --------- ---------
Total shareholders' equity............................... 1,014,522 845,819 855,404
Commitments and contingencies
(Notes 5, 6, 8, 9, 11 and 12)................................ -- -- --
---------- --------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY................... $ 1,480,306 $ 1,304,239 $ 1,116,377
========= ========= =========
See accompanying Notes to Consolidated Financial Statements.
27
DOLLAR TREE STORES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended Month Ended Year Ended
January 31, February 1, December 31,
--------------------
2004 2003 2002 2001
---- ---- ---- ----
(In thousands, except per share data)
Net sales......................................... $ 2,799,872 $ 160,789 $ 2,329,188 $ 1,987,271
Cost of sales (Note 6)............................ 1,787,052 113,980 1,481,232 1,271,314
--------- --------- --------- ---------
Gross profit ............................ 1,012,820 46,809 847,956 715,957
Selling, general and administrative
expenses (Notes 6 and 11)....................... 719,223 55,237 594,035 512,092
--------- --------- --------- ---------
Operating income (loss).................. 293,597 (8,428) 253,921 203,865
Interest income................................... 2,648 389 3,526 3,573
Interest expense ................................. (8,382) (719) (4,519) (5,464)
Changes in fair value of non-hedging
interest rate swaps (Note 9).................... 889 239 (1,469) (1,723)
--------- --------- --------- ---------
Income (loss) before income taxes........ 288,752 (8,519) 251,459 200,251
Provision for income taxes (Note 4)............... 111,169 (3,279) 96,812 77,170
--------- --------- --------- ---------
Income (loss) before cumulative
effect of a change in accounting
principle.............................. 177,583 (5,240) 154,647 123,081
Cumulative effect of a change in
accounting principle, net of tax
benefit of $3,309 (Note 6)..................... -- (5,285) -- --
--------- --------- --------- ---------
Net income (loss)........................ $ 177,583 $ (10,525) $ 154,647 $ 123,081
========= ========= ========= =========
Basic net income (loss) per share (Note 10):
Income (loss) before cumulative
effect of a change in accounting
principle.................................. $ 1.55 $ (0.05) $ 1.36 $ 1.10
Cumulative effect of a change in
accounting principle........................ -- (0.04) -- --
--------- --------- --------- ---------
Net income (loss)............................ $ 1.55 $ (0.09) $ 1.36 $ 1.10
========= ========= ========= =========
Diluted net income (loss) per share (Note 10):
Income (loss) before cumulative effect
of a change in accounting
principle.................................. $ 1.54 $ (0.05) $ 1.35 $ 1.09
Cumulative effect of a change in
accounting principle....................... -- (0.04) -- --
--------- --------- --------- ---------
Net income (loss)................................. $ 1.54 $ (0.09) $ 1.35 $ 1.09
========= ========= ========= =========
See accompanying Notes to Consolidated Financial Statements.
28
DOLLAR TREE STORES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS)
Year Ended January 31, 2004,
Month Ended February 1, 2003 and Years Ended December 31, 2002 and 2001
Accumulated
Common Additional Other Unearned Share-
Stock Common Paid-in Comprehensive Compen- Retained holders'
Shares Stock Capital Loss sation Earnings Equity
------ ----- ------- ---- --------- -------- ------
(In thousands)
Balance at December 31, 2000 ....................... 112,046 $ 1,121 $ 156,780 $ -- $ -- $ 360,757 $ 518,658
----------
Net income for the year ended December 31, 2001 .... -- -- -- -- -- 123,081 123,081
Other comprehensive loss (Note 10) ................. -- -- -- (378) -- -- (378)
----------
Total comprehensive income .................... 122,703
Issuance of stock under Employee Stock
Purchase Plan and other plans (Note 12) ......... 91 -- 1,555 -- -- -- 1,555
Exercise of stock options, including
income tax benefit of $2,345 (Note 12) .......... 594 6 12,589 -- -- -- 12,595
Repurchase and retirement of shares (Note 10) ...... (225) (2) (3,773) -- -- -- (3,775)
------- ------- --------- ------- ----- --------- ----------
Balance at December 31, 2001 ....................... 112,506 1,125 167,151 (378) -- 483,838 651,736
------- ------- --------- ------- ----- --------- ----------
Net income for the year ended December 31, 2002 .... -- -- -- -- -- 154,647 154,647
Other comprehensive loss (Note 10) ................. -- -- -- (995) -- -- (995)
----------
Total comprehensive income .................... 153,652
Issuance of stock under Employee Stock
Purchase Plan and other plans (Note 12) ......... 96 1 2,038 -- -- -- 2,039
Exercise of stock options, including
income tax benefit of $10,696 (Note 12) ......... 1,633 16 41,117 -- -- -- 41,133
Restricted stock issuance and amortization (Note 10) 9 -- 275 -- (117) -- 158
Settlement of merger-related contingencies ......... (57) -- 6,686 -- -- -- 6,686
------- ------- --------- ------- ----- --------- ----------
Balance at December 31, 2002 ....................... 114,187 1,142 217,267 (1,373) (117) 638,485 855,404
------- ------- --------- ------- ----- --------- ----------
Net loss for the month ended February 1, 2003 ...... -- -- -- -- -- (10,525) (10,525)
Other comprehensive income (Note 10) ............... -- -- -- 96 -- -- 96
----------
Total comprehensive loss ...................... (10,429)
Issuance of stock under Employee Stock
Purchase Plan and other plans (Note 12) ......... 32 -- 614 -- -- -- 614
Exercise of stock options, including
income tax benefit of $65 (Note 12) ............. 12 -- 225 -- -- -- 225
Restricted stock amortization (Note 10) ............ -- -- -- -- 5 -- 5
------- ------- --------- ------- ----- --------- ----------
Balance at February 1, 2003 ........................ 114,231 1,142 218,106 (1,277) (112) 627,960 845,819
------- ------- --------- ------- ----- --------- ----------
Net income for the year ended January 31, 2004 ..... -- -- -- -- -- 177,583 177,583
Other comprehensive income (Note 10) ............... -- -- -- 307 -- -- 307
----------
Total comprehensive income .................... 177,890
Issuance of stock under Employee Stock
Purchase Plan and other plans (Note 12) ......... 132 1 2,724 -- -- -- 2,725
Exercise of stock options, including
income tax benefit of $5,620 (Note 12) .......... 994 10 25,060 -- -- -- 25,070
Settlement of merger-related contingencies ......... (8) -- 1,021 -- -- -- 1,021
Repurchase and retirement of shares (Note 10) ...... (1,265) (12) (38,041) -- -- -- (38,053)
Restricted stock amortization (Note 10) ............ -- -- -- -- 50 -- 50
------- ------- --------- ------- ----- --------- ----------
Balance at January 31, 2004 ........................ 114,084 $ 1,141 $ 208,870 $ (970) $ (62) $ 805,543 $1,014,522
======= ======= ========= ======= ===== ========= ==========
See accompanying Notes to Consolidated Financial Statements.
29
DOLLAR TREE STORES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended Month Ended Year Ended
January 31, February 1, December 31,
-------------------
2004 2003 2002 2001
---- ---- ---- ----
(In thousands)
Cash flows from operating activities
Net income (loss)................................................. $ 177,583 $ (10,525) $ 154,647 $ 123,081
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization................................. 101,495 7,217 71,615 53,763
Loss on disposal of property and equipment.................... 4,015 107 1,599 1,726
Cumulative effect of a change in accounting principle......... -- 5,285 -- --
Change in fair value of non-hedging interest rate swaps...... (889) (239) 1,469 1,723
Provision for deferred income taxes........................... 21,059 1,111 16,439 (6,219)
Tax benefit of stock option exercises........................ 5,620 65 10,696 2,345
Other non-cash adjustments to net income...................... 587 58 313 1,318
Changes in assets and liabilities increasing
(decreasing) cash and cash equivalents:
Merchandise inventories.................................. (61,166) (80,774) (61,192) (37,786)
Prepaid expenses and other current assets................ (428) (3,689) 6,707 10,594
Other assets............................................. (1,424) (679) (999) (936)
Accounts payable......................................... (29,135) 78,217 1,361 (17,314)
Income taxes payable..................................... 16,910 (4,493) (10,807) 15,400
Other current liabilities................................ 803 (12,505) 13,018 28,313
Other liabilities........................................ (745) (3,185) 2,011 2,718
---------- --------- --------- -------
Net cash provided by (used in) operating
activities....................................... 234,285 (24,029) 206,877 178,726
---------- --------- --------- -------
Cash flows from investing activities:
Acquisition of favorable lease rights............................. (105) -- (813) --
Capital expenditures.............................................. (227,316) (11,555) (136,127) (121,566)
Purchase of Greenbacks, Inc., net of cash acquired of $1,248...... (100,523) -- -- --
Investment in Ollie's Holdings, Inc............................... (4,000) -- -- --
Proceeds from sale of property and equipment...................... 35 -- 216 98
Purchase of short-term investments................................ (30,360) (21,745) (60,280) --
Proceeds from sales of short-term
investments..................................................... 93,885 2,000 16,500 --
Settlement of merger-related contingencies........................ 1,021 -- 6,686 --
---------- --------- -------- --------
Net cash used in investing activities.............. (267,363) (31,300) (173,818) (121,468)
---------- --------- -------- --------
Cash flows from financing activities:
Proceeds from revolving credit facilities......................... 39,700 -- -- 82,000
Repayment of revolving credit facilities ......................... (39,700) -- -- (82,000)
Repayment of long-term debt and facility fees..................... (11,667) -- (6,025) (6,239)
Principal payments under capital lease obligations................ (7,994) (335) (3,971) (3,562)
Proceeds from stock issued pursuant to
stock-based compensation plans ................................. 22,175 774 32,476 11,805
Repurchase of common stock (Note 10).............................. (38,053) -- -- (3,775)
---------- --------- --------- --------
Net cash provided by (used in)
financing activities............................. (35,539) 439 22,480 (1,771)
---------- --------- --------- --------
Net increase (decrease) in cash and cash equivalents................... (68,617) (54,890) 55,539 55,487
Cash and cash equivalents at beginning of period....................... 237,302 292,192 236,653 181,166
---------- --------- --------- -------
Cash and cash equivalents at end of period............................. $ 168,685 $ 237,302 $ 292,192 $ 236,653
========== ======== ========= =======
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest...................................................... $ 7,252 $ 195 $ 3,685 $ 5,144
========== ========= ========= ========
Income taxes.................................................. $ 70,172 $ 110 $ 82,420 $ 65,688
========== ========= ========= ========
(continued on following page)
30
DOLLAR TREE STORES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued from previous page)
Supplemental disclosure of non-cash investing and financing activities:
The Company purchased equipment under capital lease obligations amounting
to $2,134, $2,177 and $222 in the years ended January 31, 2004, December 31,
2002 and 2001, respectively. The Company did not purchase any equipment under
capital leases in the month ended February 1, 2003.
