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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 1-11735
99 CENTS ONLY STORES
(Exact name of registrant as specified in its charter)
CALIFORNIA
(State or other Jurisdiction 95-2411605
of Incorporation or Organization) (I.R.S. Employer Identification No.)
4000 UNION PACIFIC AVENUE,
CITY OF COMMERCE, CALIFORNIA 90023
(Address of Principal Executive Offices) (zip code)
Registrant's telephone number, including area code: (323) 980-8145
NONE
Former name, address and fiscal year, if change since last report
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the last 90 days. Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes
of common stock as of the latest practicable date.
Common Stock, No Par Value, 72,087,620 Shares as of September 30, 2003
================================================================================
1
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
99 CENTS ONLY STORES
BALANCE SHEETS
(Amounts In Thousands, Except Share Data)
(UNAUDITED)
ASSETS
SEPTEMBER 30, DECEMBER 31,
2003 2002
--------------- --------------
CURRENT ASSETS:
Cash and cash equivalents. . . . . . . . . . . . . . . . . . $ 2,054 $ 7,985
Short-term investments . . . . . . . . . . . . . . . . . . . 127,276 146,857
Accounts receivable, net of allowance for doubtful accounts
of $142 and $149 as of September 30, 2003 and December 31,
2002, respectively . . . . . . . . . . . . . . . . . . . . 2,569 2,753
Due from shareholder . . . . . . . . . . . . . . . . . . . . 2,179 1,232
Income taxes receivable. . . . . . . . . . . . . . . . . . . 11,744 -
Inventories. . . . . . . . . . . . . . . . . . . . . . . . . 106,248 83,176
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,905 2,869
--------------- --------------
Total current assets . . . . . . . . . . . . . . . . . . . 255,975 244,872
PROPERTY AND EQUIPMENT, at cost:
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33,536 26,779
Building and improvements. . . . . . . . . . . . . . . . . . 51,456 29,216
Leasehold improvements . . . . . . . . . . . . . . . . . . . 90,809 70,887
Fixtures and equipment . . . . . . . . . . . . . . . . . . . 52,530 42,018
Transportation equipment . . . . . . . . . . . . . . . . . . 3,339 3,045
Construction in progress . . . . . . . . . . . . . . . . . . 20,603 14,105
--------------- --------------
252,273 186,050
Less accumulated depreciation and amortization . . . . . . . (75,147) (58,490)
--------------- --------------
177,126 127,560
OTHER ASSETS:
Deferred income taxes. . . . . . . . . . . . . . . . . . . . 19,078 19,078
Long-term investments in marketable securities . . . . . . . 50,341 37,223
Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . 534 446
Long-term investments in partnerships. . . . . . . . . . . . 4,416 4,565
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,100 6,166
--------------- --------------
82,469 67,478
--------------- --------------
$ 515,570 $ 439,910
=============== ==============
The accompanying notes are an integral part of these consolidated financial
statements.
2
99 CENTS ONLY STORES
BALANCE SHEETS
(Amounts In Thousands, Except Share Data)
(UNAUDITED)
LIABILITIES AND SHAREHOLDERS' EQUITY
SEPTEMBER 30, DECEMBER 31,
2003 2002
-------------- -------------
CURRENT LIABILITIES:
Accounts payable . . . . . . . . . . . . . . . . . . . . . $ 16,811 $ 16,946
Accrued expenses:
Payroll and payroll-related. . . . . . . . . . . . . . . 3,429 3,652
Sales tax. . . . . . . . . . . . . . . . . . . . . . . . 3,341 4,329
Other. . . . . . . . . . . . . . . . . . . . . . . . . . 4,654 2,216
Workers' compensation. . . . . . . . . . . . . . . . . . . 8,412 7,725
Income taxes payable . . . . . . . . . . . . . . . . . . . - 3,518
-------------- -------------
Total current liabilities. . . . . . . . . . . . . . . . 36,647 38,386
-------------- -------------
LONG-TERM LIABILITIES:
Deferred compensation. . . . . . . . . . . . . . . . . . . 1,780 1,102
Deferred rent. . . . . . . . . . . . . . . . . . . . . . . 2,400 2,210
Capitalized lease obligation . . . . . . . . . . . . . . . 1,564 1,597
-------------- -------------
Total long-term liabilities. . . . . . . . . . . . . . . 5,744 4,909
-------------- -------------
COMMITMENTS AND CONTINGENCIES. . . . . . . . . . . . . . . . - -
SHAREHOLDERS' EQUITY:
Preferred stock, no par value
Authorized-1,000,000 shares
Issued and outstanding-none. . . . . . . . . . . . . . . - -
Common stock, no par value
Authorized-200,000,000 shares
Issued and outstanding 71,313,336 at September 30, 2003
and 70,369,178 at December 31, 2002. . . . . . . . . . 209,168 174,152
Retained earnings. . . . . . . . . . . . . . . . . . . . . 264,011 222,463
-------------- -------------
473,179 396,615
-------------- -------------
$ 515,570 $ 439,910
============== =============
The accompanying notes are an integral part of these consolidated financial
statements.
3
99 CENTS ONLY STORES
STATEMENTS OF INCOME
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND SEPTEMBER 30, 2002
(Amounts In Thousands, Except Per Share Data)
(Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
--------- --------- --------- ---------
NET SALES:
99 Cents Only Stores. . . . . . . . . . . . $200,567 $160,424 $580,331 $465,507
Bargain Wholesale . . . . . . . . . . . . . 10,969 11,839 34,660 37,722
--------- --------- --------- ---------
211,536 172,263 614,991 503,229
COST OF SALES . . . . . . . . . . . . . . . . 128,659 103,509 369,913 302,668
--------- --------- --------- ---------
Gross profit. . . . . . . . . . . . . . . . 82,877 68,754 245,078 200,561
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:
Selling, general and administrative expenses 58,437 43,577 164,038 126,840
Depreciation and amortization . . . . . . . 6,317 4,570 16,934 12,769
--------- --------- --------- ---------
64,754 48,147 180,972 139,609
--------- --------- --------- ---------
Operating income. . . . . . . . . . . . . . 18,123 20,607 64,106 60,952
OTHER (INCOME) EXPENSE:
Interest income . . . . . . . . . . . . . . (1,280) (775) (2,649) (2,398)
Interest expense. . . . . . . . . . . . . . 31 - 94 48
Other . . . . . . . . . . . . . . . . . . . (360) (360) (1,080) (1,080)
--------- --------- --------- ---------
(1,609) (1,135) (3,635) (3,430)
--------- --------- --------- ---------
Income before provision for income taxes. . 19,732 21,742 67,741 64,382
PROVISION FOR INCOME TAXES. . . . . . . . . . 7,630 8,487 26,195 25,139
--------- --------- --------- ---------
NET INCOME. . . . . . . . . . . . . . . . . . $ 12,102 $ 13,255 $ 41,546 $ 39,243
========= ========= ========= =========
NET EARNINGS PER COMMON SHARE:
Basic . . . . . . . . . . . . . . . . . . . $ 0.17 $ 0.19 $ 0.58 $ 0.56
Diluted . . . . . . . . . . . . . . . . . . $ 0.17 $ 0.19 $ 0.57 $ 0.55
SHARES USED IN COMPUTATION OF NET EARNINGS
PER COMMON SHARE
Basic . . . . . . . . . . . . . . . . . . . 71,929 70,043 71,513 69,830
Diluted . . . . . . . . . . . . . . . . . . 73,033 71,217 72,306 71,139
The accompanying notes are an integral part of these consolidated financial
statements.