As described in Note 2, the Company acquired Greenbacks, Inc. In
conjunction with the acquisition, the Company assumed liabilities of $5,187.
As described in Note 6, the Company consolidated its variable interest
entity effective January 1, 2003. As a result, the Company recorded the
following on January 1, 2003: an increase of $128,791 in net property and
equipment; an increase of $970 for deferred financing costs in other assets and
an increase of $140,628 in long-term debt. In addition, the cumulative effect of
a change in accounting principle represents, net of the tax effect of $3,309,
the catch-up of depreciation related to the distribution center assets and the
catch-up of the amortization of the deferred financing costs offset by the
write-off of the straight-lined rent liability.
See accompanying Notes to Consolidated Financial Statements.
31
DOLLAR TREE STORES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share data)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
At January 31, 2004, Dollar Tree Stores, Inc. (DTS or the Company) owns and
operates 2,513 discount variety retail stores that sell substantially all items
for $1.00 or less. The Company's stores operate under the names of Dollar Tree,
Greenbacks, Dollar Express, Dollar Bills, Only One Dollar, and Only $One. Our
stores average approximately 6,716 selling square feet.
The Company's headquarters and one of its distribution centers are located
in Chesapeake, Virginia. The Company also operates distribution centers in
Mississippi, Illinois, California, Pennsylvania, Georgia, Oklahoma and Utah. In
February 2004, the Company commenced operations of a distribution center in
Washington. The Company's stores are located in 47 of the 48 contiguous states.
The Company's merchandise includes candy and food, housewares, health and beauty
care, seasonal goods, party goods, toys, stationery, gifts and other consumer
items. Approximately 40% of the Company's merchandise is directly imported,
primarily from China.
Principles of Consolidation
The consolidated financial statements include the financial statements of
Dollar Tree Stores, Inc., and its wholly owned subsidiaries. Effective January
1, 2003, the consolidated financial statements also include the financial
statements of a variable interest entity that owns four of the Company's
distribution centers (see Note 6). All significant intercompany balances and
transactions have been eliminated in consolidation.
Fiscal Year
The Company's fiscal years were calendar years in 2002 and 2001. The
Company changed its fiscal year end from December 31 to the Saturday closest to
January 31, effective for the fiscal year beginning February 2, 2003 and ending
January 31, 2004. The one-month period of January 1, 2003 through February 1,
2003 (the "Transition Period") is presented separately in these consolidated
financial statements. Unless specifically indicated otherwise, any reference
herein to "2003" or "Fiscal 2003" relates to as of or for the year ended January
31, 2004. Any references to "2002" and "2001" or "Fiscal 2002" and "Fiscal 2001"
relate to as of or for the years ended December 31, 2002 and 2001, respectively.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosures of contingent assets and liabilities at
the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
Reclassifications
Certain 2002 and 2001 amounts have been reclassified for comparability with
the current period presentation.
Cash and Cash Equivalents
Cash and cash equivalents at January 31, 2004, February 1, 2003 and
December 31, 2002 includes $138,576, $211,525 and $277,170, respectively, of
investments in money market securities and bank participation agreements which
are valued at cost, which approximates market. The underlying assets of these
short-term participation agreements are primarily commercial notes. For purposes
of the statements of cash flows, the Company considers all highly liquid debt
instruments with original maturities of three months or less to be cash
equivalents.
Short-Term Investments
The Company's short-term investments consist primarily of
government-sponsored commercial paper with remaining maturities of more than 90
days at the time of purchase. These investments are classified as
held-to-maturity and carried at amortized cost, which approximates fair value.
Merchandise Inventories
In 2001, merchandise inventories at the distribution centers are stated at
the lower of cost or market, determined on a first-in, first-out (FIFO) basis.
Cost is assigned to store inventories using the retail inventory method,
determined on a FIFO basis. During the second quarter of calendar year 2002, the
Company changed its method of accounting for its merchandise inventories from
the FIFO method to the weighted-average cost method following the implementation
of its new inventory management system. The Company believes this change is
preferable because it more accurately measures the cost of the Company's
merchandise inventories and more accurately matches revenues and costs. The
Company's store inventory turns four to five times per year and is,
32
therefore, comprised of products with older and newer costs. Because the Company
purchases merchandise throughout the year to maintain high in-stock levels, the
weighted-average cost method is more representative of the cost of the products
the Company sells than is FIFO. In accordance with generally accepted accounting
principles, the Company implemented this change retroactively to January 1,
2002. The cumulative effect of the accounting change at January 1, 2002 was not
material. In addition, there was no material impact to the first and second
calendar quarter 2002 financial statements as a result of this change in
accounting principle. Additional pro forma disclosures of the impact of the
change on prior periods as required under Accounting Principles Board Opinion
No. 20, "Accounting Changes," are not provided since weighted-average cost
information was not available from the prior inventory management system;
however, the Company does not believe the effect would have been material.
Costs directly associated with warehousing and distribution are capitalized
as merchandise inventories. Total warehousing and distribution costs capitalized
into inventory amounted to $24,510, $19,990, and $16,674 at January 31, 2004,
February 1, 2003 and December 31, 2002, respectively.
Property and Equipment
Property and equipment are stated at cost and depreciated using the
straight-line method over the estimated useful lives of the respective assets as
follows:
Buildings.................................. 39 years
Furniture, fixtures and equipment.......... 3 to 10 years
Transportation vehicles.................... 4 to 6 years
Leasehold improvements and assets held under capital leases are amortized
over the estimated useful lives of the respective assets or terms of the related
leases, whichever is shorter. If title to the related asset passes to the
Company at the end of the lease term, the asset is amortized over its estimated
useful life, even if the lease term is shorter. The amortization is included in
"selling, general and administrative expenses" on the accompanying consolidated
statements of operations.
Costs incurred related to software developed for internal use are
capitalized and amortized over three years. Costs capitalized include those
incurred in the application development stage as defined in Statement of
Position 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use."
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of
Effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets," which requires that long-lived assets be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. SFAS No. 144 also changes
the criteria for classifying an asset as held for sale and broadens the scope of
businesses to be disposed of that qualify for reporting as discontinued
operations and changes the timing of recognizing losses on such operations. The
adoption of SFAS No. 144 did not have a material effect on the Company's
consolidated financial statements.
The Company reviews its long-lived assets and certain identifiable
intangible assets for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by comparing the
carrying amount of an asset to future net undiscounted cash flows expected to be
generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets based on discounted
cash flows or other readily available evidence of fair value, if any. Assets to
be disposed of are reported at the lower of the carrying amount or fair value
less costs to sell. In fiscal 2003 and 2001, the Company recorded charges of
$234 and $1,400, respectively, to write-down certain assets. No charges were
recorded in the month ended February 1, 2003 or the year ended December 31,
2002. These charges are recorded as a component of "selling, general and
administrative expenses" in the accompanying consolidated statements of
operations.
Prior to the adoption of SFAS No. 144, the Company accounted for long-lived
assets in accordance with SFAS No. 121, "Accounting for Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of."
Intangible Assets
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and
Other Intangible Assets," which establishes accounting and reporting standards
for intangible assets and goodwill. SFAS No. 142 requires that goodwill and
intangible assets with indefinite useful lives no longer be amortized, but
rather tested for impairment at least annually. SFAS No. 142 also requires that
intangible assets with definite useful lives be amortized over their respective
estimated useful lives and reviewed for impairment in accordance with SFAS No.
144. The Company performed the required transition impairment tests of goodwill
and other intangibles as of January 1, 2002, and determined that no impairment
existed. In addition, the Company performs its annual assessment of
33
impairment each November.
Prior to January 1, 2002, goodwill was amortized on a straight-line basis
over the expected periods to be benefited, generally 20 to 25 years.
Financial Instruments
The Company utilizes derivative financial instruments to reduce its
exposure to market risks from changes in interest rates. By entering into
receive-variable, pay-fixed interest rate swaps, the Company limits its exposure
to changes in variable interest rates. The Company is exposed to credit related
losses in the event of non-performance by the counterparty to the interest rate
swaps; however, the counterparties are major financial institutions, and the
risk of loss due to non-performance is considered remote. Interest rate
differentials paid or received on the swap are recognized as adjustments to
expense in the period earned or incurred. The Company formally documents all
hedging relationships, if applicable, and assesses hedge effectiveness both at
inception and on an ongoing basis.
Prior to the implementation of SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," the fair value of the interest rate swaps
was not recorded in the Company's balance sheet because they met the
requirements for hedge accounting treatment prior to the implementation of SFAS
No. 133.
Effective January 1, 2001, the Company adopted SFAS No. 133. This
statement, as amended by SFAS No. 138, establishes accounting and reporting
standards for derivative instruments, including derivative instruments embedded
in other contracts, and for hedging activities. Three of the Company's interest
rate swaps do not qualify for hedge accounting treatment pursuant to the
provisions of SFAS No. 133. As a result, the interest rate swaps are recorded at
their fair values in the consolidated balance sheets as a component of "other
liabilities" (see Note 9). Changes in the fair value of the interest rate swaps
are recorded as "change in the fair value of non-hedging interest rate swaps" in
the statements of cash flows and the consolidated statements of operations. Upon
termination of these non-hedging interest rate swaps, the remaining asset or
liability, if any, will be removed from the accompanying consolidated balance
sheets.
The Company is party to one interest rate swap that qualifies for hedge
accounting treatment pursuant to the provisions of SFAS No. 133. Accordingly,
changes in the fair value of the interest rate swap are reported in the
accompanying consolidated balance sheets as a component of "accumulated other
comprehensive loss." These amounts are subsequently reclassified into earnings
as a yield adjustment in the period in which the related interest on the
variable-rate obligations affects earnings. If the swap is terminated prior to
its expiration date, the amount recorded in accumulated other comprehensive loss
will be recorded as a yield adjustment over the term of the forecasted
transaction.
Revenue Recognition
The Company recognizes sales revenue at the time a sale is made to its
customer.
Cost of Sales
The Company includes the cost of merchandise, warehousing and distribution
costs, and certain occupancy costs in cost of sales.
Pre-Opening Costs
The Company expenses pre-opening costs for new, expanded and relocated
stores, as incurred.
Advertising Costs
The Company expenses advertising costs as they are incurred. Advertising
costs approximated $5,181 in the year ended January 31, 2004 and $789 in the
month ended February 1, 2003. The Company did not incur significant advertising
costs in the years ended December 31, 2002 and 2001.
Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between financial statement carrying
amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date of such change.
Stock-Based Compensation
The Company applies the intrinsic value-based method of accounting
prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees," and related Interpretations in accounting for its fixed
stock option plans. As such, compensation expense would be recorded on the date
of grant only if the current market price of the underlying stock exceeded the
exercise price. SFAS No. 123, "Accounting for Stock-Based Compensation,"
established accounting and disclosure requirements using a fair value-based
method of accounting for stock-
34
based employee compensation plans. As allowed by SFAS No. 123, the Company has
elected to continue to apply the intrinsic value-based method of accounting
described above, and has adopted the disclosure only requirements of SFAS No.
123.
If the accounting provisions of SFAS No. 123 had been adopted, the
Company's net income (loss) and net income (loss) per share would have been
reduced to the pro forma amounts indicated in the following table:
Year Ended Month Ended Year Ended
January 31, February 1, December 31,
------------------
2004 2003 2002 2001
---- ---- ---- ----
Net income (loss)
As reported........................................... $ 177,583 $ (10,525) $ 154,647 $ 123,081
Deduct: Total stock-based employee
compensation expense determined under
fair value based method,
net of related tax effects............................ $ 13,181 $ 1,108 $ 12,625 $ 11,417
-------- -------- -------- ----------
Net income (loss) for SFAS No. 123.................. $ 164,402 $ (11,633) $ 142,022 $ 111,664
======== ======= ======== ========
Net income (loss) per share:
Basic, as reported.................................... $ 1.55 $ (0.09) $ 1.36 $ 1.10
Basic, pro forma for SFAS No. 123..................... $ 1.43 $ (0.10) $ 1.25 $ 0.99
Diluted, as reported.................................. $ 1.54 $ (0.09) $ 1.35 $ 1.09
Diluted, pro forma for SFAS No. 123................... $ 1.43 $ (0.10) $ 1.24 $ 0.99
These pro forma amounts for SFAS No. 123 may not be representative of
future disclosures because compensation cost is reflected over the options'
vesting periods and because additional options may be granted in future years.
Net Income Per Share
Basic net income per share has been computed by dividing net income by the
weighted average number of shares outstanding. Diluted net income per share
reflects the potential dilution that could occur assuming the inclusion of
dilutive potential shares and has been computed by dividing net income by the
weighted average number of shares and dilutive potential shares outstanding.
Dilutive potential shares include all outstanding stock options and restricted
stock after applying the treasury stock method.
Financial Guarantees
In November 2002, the Financial Accounting Standards Board issued
Interpretation No. 45 (FIN 45), "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to
Others, an Interpretation of SFAS Nos. 5, 57 and 107 and a recission of FASB
Interpretation No. 34." FIN 45 elaborates on the disclosures to be made by a
guarantor in its interim and annual financial statements about its obligations
under guarantees issued. FIN 45 also clarifies that a guarantor is required to
recognize, at inception of a guarantee, a liability for the fair value of the
obligation undertaken. The initial recognition and measurement provisions are
applicable to guarantees issued or modified after December 31, 2002. The
disclosure requirements are effective for periods ending after December 15,
2002. The Company has no guarantees as of and for the year ended January 31,
2004 or as of and for the month ended February 1, 2003.
NOTE 2 - ACQUISITION
On June 29, 2003, the Company acquired 100% of the outstanding capital
stock of Greenbacks, Inc. (Greenbacks). The results of Greenbacks' operations
are included in the accompanying consolidated financial statements since that
date. Greenbacks was a privately-held company operating 100 stores in 10 western
states and one expandable 252,000 square foot distribution center in Salt Lake
City. As a result of this acquisition, the Company extended its geographical
reach to include 47 states compared with 41 states prior to the acquisition. In
addition, this acquisition has provided the Company with an expandable
distribution infrastructure in the Rocky Mountain area of the country. The
aggregate purchase price was approximately $100,000 and was paid in cash. In
addition, the Company incurred approximately $800 in direct costs associated
with the acquisition.
35
The following table summarizes the fair value of the assets acquired and
liabilities assumed at the date of acquisition.
Current assets................................ $ 27,601
Deferred tax asset-current.................... 860
Property and equipment........................ 7,856
Intangible assets............................. 3,031
Goodwill...................................... 80,284
Other assets 27
----------
Total assets acquired ................... 119,659
----------
Current liabilities........................... 11,155
Deferred tax liability........................ 1,636
Long-term debt 4,838
Other liabilities............................. 257
----------
Total liabilities assumed................ 17,886
----------
Net assets acquired...................... $ 101,773
==========
In accordance with SFAS No. 142, goodwill will not be amortized, but rather
tested annually for impairment.
Included in the intangible assets acquired were non-compete agreements of
$2,000 and favorable lease rights for operating leases for retail locations of
$1,000. The non-compete agreements are with former key executives of Greenbacks.
They are being amortized over five years, the weighted average term of the
agreements. The favorable lease rights are being amortized on a straight-line
basis to rent expense over the remaining initial lease terms, which expire at
various dates through 2012.
NOTE 3 - INVESTMENT
On August 7, 2003, the Company paid $4,000 to acquire a 10.5% fully diluted
interest in Ollie's Holdings, Inc. (Ollie's), a multi-price point discount
retailer located in the mid-Atlantic region. In addition, the SKM Equity Fund
III, L.P. (SKM Equity) and SKM Investment Fund (SKM Investment), acquired a
combined fully diluted interest in Ollie's of 53.1%. Two of the Company's
directors, Thomas Saunders and John Megrue, are principal members of Saunders
Karp & Megrue Partners, L.L.C., which serves as the general partner of SKM
Equity and SKM Investment. In conjunction with the acquisition of its interest
in Ollie's, the Company also entered into a call option agreement. The option
agreement provides the Company with the right to purchase all of SKM Equity's
and SKM Investment's equity in Ollie's, for a fixed price as set forth in the
agreement, subject to adjustments dependent on the occurrence of certain future
events. The Company has no obligation to exercise the option or make any
additional investment in Ollie's. The $4,000 investment in Ollie's is accounted
for under the cost method of accounting and is included in "other assets" on the
accompanying consolidated balance sheets.
NOTE 4 - INCOME TAXES
Total income taxes were allocated as follows:
Year Ended Month Ended Year Ended
January 31, February 1, December 31,
---------------
2004 2003 2002 2001
---- ---- ---- ----
Income (loss) from continuing operations....................... $ 111,169 $ (3,279) $ 96,812 $ 77,170
Cumulative effect of a change in accounting
principle.................................................... -- (3,309) -- --
Accumulated other comprehensive (income) loss, marking
derivative financial instruments to fair value............... 192 61 (633) (237)
Stockholders' equity, tax benefit on exercise of
stock options................................................ (5,620) (65) (10,696) (2,345)
------- -------- ------- ------
$ 105,741 $ (6,592) $ 85,483 $ 74,588
======== ======== ======== ======
36
The provision for income taxes from continuing operations consists of the
following:
Year Ended Month Ended Year Ended
January 31, February 1, December 31,
--------------
2004 2003 2002 2001
---- ---- ---- ----
Federal - Current.............................................. $ 76,017 $ (3,778) $ 69,003 $ 71,504
Federal - Deferred............................................. 19,465 956 14,141 (5,339)
State - Current................................................ 15,471 (611) 11,373 11,885
State - Deferred............................................... 216 154 2,295 (880)
------- -------- -------- --------
$ 111,169 $ (3,279) $ 96,812 $ 77,170
======== ======== ======== ========
A reconciliation of the statutory federal income tax rate and the effective
rate follows:
Year Ended Month Ended Year Ended
January 31, February 1, December 31,
--------------
2004 2003 2002 2001
---- ---- ---- ----
Statutory tax rate.............................................. 35.0% (35.0%) 35.0% 35.0%
Effect of:
State and local income taxes, net of
federal income tax benefit.................................. 3.5 (3.5) 3.5 3.6
Other, net.................................................... -- -- -- (0.1)
----- ----- ----- ----
Effective tax rate........................................ 38.5% (38.5%) 38.5% 38.5%
===== ===== ===== =====
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Deferred tax assets and
liabilities are classified on the accompanying consolidated balance sheets based
on the classification of the underlying asset or liability. Significant
components of the Company's net deferred tax assets (liabilities) follows:
January 31, February 1, December 31,
2004 2003 2002
---- ---- ----
Deferred tax assets:
Accrued expenses and other liabilities principally
due to differences in the timing of deductions
for reserves............................................... $ 16,836 $ 18,383 $ 18,952
Inventories due to additional amounts inventoried
for tax purposes........................................... -- 2,314 2,474
Other........................................................ 1,092 1,294 1,344
-------- --------- ---------
Total deferred tax assets.................................. 17,928 21,991 22,770
-------- --------- ---------
Deferred tax liabilities:
Intangible assets due to differences in
amortization methods and lives............................. (6,169) (4,159) (4,073)
Deferred compensation primarily due to timing of
contributions to the profit sharing plan................... (1,087) (1,402) (1,443)
Property and equipment due to difference in
depreciation and amortization methods and lives............ (27,864) (13,472) (16,434)
Other........................................................ (809) (310) (310)
-------- --------- ---------
Total deferred tax liabilities............................. (35,929) (19,343) (22,260)
-------- --------- ---------
Net deferred tax asset (liability)......................... $ (18,001) $ 2,648 $ 510
======== ========= =========
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred
taxes will not be realized. Based upon the availability of carrybacks of future
deductible amounts to the past five years' taxable income and management's
projections for future taxable income over the periods in which the deferred tax
assets are deductible, management believes it is more likely than not the
existing net deductible temporary differences will reverse during periods in
which carrybacks are available or in which the Company generates net taxable
income. However, there can be no assurance that the Company will generate any
income or any specific level of continuing income in future years.