4
99 CENTS ONLY STORES
STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(Amounts in Thousands)
(Unaudited)
SEPTEMBER 30,
2003 2002
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income . . . . . . . . . . . . . . . . . . . $ 41,546 $ 39,243
Adjustment to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization. . . . . . . . . 16,934 12,769
Other. . . . . . . . . . . . . . . . . . . . . (119) (17)
Tax benefit from exercise of non-qualified
employee stock options . . . . . . . . . . . 10,608 3,500
Changes in assets and liabilities associated with
operating activities:
Accounts receivable. . . . . . . . . . . . . . 183 (67)
Inventories. . . . . . . . . . . . . . . . . . (23,071) (17,295)
Other assets . . . . . . . . . . . . . . . . . (2,272) (527)
Deposits . . . . . . . . . . . . . . . . . . . (89) -
Accounts payable . . . . . . . . . . . . . . . (135) (5,393)
Accrued expenses . . . . . . . . . . . . . . . 1,228 1,518
Workers' compensation. . . . . . . . . . . . . 687 486
Income taxes . . . . . . . . . . . . . . . . . (15,262) (3,958)
Deferred rent. . . . . . . . . . . . . . . . . 190 90
Due from shareholders. . . . . . . . . . . . . (947) (1,655)
--------- ---------
Net cash provided by operating activities. . . . . 29,481 28,694
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment. . . . . . . (66,381) (27,281)
Sales (purchases) of short-term and long-term
investments. . . . . . . . . . . . . . . . . . 6,464 (7,023)
Investments in partnerships. . . . . . . . . . . 129 -
--------- ---------
Net cash used in investing activities. . . . . . . (59,788) (34,304)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of capital lease obligation . . . . . . (32) (10)
Proceeds from exercise of stock options. . . . . 24,408 8,680
--------- ---------
Net cash provided by financing activities. . . . . 24,376 8,670
--------- ---------
NET INCREASE (DECREASE) IN CASH. . . . . . . . . . (5,931) 3,060
CASH, beginning of period. . . . . . . . . . . . . 7,985 232
--------- ---------
CASH, end of period. . . . . . . . . . . . . . . . $ 2,054 $ 3,292
========= =========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest . . . . . . . . . . . . . $ 93 $ 48
========= =========
Cash paid for taxes. . . . . . . . . . . . . . . $ 25,580 $ 28,857
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
5
99 CENTS ONLY STORES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in conformity with accounting principles generally accepted in the
United States of America. However, certain information and footnote disclosures
normally included in financial statements prepared in conformity with accounting
principles generally accepted in the United States of America have been omitted
or condensed pursuant to the rules and regulations of the Securities and
Exchange Commission (SEC). These statements should be read in conjunction with
the Company's December 31, 2002 audited financial statements and notes thereto
included in the Company's Form 10-K filed March 31, 2003. In the opinion of
management, these interim consolidated financial statements reflect all
adjustments (consisting of normal recurring adjustments) necessary for a fair
statement of the consolidated financial position and results of operations for
each of the periods presented. The results of operations and cash flows for such
periods are not necessarily indicative of results to be expected for the full
year.
CONCENTRATION OF OPERATIONS
As of September 30, 2003, all but 32 of our 174, 99 Cents Only Stores are
located in California. The Company operates 10 stores in Las Vegas, Nevada, 12
stores in Arizona and 10 stores in Houston, Texas. The Company expects that it
will continue to open additional stores in California as well as in Nevada,
Arizona and Texas. Consequently, the Company's results of operations and
financial condition are substantially dependent upon general economic trends and
various environmental factors in these regions.
2. EARNINGS PER COMMON SHARE
"Basic" earnings per share is computed by dividing net income by the
weighted average number of shares outstanding for the period. "Diluted" earnings
per share is computed by dividing net income by the total of the weighted
average number of shares outstanding plus the dilutive effect of outstanding
stock options (applying the treasury stock method).