37
NOTE 5 - COMMITMENTS AND CONTINGENCIES
Operating Lease Commitments
Future minimum lease payments under noncancelable store, distribution
center and former corporate headquarters operating leases (including leases with
related parties) are as follows:
Operating
Leases
---------
Fiscal year:
2004......................................... $ 186,861
2005......................................... 169,717
2006......................................... 138,662
2007......................................... 107,113
2008......................................... 71,556
Thereafter................................... 127,076
---------
$ 800,985
=========
Amounts presented above are as of December 31, 2003 for leases signed prior
to that date. In addition, amounts presented have been updated for new leases
entered into during the month of January 2004. The above future minimum lease
payments include amounts for leases that were signed prior to January 31, 2004
for stores that were not open as of January 31, 2004. The above amounts exclude
the future minimum lease payments associated with the lease of four distribution
centers from a variable interest entity. As discussed in Note 6, the variable
interest entity was consolidated in the financial statements effective January
1, 2003.
Minimum rental payments for operating leases do not include contingent
rentals that may be paid under certain store leases based on a percentage of
sales in excess of stipulated amounts. Future minimum lease payments have not
been reduced by expected future minimum sublease rentals of $302 under operating
leases.
Minimum and Contingent Rentals
Rental expense for store, distribution center and former corporate
headquarters operating leases (including payments to related parties) included
in the accompanying consolidated statements of operations are as follows:
Year Ended Month Ended Year Ended
January 31, February 1, December 31,
---------------
2004 2003 2002 2001
---- ---- ---- ----
Minimum rentals............... $ 172,720 $ 12,818 $ 142,674 $ 120,578
Contingent rentals............ 1,229 1 1,277 1,067
-------- --------- --------- ---------
Total....................... $ 173,949 $ 12,819 $ 143,951 $ 121,645
======== ========= ========= =========
Non-Operating Facilities
The Company is responsible for payments under leases for a former
distribution center and certain closed stores. The lease for the facility
expires in September 2005. The Company accounts for abandoned lease facilities
in accordance with SFAS No. 146, "Accounting for Costs Associated with Exit or
Disposal Activities." Facilities are considered abandoned on the date that the
Company ceases to use the facility. On this date, the Company records an expense
for the present value of the total remaining costs for the abandoned facility
reduced by any actual or probable sublease income. Due to the uncertainty
regarding the ultimate recovery of the future lease and related payments, the
Company recorded a $364 charge in 2002 and a $1,160 charge in 2001. There was no
charge recorded in 2003. The total accrual for these vacated facilities was
$1,310, $2,102 and $2,180 at January 31, 2004, February 1, 2003 and December 31,
2002, respectively.
Related Parties
The Company also leases properties for six of its stores from partnerships
owned by related parties. The total rental payments related to these leases were
$469, $31, $1,222 and $1,964, for the year ended January 31, 2004, the month
ended February 1, 2003 and the years ended December 31, 2002 and 2001,
respectively.
Management Advisory Services
During the year ended December 31, 2001, the Company paid $200 under a
financial and management advisory service agreement with one of its non-employee
shareholders. No payments were made under this agreement during the fiscal year
ended January 31, 2004, the month ended February 1, 2003 or the calendar year
ended December 31, 2002.
Purchase Contract
During 1996, the Company entered into a purchase agreement with a vendor,
which committed the Company to purchase a minimum of $39,462 in vendor products
by April 2003, of which $11,846 had been purchased through December 31, 2000. In
June 2001, the Company terminated the agreement and recognized a $1,600 gain
related to the unamortized portion of the payment received upon commencement of
the contract.
38
Freight Services
The Company has contracted outbound freight services from various contract
carriers with contracts expiring through January 2007. The total amount of these
commitments is approximately $29,700, of which approximately $3,700 is committed
in 2004, $7,200 is committed in 2005, and $18,800 is committed in 2006.
Technology Assets
The Company has commitments totaling approximately $24.1 million to
purchase store technology assets for its stores during 2004.
Letters of Credit
In March 2001, the Company entered into a Letter of Credit Reimbursement
and Security Agreement. The agreement provides $125,000 for letters of credit,
which are generally issued for the routine purchase of imported merchandise.
Approximately $67,011 was committed to letters of credit at January 31, 2004.
The Company also has approximately $26,700 in letters of credit that serve as
collateral for its high-deductible insurance programs and expire in fiscal 2004.
Surety Bonds
The Company has issued various surety bonds that primarily serve as
collateral for utility payments at the Company's stores. The total amount of the
commitment is approximately $1,128 of which $978 is committed through fiscal
2004 and $150 is committed through fiscal 2005.
Contingencies
The Company has contingent liabilities related to legal proceedings and
other matters arising from the normal course of operations. Management does not
expect that amounts, if any, which may be required to satisfy such contingencies
will be material in relation to the accompanying consolidated financial
statements.
NOTE 6 - CONSOLIDATION OF VARIABLE INTEREST ENTITY
In March 2001, the Company entered into an operating lease arrangement,
known as a synthetic lease, with a variable interest entity to finance the
construction of four distribution centers. At December 31, 2002, approximately
$154,500 of the $165,000 facility was committed to the Stockton, Savannah, Briar
Creek and Marietta facilities. Because the Company accounted for this
transaction as an operating lease, the related fixed assets and lease
liabilities were not included in the consolidated balance sheets.
In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46, Consolidation of Variable Interest Entities" (FIN 46).
Under the terms of this standard, certain variable interest entities, such as
the entity in which the Company's lease facility is held, are required to be
consolidated. The Company implemented this standard effective January 1, 2003
and, as a result, the distribution center assets and the debt incurred by the
variable interest entity to purchase and construct the assets are included in
balance sheets for periods after January 1, 2003. The cumulative effect of a
change in accounting principle represents, net of the tax effect, the historical
depreciation related to the distribution center assets and, the historical
amortization of the deferred financing costs recognized previously by the
variable interest entity and the write-off of a deferred rent liability related
to the lease.
At January 31, 2004 and February 1, 2003, amounts included in the balance
sheet related to the variable interest entity are as follows:
January 31, 2004 February 1, 2003
---------------- ----------------
Property and equipment, net ......................... $ 114,426 $ 128,296
Long-term debt, excluding current portion ........... 142,568 140,628
Other assets, net ................................... 639 945
Interest is payable monthly and the principal amount is payable upon
maturity of the debt in March 2006. The debt, among other things, requires the
maintenance of certain specified financial ratios, restricts the payment of
certain distributions and limits certain types of debt the Company can incur.
The Company refinanced the variable interest entity debt in March 2004 (see Note
14).
39
The following table reconciles reported net income and net income per share
to net income and net income per share that would have been recorded if FIN 46
were effective for each of the periods presented:
Year Ended December 31,
-----------------------
2002 2001
---- ----
(In thousands, except per share data)
Reconciliation of net income:
Net income............................................ $ 154,647 $ 123,081
Less: Depreciation, amortization
and deferred rent effect (net of tax).............. 4,121 1,164
------------ ----------
Adjusted net income................................... $ 150,526 $ 121,917
============ ==========
Basic net income per share:
Net income available to common shareholders........... $ 1.36 $ 1.10
Depreciation, amortization
and deferred rent effect (net of tax).............. (0.04) (0.01)
------------ ----------
Adjusted net income................................... $ 1.32 $ 1.09
============ ==========
Diluted net income per share:
Net income............................................ $ 1.35 $ 1.09
Depreciation, amortization
and deferred rent effect (net of tax).............. (0.04) (0.01)
------------ ----------
Adjusted net income................................... $ 1.31 $ 1.08
============ ==========
NOTE 7 - BALANCE SHEET COMPONENTS
Intangible Assets
Intangible assets, net, as of January 31, 2004, February 1, 2003 and
December 31, 2002 consists of the following:
January 31, February 1, December 31,
2004 2003 2002
----------- ----------- -------------
Non-competition agreements............................... $ 6,398 $ 4,413 $ 4,413
Accumulated amortization................................. (2,685) (1,971) (1,930)
---------- ---------- -----------
Non-competition agreements, net.......................... 3,713 2,442 2,483
---------- ---------- -----------
Favorable lease rights................................... 2,189 813 813
Accumulated amortization................................. (806) (262) (236)
---------- ---------- -----------
Favorable lease rights, net.............................. 1,383 551 577
---------- ---------- -----------
Goodwill................................................. 130,271 49,987 49,987
Accumulated amortization................................. (11,629) (11,629) (11,629)
---------- ---------- -----------
Goodwill, net............................................ 118,642 38,358 38,358
---------- ---------- -----------
Total intangibles, net................................... $ 123,738 $ 41,351 $ 41,418
========== ========== ===========
Non-Competition Agreements
The Company issued options to certain former shareholders of an acquired
entity in exchange for non-competition agreements and a consulting agreement.
These assets are being amortized over the legal term of the individual
agreements, which is generally over a ten-year period. In addition, in 2003, the
Company acquired non-competition agreements with former executives of
Greenbacks, which are being amortized over five years (see Note 2). These
intangible assets will continue to be amortized over their remaining legal term
in accordance with SFAS No. 142, which was adopted effective January 1, 2002.
Favorable Lease Rights
In 2002, the Company acquired favorable lease rights for operating leases
for retail locations from a third party. In addition, in 2003, the Company
acquired favorable lease rights in its acquisition of Greenbacks (see Note 2).
The Company's favorable lease rights are amortized on a straight-line basis to
rent expense over the remaining initial lease terms, which expire at various
dates through 2012.
Amortization expense related to the non-competition agreements and
favorable lease rights was $1,300 in the year ended January 31, 2004, $40 in the
month ended February 1, 2003, and $746 and $483 in the years ended December 31,
2002 and 2001, respectively. Estimated annual amortization expense for the next
five years follows: 2004 - $1,400; 2005 - $1,100; 2006 - $1,000; 2007 - $1,000;
and 2008 - $600.