A reconciliation of the basic weighted average number of shares outstanding
and the diluted weighted average number of shares outstanding for the three and
nine months ended September 30, 2003 and 2002 follows:
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -------------------
SEPTEMBER 30, SEPTEMBER 30,
------------------ -------------------
2003 2002 2003 2002
-------- -------- -------- --------
Weighted average number of common shares
outstanding-Basic. . . . . . . . . . . . . 71,929 70,043 71,513 69,830
Dilutive effect of outstanding stock options 1,104 1,174 793 1,309
-------- -------- -------- --------
Weighted average number of common shares
outstanding-Diluted. . . . . . . . . . . . 73,033 71,217 72,306 71,139
======== ======== ======== ========
6
In December, 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure" (SFAS 148) - an amendment
of SFAS 123 "Accounting for Stock Based Compensation". The standard is intended
to encourage the adoption of the accounting provisions of SFAS 123. It is also
intended to address constituent concerns about the so-called "ramp-up effect" on
net income that resulted from the application of the transition guidance
originally required by SFAS 123. The transition and annual disclosure provisions
of SFAS 148 are effective for fiscal years ending after December 15, 2002. Under
the provisions of SFAS 148, companies that choose to adopt the accounting
provisions of SFAS 123 will be permitted to select from three transition
methods.
The Company has elected to continue to measure compensation costs
associated with its stock option plan under APB Opinion No. 25, "Accounting for
Stock Issued to Employees" and accordingly, under SFAS No. 123, had the Company
applied the fair value based method of accounting, which is not required, to all
grants of stock options, under SFAS No. 123, the Company would have recorded
additional compensation expense and pro forma net income and earnings per share
amounts as follows for the three and nine month periods ended September 30, 2003
and 2002:
(Amounts in thousands, except for per share data)
3 MONTHS 3 MONTHS 9 MONTHS 9 MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER SEPTEMBER SEPTEMBER SEPTEMBER
30, 30, 30, 30,
2003 2002 2003 2002
---------- ---------- ---------- ----------
Net income, as reported $ 12,102 $ 13,255 $ 41,546 $ 39,243
Compensation expense reported - - - -
Additional compensation
expense 2,578 2,360 6,548 5,924
Pro forma net income $ 9,524 $ 10,895 $ 34,998 $ 33,319
========== ========== ========== ==========
Earnings per share:
Basic-as reported $ 0.17 $ 0.19 $ 0.58 $ 0.56
Basic-pro forma $ 0.13 $ 0.16 $ 0.49 $ 0.48
Diluted-as reported $ 0.17 $ 0.19 $ 0.57 $ 0.55
Diluted-pro forma $ 0.13 $ 0.15 $ 0.48 $ 0.47
These pro forma amounts were determined by estimating the fair value of each
option on its grant date using the Black-Scholes option-pricing model with the
following assumptions:
3 MONTHS 3 MONTHS 9 MONTHS 9 MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER SEPTEMBER SEPTEMBER SEPTEMBER
30, 30, 30, 30,
2003 2002 2003 2002
---------- ---------- ---------- ----------
Risk free interest rate 3.94% 1.90% 3.94% 1.90%
Expected life 10 Years 10 Years 10 Years 10 Years
Expected stock price volatility 50.2% 51.0% 50.2% 51.0%
Expected dividend yield None None None None
3. SHORT-TERM INVESTMENTS
Investments in debt and equity securities are recorded as required by SFAS
No. 115, "Accounting for Certain Investments in Debt and Equity Securities" as
trading securities. The Company's investments are comprised primarily of
investment grade federal and municipal bonds and commercial paper. As of
September 30, 2003 and December 31, 2002, the fair value of investments
approximated the carrying values and were invested as follows (amounts in
thousands):
7
(UNAUDITED)
MATURITY MATURITY
-------- --------
SEPTEMBER WITHIN 1 1 YEAR OR DEC. 31, WITHIN 1 1 YEAR OR
---------- --------- ---------- --------- --------- ----------
30, 2003 YEAR MORE 2002 YEAR MORE
---------- --------- ---------- --------- --------- ----------
Municipal & Federal
Bonds . . . . . . . . $ 130,753 $ 95,077 $ 35,676 $ 119,798 $ 99,180 $ 20,618
Corporate Securities. 39,776 25,111 14,665 40,373 40,373 -
Commercial Paper. . . 7,088 7,088 - 23,909 7,304 16,605
---------- --------- ---------- --------- --------- ----------
$ 177,617 $ 127,276 $ 50,341 $ 184,080 $ 146,857 $ 37,223
========== ========= ========== ========= ========= ==========
4. NEW AUTHORITATIVE PRONOUNCEMENTS
In January 2003, the FASB issued Interpretation No. 46, (Consolidation of