40
Goodwill
In accordance with SFAS No. 142, goodwill is no longer being amortized, but
is tested at least annually for impairment. In addition, goodwill will be tested
on an interim basis if an event or circumstance indicates that it is more likely
than not that an impairment loss has been incurred. The Company performed its
annual impairment testing in November 2003 and determined that no impairment
loss existed.
The following table reconciles reported net income and net income per share
that would have been recorded if SFAS No. 142 were effective for the period
presented:
Year Ended December 31,
-----------------------
2001
----
Reconciliation of net income:
Net income.................................................... $ 123,081
Add back: Goodwill amortization
(net of tax)................................................. 1,241
----------
Adjusted net income........................................... $ 124,322
==========
Basic net income per share:
Net income.................................................... $ 1.10
Goodwill amortization......................................... 0.01
----------
Adjusted net income........................................... $ 1.11
==========
Diluted net income per share:
Net income.................................................... $ 1.09
Goodwill amortization......................................... 0.01
----------
Adjusted net income........................................... $ 1.10
==========
Accumulated amortization relating to goodwill was approximately $11,629 at
December 31, 2001.
Property and Equipment, Net
Property and equipment, net, as of January 31, 2004, February 1, 2003 and
December 31, 2002 consists of the following:
January 31, February 1, December 31,
2004 2003 2002
---- ---- ----
Land............................................... $ 16,807 $ 15,936 $ 8,059
Buildings.......................................... 105,558 88,627 31,281
Improvements....................................... 252,987 204,712 185,301
Furniture, fixtures and equipment.................. 441,259 358,744 319,811
Transportation vehicles............................ 3,492 3,504 3,504
Construction in progress........................... 107,703 45,720 19,936
-------- -------- --------
Total property and equipment................... 927,806 717,243 567,892
Less: accumulated depreciation and
amortization..................................... 314,592 239,296 223,570
-------- -------- --------
Total.......................................... $ 613,214 $ 477,947 $ 344,322
======== ======== ========
Other Current Liabilities
Other current liabilities as of January 31, 2004, February 1, 2003 and
December 31, 2002 consists of accrued expenses for the following:
January 31, February 1, December 31,
2004 2003 2002
---- ---- ----
Compensation and benefits................................. $ 25,435 $ 22,243 $ 24,573
Taxes (other than income taxes)........................... 10,450 12,808 24,364
Insurance................................................. 25,398 22,057 18,064
Other..................................................... 21,488 17,925 21,236
------ ------ ------
Total ............................................... $ 82,771 $ 75,033 $ 88,237
====== ====== ======
41
Capital Leases
The present value of future minimum capital lease payments as of January
31, 2004 is as follows:
2004..................................................... $ 6,811
2005..................................................... 8,035
2006..................................................... 5,302
2007..................................................... 104
2008..................................................... 37
Thereafter............................................... 30
---------
Total minimum lease payments................................. $ 20,319
Less amount representing interest
(at an average rate of approximately 9%)................... 2,736
---------
Present value of net minimum capital lease payments.......... 17,583
Less current installments of obligations under
capital leases............................................. 5,324
---------
Obligations under capital leases, excluding current
installments............................................... $ 12,259
=========
Included in property and equipment at January 31, 2004, February 1, 2003
and December 31, 2002 are leased furniture and fixtures and transportation
vehicles, excluding sale-leaseback assets, with a cost of $5,641, $5,424 and
$5,424, respectively. Accumulated depreciation on these assets totaled $3,370,
$2,346 and $2,295 at January 31, 2004, February 1, 2003 and December 31, 2002,
respectively.
Sale-Leaseback Transaction
On September 30, 1999, the Company sold certain retail store leasehold
improvements to an unrelated third party and leased them back for a period of
seven years. The Company has an option to purchase the leasehold improvements at
the end of the fifth and seventh years at amounts approximating their fair
market values at the time the option is exercised. This transaction is being
accounted for as a financing arrangement. The total amount of the lease
obligation is $16,265 at January 31, 2004. The lease agreement includes
financial covenants that are not more restrictive than those of existing loan
agreements. As part of the transaction, the Company received proceeds of
$20,880, net of financing costs, and an $8,120 11% note receivable, which
matures in September 2006 and is included in "other assets, net." The future
minimum lease payments related to the capital lease obligation are included in
the schedule above.
Fair Value of Financial Instruments
The carrying values of cash and cash equivalents, short-term investments,
prepaid expenses, other current assets, accounts payable and other current
liabilities approximate fair value because of the short maturity of these
instruments. The carrying values of other liabilities, excluding interest rate
swaps, approximate fair value because they are recorded using discounted future
cash flow or quoted market rates.
The carrying value of the Company's variable-rate and fixed-rate long-term
debt approximates its fair value. The fair value is estimated by discounting the
future cash flows of each instrument at rates offered for similar debt
instruments of comparable maturities.
It is not practicable to estimate the fair value of our outstanding
commitments for letters of credit, surety bonds and guarantees without
unreasonable cost.
The fair value of the interest rate swaps (see Note 9) are the estimated
amounts the Company would pay to terminate the agreements as of the reporting
date. The fair value of the liabilities associated with interest rate swaps are
as follows:
January 31, February 1, December 31,
2004 2003 2002
------------ ------------ -------------
$19,000 interest rate swap.................... $1,687 $1,892 $2,072
$10,000 interest rate swap.................... 183 659 700
$5,000 interest rate swap..................... 81 288 306
$25,000 interest rate swap.................... 1,767 2,241 2,396
The fair values of the interest rate swaps are included in "other liabilities"
in the accompanying consolidated balance sheets.
42
NOTE 8 - LONG-TERM DEBT
Long-term debt consists of the following:
January 31, February 1, December 31,
2004 2003 2002
---- ---- ----
7.29% unsecured Senior Notes, interest payable semiannually
on April 30 and October 30, principal payable $6,000 per year
beginning April 2000 and maturing April 2004.................. $ 6,000 $ 12,000 $ 12,000
Variable-rate debt, interest payable monthly at
LIBOR, principal payable upon maturity in
March 2006 (Note 6)........................................... 142,568 140,628 --
Demand Revenue Bonds, interest payable monthly at a
variable rate which was 1.12% at January 31,
2004, principal payable on demand, otherwise
beginning June 2006 and maturing June 2018.................... 19,000 19,000 19,000
--------- ---------- ---------
Total long-term debt....................................... 167,568 171,628 31,000
Less: current portion........................................... 25,000 25,000 25,000
--------- ---------- ---------
Long-term debt, excluding current portion..................... $ 142,568 $ 146,628 $ 6,000
========= ========== =========
Maturities of long-term debt are as follows: 2004 - $25,000 and 2006 - $142,568.
Senior Notes
The holders of the Senior Notes (the Notes) have the right to require the
Company to prepay the Notes in full without premium upon a change of control or
upon certain other transactions by the Company. The Notes rank pari passu with
the Company's other debt. The Note agreements, among other things, prohibit
certain mergers and consolidations and require the maintenance of certain
specified ratios. In the event of default or a prepayment at the option of the
Company, the Company is required to pay a prepayment penalty equal to a
make-whole amount.
Variable-Rate Debt
As indicated in Note 6, in March 2001, the Company entered into an
operating lease facility with a variable interest entity. Effective with the
implementation of FIN 46, the Company consolidated the variable interest entity.
As a result, the balance sheets at January 31, 2004 and February 1, 2003 include
the debt incurred by the variable interest entity to construct the Company's
distribution center assets. The debt, among other things, requires the
maintenance of certain specified financial ratios, restricts the payment of
certain distributions and limits certain types of debt. The debt is secured by
the related distribution center assets.
Demand Revenue Bonds
On May 20, 1998, the Company entered into a Loan Agreement with the
Mississippi Business Finance Corporation (MBFC) under which the MBFC issued
Taxable Variable Rate Demand Revenue Bonds (the Bonds) in an aggregate principal
amount of $19,000 to finance the acquisition, construction, and installation of
land, buildings, machinery and equipment for the Company's distribution facility
in Olive Branch, Mississippi. The Bonds do not contain a prepayment penalty as
long as the interest rate remains variable. The Bonds are secured by a $19,300
letter of credit issued by one of the Company's existing lending banks. The
letter of credit is renewable annually. The Letter of Credit and Reimbursement
Agreement requires, among other things, the maintenance of certain specified
ratios and restricts the payment of dividends. The Bonds contain a demand
provision and, therefore, are classified as current liabilities.
Revolving Credit Facility
In March 2001, the Company entered into a Revolving Credit Facility with
its banks (the Revolver). Terms of the Revolver include, among other things: (1)
a $50,000 revolving line of credit, bearing interest at LIBOR, plus a spread;
(2) an annual facilities fee, calculated as a percentage, as defined, of the
amount available under the line of credit; and (3) an annual administrative fee
payable quarterly.
Effective May 30, 2003, the Company terminated its $50,000 Revolving Credit
Facility concurrent with entering into a new $150,000 million Revolving Credit
Facility (the Revolver Agreement). The Revolver Agreement provides for, among
other things: (1) a $150.0 million revolving line of credit, bearing interest at
LIBOR, plus a spread; and (2) an annual facilities fee, calculated as a
percentage, as defined, of the amount available under the line of credit and an
annual administrative fee payable quarterly.
The Revolver Agreement, among other things, requires the maintenance of
certain specified financial ratios, restricts the payment of certain
distributions and prohibits the incurrence of certain new indebtedness. The
Revolver Agreement matures on May 29, 2004. As of January 31, 2004, there was no
outstanding balance under the Revolver Agreement. As discussed in Note 14, the
Revolver Agreement was refinanced in March 2004.
43
NOTE 9 - Derivative Financial Instruments
The fair value of interest rate swaps at January 31, 2004, February 1, 2003
and December 31, 2002 is approximately $3,718, $5,081 and $5,474, respectively,
and is recorded in "other liabilities" on the accompanying consolidated balance
sheets.