Variable Interest Entities) (FIN 46). The objective of FIN 46 is to improve
financial reporting by companies involved with variable interest entities. This
new model for consolidation applies to an entity in which either (1) the powers
or rights of the equity holders do not give them sufficient decision making
powers or (2) the equity investment at risk is insufficient to finance that
entity's activities without receiving additional subordinated financial support
from other parties. FIN 46 requires a variable interest entity to be
consolidated into the company that is subject to a majority of the risk of loss
from the variable interest entity's activities or that is entitled to receive a
majority of the entity's residual returns or both. The consolidation
requirements of FIN 46 apply immediately to variable interest entities created
after January 31, 2003. For entities created on or prior to January 31, 2003,
the consolidation requirements apply in the first fiscal year or interim period
beginning after December 15, 2003. The Company does not expect that adoption of
FIN 46 will have a material impact on the Company's results of operations,
financial position or cash flows. The Company's variable interest entities
consist of its long-term investments in two partnerships formed for the purpose
of acquiring two 99 Cents Only Stores locations in California.
In May 2003, the FASB issued Statement of Financial Accounting Standards,
or SFAS, No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity," which established standards for
how a company classifies and measures certain financial instruments with
characteristics of both liabilities and equity. SFAS 150 requires certain
financial instruments to be classified as liabilities, which were previously
classified as equity. SFAS 150 is effective for financial instruments entered
into or modified after May 31, 2003, and otherwise is effective at the beginning
of the Company's third quarter. The adoption of this statement did not have an
impact on the Company's results of operations, financial position or cash flows.
5. RELATED-PARTY TRANSACTIONS
Effective September 30, 2000, the Company sold its discontinued operation,
Universal International, Inc. ("Universal"), to a Company owned 100% by David
and Sherry Gold, both significant shareholders of 99 Cents Only Stores. Mr. Gold
is also the Chief Executive Officer and a director. Subsequent to December 31,
2002, Universal ceased operations and closed its business. It is expected that
Universal will terminate its service agreement and lease arrangement with 99
Cents Only Stores some time before the end of 2003. For each of the three-month
periods ended September 30, 2003 and 2002, the Company recorded $0.4 million in
management fee income under the service agreement and $0.4 million in rental
income under the lease agreement. In the first nine months of 2003 and 2002, the
Company recorded $1.2 million in management fee income under the service
agreement and $1.1 million in rental income under the lease agreement. In
connection with these fees and lease payments the Company has amounts due from
shareholder of $2,179,000 at September 30, 2003 and $1,232,000 at December 31,
2002.
8
6. OPERATING SEGMENTS
The Company has two business segments, retail operations and wholesale
distribution. The retail segment includes 99 Cents Only Stores retail stores.
The majority of the product offerings include recognized brand-name consumable
merchandise, regularly available for reorder. Bargain Wholesale sells the same
merchandise at prices generally below normal wholesale levels to local, regional
and national distributors, exporters, and other retailers.
The accounting policies of the segments are described in the summary of
significant accounting policies noted in the Company's Annual Report on Form
10-K for the year ended December 31, 2002. The Company evaluates segment
performance based on the net sales and gross profit of each segment. Management
does not track segment data or evaluate segment performance on additional
financial information. As such, there are no separately identifiable segment
assets nor is there any separately identifiable statements of income data (below
gross profit) to be disclosed.
The Company accounts for inter-segment transfers at cost through its
inventory accounts.
At September 30, 2003, the Company had no customers representing more than
4.5% of Bargain Wholesale's net sales. Substantially all of the Company's net
sales were to customers located in the United States.