Non-Hedging Derivatives
The Company is party to three derivative instruments in the form of
interest rate swaps that do not qualify for hedge accounting treatment pursuant
to the provisions of SFAS No. 133. These interest rate swaps do not qualify for
hedge accounting because each instrument contains a knock-out provision. The
swaps create the economic equivalent of fixed rate obligations by converting the
variable interest rates to fixed rates. Under these interest rate swaps, the
Company pays interest to a financial institution at fixed rates, as defined in
each agreement. In exchange, the financial institution pays the Company at
variable interest rates, which approximate the floating rates on the
variable-rate obligations, excluding the credit spreads. The interest rates on
the swap are subject to adjustment monthly. No payments are made by either party
for months in which the variable interest rates, as calculated under the swap
agreements, are greater than the "knock-out rate." The following table
summarizes the terms of each interest rate swap:
Derivative Origination Expiration Pay Fixed Knock-out
Instrument Date Date Rate Rate
---------- ---- ---- ---- ----
$19,000 swap 4/1/99 4/1/09 4.88% 7.75%
$10,000 swap 9/8/00 6/2/04 6.45% 7.41%
$ 5,000 swap 12/20/00 6/2/04 5.83% 7.41%
The $19,000 swap reduces the Company's exposure to the variable interest rate
related to the Demand Revenue Bonds (see Note 8). The $10,000 and $5,000 swaps
reduce the Company's exposure to interest rate fluctuations on a portion of the
Company's variable interest entity debt (see Note 6).
Hedging Derivative
The Company is party to one derivative instrument in the form of an
interest rate swap that qualifies for hedge accounting treatment pursuant to the
provisions of SFAS No. 133.
On April 12, 2001, the Company entered into a $25,000 interest rate swap
agreement (swap) to manage the risk associated with interest rate fluctuations
on a portion of the Company's variable interest entity debt. The swap creates
the economic equivalent of fixed-rate debt by converting the variable-interest
rate to a fixed-rate. Under this agreement, the Company pays interest to a
financial institution at a fixed-rate of 5.43%. In exchange, the financial
institution pays the Company at a variable-interest rate, which approximates the
floating rate on the debt, excluding the credit spread. The interest rate on the
swap is subject to adjustment monthly consistent with the interest rate
adjustment on the debt. The swap is effective through March 2006.
NOTE 10 - SHAREHOLDERS' EQUITY
Preferred Stock
The Company is authorized to issue 10,000,000 shares of Preferred Stock,
$0.01 par value per share. No preferred shares are issued and outstanding at
January 31, 2004, February 1, 2003 and December 31, 2002.
44
Net Income (Loss) Per Share
The following table sets forth the calculation of basic and diluted net
income (loss) per share:
Year Ended Month Ended Year Ended
January 31, February 1, December 31,
----------------
2004 2003 2002 2001
---- ---- ---- ----
Basic income (loss) before accounting change per share:
Income (loss) before accounting change............... $ 177,583 $ (5,240) $ 154,647 $ 123,081
Cumulative effect of a change in accounting
principle, net of tax benefit of $3,309........... -- (5,285) -- --
-------- -------- -------- -------
Net income (loss).................................... $ 177,583 $ (10,525) $ 154,647 $ 123,081
======== ======== ======== =======
Weighted average number of shares
outstanding........................................ 114,641 114,224 113,637 112,238
======== ======== ======== =======
Basic income (loss) before accounting
change per share................................... $ 1.55 $ (0.05) $ 1.36 $ 1.10
Cumulative effect of a change in
accounting principle per share..................... -- (0.04) -- --
-------- -------- -------- -------
Net income (loss) per share.......................... $ 1.55 $ (0.09) $ 1.36 $ 1.10
======== ======== ======== =======
Year Ended Month Ended Year Ended
January 31, February 1, December 31,
------------------
2004 2003 2002 2001
---- ---- ---- ----
Diluted income (loss) before accounting change per share:
Income (loss) before accounting change................. $ 177,583 $ (5,240) $ 154,647 $ 123,081
Cumulative effect of a change in accounting
principle, net of tax benefit of $3,309............. -- (5,285) -- --
--------- -------- --------- ---------
Net income (loss)...................................... $ 177,583 $ (10,525) $ 154,647 $ 123,081
========= ======== ========= =========
Weighted average number of shares
outstanding.......................................... 114,641 114,224 113,637 112,238
Dilutive effect of stock options and restricted
stock (as determined by applying the treasury
stock method)........................................ 940 437 910 752
--------- -------- --------- ---------
Weighted average number of shares and
dilutive potential shares outstanding................. 115,581 114,661 114,547 112,990
========= ======== ========= =========
Diluted income (loss) before accounting
change per share.................................... $ 1.54 $ (0.05) $ 1.35 $ 1.09
Cumulative effect of a change in accounting
principle per share................................. -- (0.04) -- --
--------- -------- --------- ---------
Diluted income (loss) per share........................ $ 1.54 $ (0.09) $ 1.35 $ 1.09
========= ======== ========= =========
At January 31, 2004, February 1, 2003, December 31, 2002 and December 31,
2001, respectively, 203,015, 2,171,350, 1,704,153 and 731,304 stock options are
not included in the calculation of the weighted average number of shares and
dilutive potential shares outstanding because their effect would be
anti-dilutive.
45
Comprehensive Income (Loss)
The Company's comprehensive income (loss) reflects the effect of recording
derivative financial instruments pursuant to SFAS No. 133. The following table
provides a reconciliation of net income (loss) to total comprehensive income
(loss):
Year Ended Month Ended Year Ended
January 31, February 1, December 31,
-----------------
2004 2003 2002 2001
---- ---- ---- ----
Net income (loss)...................................... $ 177,583 $ (10,525) $ 154,647 $ 123,081
-------- --------- --------- ---------
Cumulative effect of change in accounting
for derivative financial instruments (net of
$44 tax expense)..................................... -- -- -- 70
Fair value adjustment - derivative cash flow
hedging instruments ................................. 475 155 (1,652) (744)
Income tax benefit (expense)........................... (183) (60) 642 287
--------- --------- --------- ---------
Fair value adjustment, net of tax...................... 292 95 (1,010) (387)
--------- --------- --------- ---------
Amortization of SFAS No. 133 cumulative
effect ............................................. 24 2 24 15
Income tax expense..................................... (9) (1) (9) (6)
--------- --------- --------- ---------
Amortization of SFAS No. 133 cumulative
effect, net of tax................................... 15 1 15 9
--------- --------- --------- ---------
Total comprehensive income (loss)...................... $ 177,890 $ (10,429) $ 153,652 $ 122,703
========= ========= ========= =========
The cumulative effect recorded in "accumulated other comprehensive loss" is
being amortized over the remaining lives of the related interest rate swaps.
Restricted Stock
In 2002, the Company adopted a restricted stock plan, under which a maximum
of 4,500 shares of common stock may be awarded to certain employees with no cash
payments required by the recipient. Under this plan, the Company awarded 4,500
shares of common stock to an employee during 2002, which vest ratably over a
three-year period. The $150 market value of the shares awarded was recorded as
unearned compensation and is shown as a separate component of shareholders'
equity. The unearned compensation is being amortized to compensation expense
over the three-year vesting period. Total amortization for the fiscal year ended
2003, the one-month period ended February 1, 2003 and the year ended 2002 was
approximately $50, $4 and $33, respectively.
In 2002, the Company issued 4,000 shares of restricted stock to
non-employees in recognition of past services provided to the Company. The
shares vested immediately upon issuance. The market value of the shares awarded
was approximately $125 and was recorded as a component of operating expenses
during 2002.
Share Repurchase Programs
In 2001, the Company's Board of Directors authorized the repurchase of up
to $100,000 of the Company's common stock in connection with the Securities and
Exchange Commission's (SEC) Emergency Relief Order issued immediately following
the terrorist attacks on September 11, 2001. Pursuant to this program, the
Company repurchased and retired 225,000 shares of common stock for approximately
$3,800. The Company's limited share repurchase plan expired concurrently with
the expiration of the SEC's Exemptive Order on October 12, 2001. Shares retired
under this authorization totaled 225,000.
In November 2002, the Company's Board of Directors authorized the
repurchase of up to $200,000 of the Company's common stock. Stock repurchases
may be made until November 2005 and may be made either in the open market or
through privately negotiated transactions. As of January 31, 2004, 1,265,400
shares were repurchased for approximately $38,100, under this plan.
NOTE 11 - EMPLOYEE BENEFIT PLANS
Profit Sharing and 401(k) Retirement Plan
The Company maintains a defined contribution profit sharing and 401(k) plan
which is available to all employees over 21 years of age who have completed one
year of service in which they have worked at least 1,000 hours. Eligible
employees may make elective salary deferrals. The Company may make contributions
at its discretion.
46
Contributions to and reimbursements by the Company of expenses of the plans
included in the accompanying consolidated statements of operations were as
follows:
Year Ended January 31, 2004....................... $9,760
Month Ended February 1, 2003...................... 755
Year Ended December 31, 2002...................... 9,728
Year Ended December 31, 2001...................... 8,914
Deferred Compensation Plan
The Company adopted a deferred compensation plan in 2000 providing certain
highly compensated employees and executives the ability to defer a portion of
their base compensation and bonuses and earn interest on their deferred amounts.
The plan is an unfunded nonqualified plan; however, the Company may make
discretionary contributions. The deferred amounts and earnings thereon are
payable to participants, or designated beneficiaries, at specified future dates,
upon retirement or death. Total cumulative participant deferrals were
approximately $1,718, $871 and $848, respectively, at January 31, 2004, February
1, 2003 and December 31, 2002 and are included in "other liabilities" on the
accompanying consolidated balance sheets. The related assets are included in
"other assets, net" on the accompanying consolidated balance sheets. The Company
made no discretionary contributions in the year ended January 31, 2004, the
month ended February 1, 2003 or in the years ended December 31, 2002 and 2001.
NOTE 12 - STOCK-BASED COMPENSATION PLANS
At January 31, 2004, the Company has seven stock-based compensation plans.
Each plan and the accounting method are described below.
Fixed Stock Option Plans
The Company has four fixed stock option plans. Under the Non-Qualified
Stock Option Plan (SOP), the Company granted options to its employees for
1,047,264 shares of Common Stock in 1993 and 1,048,289 shares in 1994. Options
granted under the SOP have an exercise price of $0.86 and are fully vested at
the date of grant.
Under the 1995 Stock Incentive Plan (SIP), the Company may grant options to
its employees for up to 12,600,000 shares of Common Stock. The exercise price of
each option equals the market price of the Company's stock at the date of grant,
unless a higher price is established by the Board of Directors, and an option's
maximum term is ten years. Options granted under the SIP generally vested over a
three-year period. In exchange for their options to purchase Dollar Express
Common Stock, certain employees of Dollar Express were granted 228,072 options
to purchase the Company's common stock based on an exchange ratio of 0.8772.
Options issued in connection with the merger were fully vested as of the date of
the merger. This plan was terminated on July 1, 2003 and replaced with the
Company's 2003 Equity Incentive Plan, discussed below.
The Step Ahead Investments, Inc. Long-Term Incentive Plan (SAI Plan)
provided for the issuance of stock options, stock appreciation rights, phantom
stock and restricted stock awards to officers and key employees. Effective with
the merger with 98 Cent Clearance Center and in accordance with the terms of the
SAI Plan, outstanding 98 Cent Clearance Center options were assumed by the
Company and converted, based on 1.6818 Company options for each 98 Cent
Clearance Center option, to options to purchase the Company's common stock.
Options issued as a result of this conversion were fully vested as of the date
of the merger.
Under the 1998 Special Stock Option Plan (Special Plan), options to
purchase 247,500 shares were granted to five former officers of 98 Cent
Clearance Center who were serving as employees or consultants of the Company
following the merger. The options were granted as consideration for entering
into non-competition agreements and a consulting agreement. The exercise price
of each option equals the market price of the Company's stock at the date of
grant, and the options' maximum term is ten years. Options granted under the
Special Plan vest over a five-year period.
The 2003 Equity Incentive Plan (EIP) replaces the Company's SIP plan
discussed above. Under the EIP, the Company may grant up to 6,000,000 shares of
its Common Stock, plus any shares available for future awards under the SIP, to
the Company's employees including, executive officers and independent
contractors. The EIP plan permits the Company to grant equity awards in the form
of stock options, stock appreciation rights and restricted stock. The exercise
price of each stock option granted equals the market price of the Company's
stock at the date of grant. The options generally vest over a three-year period
and have a maximum term of ten years.
Stock appreciation rights may be awarded alone or in tandem with stock
options. When the stock appreciation rights are exercisable, the holder may
surrender all or a portion of the unexercised stock appreciation right and
receive in exchange an amount equal to the excess of the fair market value at
the date of exercise over the fair market value at the date of the grant.
Any restricted stock awarded is subject to certain general restrictions.
The restricted stock shares may not be sold, transferred, pledged or disposed of
until the restrictions on the shares have lapsed or been removed under the
provisions of the plan. In addition, if a holder of the restricted shares ceases
to be employed by the Company, any shares in which the restrictions have
47
not lapsed will be forfeited.
The 2003 Non-Employee Director Stock Option Plan provides non-qualified
stock options to non-employee members of the Company's Board of Directors. The
stock options are functionally equivalent to such options issued under the EIP
discussed above. The exercise price of each stock option granted equals the
market price of the Company's stock at the date of grant. The options generally
vest immediately.
The 2003 Director Deferred Compensation Plan permits any of the Company's
directors who receive a retainer or other fees for Board or committee service to
defer all or a portion of such fees until a future date, at which time they may
be paid in cash or shares of the Company's common stock, or to receive all or a
portion of such fees in non-statutory stock options. Deferred fees that are paid
out in cash will earn interest at the 30-year Treasury Bond Rate. If a director
elects to be paid in common stock, the number of shares will be determined by
dividing the deferred fee amount by the current market price of a share of the
Company's common stock. The number of options issued to a director will equal
the deferred fee amount divided by 33% of the price of a share of the Company's
common stock. The exercise price will equal the fair market value of the
Company's common stock at the date the option was issued. The options are fully
vested when issued and have a term of ten years.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions:
Fiscal
2003 2002 2001
---- ---- ----
Expected term in years................. 5.4 5.7 6.0
Expected volatility.................... 60.7% 63.8% 63.0%
Annual dividend yield.................. -- -- --
Risk-free interest rate................ 3.4% 3.0% 4.9%
The following tables summarize the Company's various option plans as of
January 31, 2004, February 1, 2003, December 31, 2002 and December 31, 2001, and
for the year ended January 31, 2004, the month ended February 1, 2003, and the
years ended December 31, 2002 and 2001 and information about fixed options
outstanding at January 31, 2004:
Stock Option Activity
--------------------------------------------------------------------------------------------
January 31, 2004 February 1, 2003 2002 2001
--------------------- --------------------- --------------------- ------------------
Weighted Weighted Weighted Weighted
Average Average Average Average
Per Share Per Share Per Share Per Share
Exercise Exercise Exercise Exercise
Shares Price Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ ----- ------ -----
Outstanding at
beginning of period...... 5,414,023 $ 24.19 5,440,547 $ 24.17 5,683,827 $ 20.39 5,091,120 $ 21.02
Granted..................... 1,904,057 20.54 6,000 25.26 1,723,000 31.54 1,527,250 17.67
Exercised................... (993,841) 19.57 (12,402) 12.93 (1,632,942) 18.64 (593,597) 17.33
Forfeited .................. (316,768) 24.01 (20,122) 25.89 (333,338) 25.02 (340,946) 22.66
--------- --------- --------- ---------
Outstanding at
end of period............ 6,007,471 $ 23.81 5,414,023 $ 24.19 5,440,547 $ 24.17 5,683,827 $ 20.39
========= ========= ========= =========
Options exercisable
at end of period......... 2,649,188 $ 24.31 2,340,921 $ 21.84 2,343,879 $ 21.77 2,713,081 $ 20.04
========= ========= ========= =========
Weighted average fair
value of options
granted during the
period................... $ 17.08 $ 15.24 $ 18.66 $ 11.00
48
Stock Options Outstanding and Exercisable
--------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
--------------------------------------------------- ----------------------------------
Weighted
Number Average Weighted Number Weighted
Range of Outstanding Remaining Average Exercisable Average
Exercise at January 31, Contractual Exercise at January 31, Exercise
Prices 2004 Life Price 2004 Price
- ------ ---- ---- ----- ---- -----
$0.86...................... 24,923 (1) $ 0.86 24,923 $ 0.86
$2.95 to $8.51............. 8,616 1.1 years 2.96 8,616 2.96
$8.52 to $21.28............ 2,737,681 8.0 years 18.88 603,256 17.03
$21.29 to $29.79........... 1,620,075 5.6 years 24.07 1,412,987 24.07
$29.80 to $42.56........... 1,616,176 7.9 years 32.36 599,406 33.47
--------- ---------
$0.86 to $42.56............ 6,007,471 2,649,188
========= =========
(1) Represent options granted under the SOP in 1993 and 1994. These options have
no expiration date.
On December 11, 2003, the Compensation Committee of the Company's Board of
Directors committed to grant to the Company's Chief Executive Officer, a
performance share award under the EIP for 30,000 shares based on the Company
achieving certain sales and profitability targets in fiscal 2004. If the
targets are achieved, 10,000 of the shares vest when they are granted at the
end of fiscal 2004 with the remaining shares vesting half at the end of fiscal
2005 and half at the end of fiscal 2006.
Employee Stock Purchase Plan
Under the Dollar Tree Stores, Inc. Employee Stock Purchase Plan (ESPP), the
Company is authorized to issue up to 759,375 shares of common stock to eligible
employees. Under the terms of the ESPP, employees can choose to have up to 10%
of their annual base earnings withheld to purchase the Company's common stock.
The purchase price of the stock is 85% of the lower of the price at the
beginning or the end of the quarterly offering period. Under the ESPP, the
Company has sold 506,403 shares as of January 31, 2004.
The fair value of the employees' purchase rights is estimated on the date
of grant using the Black-Scholes option-pricing model with the following
weighted average assumptions:
Expected term ............................ 3 months
Expected volatility....................... 14% to 72%
Annual dividend yield..................... --
Risk-free interest rate................... 1.04% to 6.20% (annualized)
The weighted average per share fair value of those purchase rights granted
in 2003, 2002 and 2001 was $4.83, $5.02 and $3.98, respectively.
NOTE 13 - QUARTERLY FINANCIAL INFORMATION AND MONTHS ENDED FEBRUARY 1, 2003 AND
JANUARY 31, 2002 FINANCIAL INFORMATION (Unaudited)
The following table sets forth certain items from the Company's unaudited
statements of operations for each quarter of fiscal year 2003 and 2002 and for
the months ended February 1, 2003 and January 31, 2002. The unaudited
information has been prepared on the same basis as the audited consolidated
financial statements appearing elsewhere in this report and includes all
adjustments, consisting only of normal recurring adjustments, which management
considers necessary for a fair presentation of the financial data shown. The
operating results for any quarter or month are not necessarily indicative of
results for a full year or for any future period.
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(In thousands, except store and per share data)
Fiscal 2003:
Net sales.......................................... $ 615,568 $ 626,028 $ 665,211 $ 893,065
Gross profit....................................... 217,788 221,107 243,599 330,326
Operating income................................... 54,491 47,600 60,365 131,141
Net income......................................... 32,795 28,799 36,161 79,828
Diluted net income per share....................... 0.29 0.25 0.31 0.69
Stores open at end of quarter...................... 2,319 2,468 2,511 2,513
Comparable store net sales increase (1)............ 2.2% 5.1% 1.7% 1.6%
49
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(In thousands, except store and per share data)
Fiscal 2002 (February 1, 2002-February 1, 2003):
Net sales.......................................... $509,668 $ 512,444 $ 556,864 $ 778,860
Gross profit....................................... 184,509 183,123 205,183 281,409
Operating income................................... 45,716 41,240 51,277 109,155
Income before cumulative effect of a change
in accounting principle.......................... -- -- -- 66,903
Cumulative effect of a change in
accounting principle............................. -- -- -- (5,285)
Net income......................................... 28,082 24,626 30,894 61,618
Diluted net income per share before
cumulative effect of a change in
accounting principle............................. -- -- -- 0.58
Cumulative effect of a change in
accounting principle............................. -- -- -- (0.04)
Diluted net income per share....................... 0.25 0.21 0.27 0.54
Stores open at end of quarter...................... 2,048 2,114 2,211 2,272
Comparable store net sales increase (1)............ 0.89% 3.08% 0.43% (1.7%)
(1) Easter was observed on April 20, 2003, March 31, 2002, and April 15, 2001.
Month Ended Month Ended
February 1, 2003 January 31, 2002
---------------- ----------------
Net sales.......................................... $ 160,789 $ 132,140
Gross profit....................................... 46,809 40,541
Operating loss..................................... (8,428) (1,895)
Loss before cumulative effect of a change
in accounting principle.......................... (5,239) --
Cumulative effect of a change in
accounting principle............................. (5,285) --
Net loss........................................... (10,525) (1,097)
Diluted net loss per share before
cumulative effect of a change in
accounting principle............................. (0.05) --
Cumulative effect of a change in
accounting principle............................. (0.04) --
Diluted net loss per share......................... (0.09) (0.01)
Stores open at end of period....................... 2,272 1,994
NOTE 14 - SUBSEQUENT EVENT (Unaudited)
In March 2004, the Company entered into a five-year Revolving Credit
Facility (the Facility). The Facility provides for, among other things: (1) a
$450,000 revolving line of credit, including up to $50,000 in available letters
of credit, bearing interest at LIBOR, plus 0.475%; and (2) an annual facilities
fee, calculated as a percentage, as defined, of the amount available under the
line of credit and an annual administrative fee payable quarterly. The Facility,
among other things, requires the maintenance of certain specified financial
ratios, restricts the payment of certain distributions and prohibits the
incurrence of certain new indebtedness. The Company used availability under the
Facility to repay the $142,568 of variable-rate debt (see Note 8). The Company's
existing $150,000 revolving credit facility (Old Facility) (see Note 8) was
terminated concurrent with entering into the Facility. The net debt issuance
costs related to the Old Facility and the variable-rate debt, included in "other
assets, net" on the January 31, 2004 accompanying consolidated balance sheet
totaling $727, will be charged to interest expense in the first quarter of
fiscal 2004. As a result of the repayment of the variable-rate debt, the assets
of the variable-interest entity were transferred to the Company and the $25,000,
$10,000 and $5,000 interest rate swaps previously designated to the
variable-rate date were redesignated to new borrowings under the Facility. This
redesignation does not affect the accounting methods used for the individual
interest rate swaps.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
Item 9A. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures
During the third and fourth quarters of 2002, we appointed a disclosure
committee, which evaluated and documented our disclosure controls, formalized
certain disclosure control procedures, and reported to our chief executive
officer and chief financial officer. Within
50
90 days prior to the date of this report, we carried out an evaluation, under
the supervision and with the participation of our management, including our
chief executive officer and our chief financial officer, of the effectiveness
of the design and operation of our disclosure controls and procedures pursuant
to Rule 13a-14 of the Securities and Exchange Act of 1934 (the "Exchange Act").
Based upon that evaluation, our chief executive officer and our chief financial
officer concluded that as of the date of our evaluation, the Company's
disclosure controls and procedures (as defined in Rule 13a-14(c) under the
Exchange Act) are effective to ensure that information required to be disclosed
by us in reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in
Securities and Exchange Commission rules and forms.
(b) Changes in internal controls
There were no significant changes in our internal controls or in other
factors that could significantly affect these controls subsequent to the date of
our most recent evaluation. In accordance with Section 404 of the Sarbanes-Oxley
Act of 2002, the Company is evaluating its internal controls and is in the
process of making changes to improve the effectiveness of its internal
control structure.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information concerning our Directors and Executive Officers required by
this Item is incorporated by reference to Dollar Tree Stores, Inc.'s Proxy
Statement relating to our Annual Meeting of Shareholders to be held on June 17,
2004, under the caption "Election of Directors."
Information set forth in the Proxy Statement under the caption "Compliance
with Section 16(a) of the Securities and Exchange Act of 1934," with respect to
director and executive officer compliance with Section 16(a), is incorporated
herein by reference.
The information concerning our code of ethics required by this Item is
incorporated by reference to Dollar Tree Stores, Inc.'s Proxy Statement relating
to our Annual Meeting of Shareholders to be held on June 17, 2004, under the
caption "Code of Business Conduct (Code of Ethics)."
Item 11. EXECUTIVE COMPENSATION
Information set forth in the Proxy Statement under the caption
"Compensation of Executive Officers," with respect to executive compensation, is
incorporated herein by reference.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Information set forth in the Proxy Statement under the caption "Ownership
of Common Stock," with respect to security ownership of certain beneficial
owners and management, is incorporated herein by reference.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information set forth in the Proxy Statement under the caption "Certain
Relationships and Related Transactions," is incorporated herein by reference.
Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information set forth in the Proxy Statement under the caption "Principal
Accounting Fees and Services," is incorporated herein by reference.
PART IV
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
1. Financial Statements. Reference is made to the Index to the
Consolidated Financial Statements set forth under Part II, Item 8, on
Page 23 of this Form 10-K.
2. Financial Statement Schedules. All schedules for which provision is
made in the applicable accounting regulations of the Securities and
Exchange Commission are not required under the related instructions,
are not applicable, or the information is included in the Consolidated
Financial Statements, and therefore have been omitted.
51
3. Exhibits. The exhibits listed on the accompanying Index to Exhibits, on
page 51 of this Form 10-K, are filed as part of, or incorporated by
reference into, this report.
(b) The following reports on Form 8-K were filed since November 1, 2003:
1. Report on Form 8-K, filed April 6, 2004, included a business update for
the first quarter of fiscal 2004.
2. Report on Form 8-K, filed March 31, 2004, included a press release
regarding the transition of Dollar Tree Stores, Inc.'s Chief Financial
Officer to a new expanded Corporate Secretary position and its
nationwide search for a new Chief Financial Officer.
3. Report on Form 8-K, filed March 19, 2004, regarding the participation
of Dollar Tree Stores, Inc. in the Merrill Lynch Retailing Leaders
Conference, the closing of a revolving debt facility and the opening of
the Ridgefield, Washington distribution center.
4. Report on Form 8-K, filed February 27, 2004, included the summarized
information discussed in Dollar Tree Stores, Inc.'s publicly available
telephone conference call on February 24, 2004, regarding its fiscal
fourth quarter and full year 2003 earnings results.
5. Report on Form 8-K, filed February 24, 2004, included a press release
regarding earnings for the fiscal fourth quarter ended January 31, 2004
and the year then ended.
6. Report on Form 8-K, filed February 5, 2004, included a press release
regarding the fiscal fourth quarter 2003 sales results.
7. Report on Form 8-K, filed January 5, 2004, included a business update
for the fourth quarter of fiscal 2003.
8. Report on Form 8-K, filed on December 16, 2003, regarding the
appointment of a new member to the Company's Board of Directors.
9. Report on Form 8-K, filed on November 28, 2003, included the summarized
information discussed in Dollar Tree Stores, Inc.'s publicly available
telephone conference call on November 25, 2003 regarding its fiscal
third quarter 2003 earnings results.
52
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
DOLLAR TREE STORES, INC.
DATE: April 13, 2004 By: /s/ Bob Sasser
-----------------------------
Bob Sasser
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Macon F. Brock, Jr.
- ---------------------------
Macon F. Brock, Jr. Chairman; Director April 13, 2004
/s/ Bob Sasser
- ---------------------------
Bob Sasser Chief Executive Officer April 13, 2004
(principal executive officer)
/s/ John F. Megrue
- ---------------------------
John F. Megrue Director April 13, 2004
/s/ J. Douglas Perry
- ---------------------------
J. Douglas Perry Chairman Emeritus; Director April 13, 2004
/s/ H. Ray Compton
- ---------------------------
H. Ray Compton Director April 13, 2004
/s/ Frederick C. Coble
- ---------------------------
Frederick C. Coble Chief Financial Officer April 13, 2004
(principal financial and
accounting officer)
/s/ Richard G. Lesser
- ---------------------------
Richard G. Lesser Director April 13, 2004
/s/ Thomas A. Saunders, III
- ---------------------------
Thomas A. Saunders, III Director April 13, 2004
/s/ Eileen R. Scott
- ---------------------------
Eileen R. Scott Director April 13, 2004
/s/ Thomas E. Whiddon
- ---------------------------
Thomas E. Whiddon Director April 13, 2004
/s/ Alan L. Wurtzel
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Alan L. Wurtzel Director April 13, 2004
53
Index to Exhibits
3. Articles and Bylaws
3.1 Third Restated Articles of Incorporation of Dollar Tree Stores,
Inc.(the Company), as amended (Exhibit 3.1 to the Company's
Quarterly Report on Form 10-Q for the fiscal quarter ended
September 30, 1996 incorporated herein by this reference)
3.2 Second Restated Bylaws of the Company (Exhibit 3.2 to the
Company's Registration Statement on Form S-1, No. 33-88502,
incorporated herein by this reference)
10. Material Contracts
10.1 Credit Agreement among Dollar Tree Distribution, Inc., as
Borrower, Certain of the Domestic Affiliates of the Borrower from
Time to Time Parties Hereto, as Guarantors; the Lender Parties
Hereto, Fleet National Bank, as Syndication Agent, SunTrust Bank,
as Documentation Agent, and Wachovia Bank, National Association,
as Administrative Agent, dated as of May 30, 2003 (Exhibit 10.1 to
the Company's Quarterly Report on Form 10-Q for the fiscal quarter
ended May 3, 2003, incorporated herein by this reference)
21. Subsidiaries of the Registrant
21.1 Subsidiaries
23. Consents of Experts and Counsel
23.1 Independent Auditors' Consent
31. Certifications required under Section 302 of the Sarbanes-Oxley Act
31.1 Certification required under Section 302 of the Sarbanes-Oxley Act
of Chief Executive Officer
31.2 Certification required under Section 302 of the Sarbanes-Oxley Act
of Chief Financial Officer
32. Statements under Section 906 of the Sarbanes-Oxley Act
32.1 Statement under Section 906 of the Sarbanes-Oxley Act of Chief
Executive Officer
32.2 Statement under Section 906 of the Sarbanes-Oxley Act of Chief
Financial Officer
54