Reportable segment information for the three and nine month periods ended
September 30, 2003 and 2002 follows (amounts in thousands):
THREE MONTHS ENDED SEPTEMBER 30
RETAIL WHOLESALE TOTAL
-------- ---------- --------
2003
- ----
Net sales . . . . . . . . . . . $200,567 $ 10,969 $211,536
Gross margin. . . . . . . . . . 80,699 2,178 82,877
2002
- ----
Net sales . . . . . . . . . . . $160,424 $ 11,839 $172,263
Gross margin. . . . . . . . . . 66,324 2,430 68,754
NINE MONTHS ENDED SEPTEMBER 30
RETAIL WHOLESALE TOTAL
-------- ---------- --------
2003
- ----
Net sales . . . . . . . . . . . $580,331 $ 34,660 $614,991
Gross margin. . . . . . . . . . 238,219 6,859 245,078
2002
- ----
Net sales . . . . . . . . . . . $465,507 $ 37,722 $503,229
Gross margin. . . . . . . . . . 192,961 7,600 200,561
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
99 Cents Only Stores (the "Company") is a leading deep-discount retailer of
primarily name-brand, consumable general merchandise. The Company's stores offer
a wide assortment of regularly available consumer goods as well as a broad
variety of first-quality, close-out merchandise. The majority of the Company's
product offerings were comprised of recognizable name-brand merchandise and were
regularly available for reorder.
9
99 Cents Only Stores has increased its net sales, operating income and
income from continuing operations in each of the last five years. In 2002, it
had net sales of $713.9 million, operating income of $90.5 million and income
from continuing operations of $59.0 million, representing a 23.5%, 22.4% and
21.7% increase over 2001, respectively. From 1998 through 2002, the Company had
a compound annual growth rate in net sales, operating income and income from
continuing operations of 25.3%, 23.7% and 25.5%, respectively. In the three
months ended September 30, 2003, the Company's net sales increased by 22.8%
compared to the same period in 2002. Operating income in this same period
decreased by 12.1%. The Company, however, expects full year 2003 operating
income to increase for the sixth straight year. During the three years in the
period ended December 31, 2002, average net sales per estimated saleable square
foot (computed on 99 Cents Only Stores open for a full year) declined from $319
per square foot to $309 per square foot. This trend reflects the Company's
determination to target larger locations for new store development. As of
September 30, 2003 existing stores average approximately 21,505 gross square
feet. The Company currently targets new store locations between 18,000 and
28,000 gross square feet. Although it is the Company's experience that larger
stores generally have lower average net sales per square foot than smaller
stores, larger stores generally achieve higher average annual store revenues and
operating income.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements requires management to make
estimates and assumptions that affect reported earnings. The estimates and
assumptions are evaluated on an on-going basis and are based on historical
experience and on other factors that management believes are reasonable.
Estimates and assumptions include, but are not limited to, the areas of customer
receivables, inventories, investments, income taxes, self-insurance reserves,
and commitments and contingencies.
The Company believes that the following represent the areas where more
critical estimates and assumptions are used in the preparation of the financial
statements:
INVESTMENTS: The Company records its investments, which are comprised primarily
of investment grade federal and municipal bonds and commercial paper, at cost
and generally holds these investments to maturity. Any premium or discount
recognized in connection with the purchase of an investment is amortized over
the term of the investment. The Company accounts for its investments in
marketable securities in accordance with Statement of Financial Accounting
Standards No. 115 as trading securities.
LONG-LIVED ASSET IMPAIRMENTS: The Company records impairment when the carrying
amounts of long-lived assets are determined not to be recoverable. Impairment is
assessed and measured by an estimate of future cash flows expected to result
from the use of the asset and its eventual disposition. Changes in market
conditions can impact estimated future cash flows from use of these assets and
impairments charges may be required should such changes occur.
SELF-INSURANCE RESERVES: The Company is self-insured in relation to workers'
compensation claims. The Company provides for losses of estimated known and
incurred but not reported insurance claims. These estimates are based on
reported claims and actuarial valuations. Should a greater amount of claims or a
higher cost of claims occur compared to what was estimated, reserves recorded
may not be sufficient and additional expense could be incurred.
UNIVERSAL INTERNATIONAL (DISCONTINUED OPERATIONS)
In conjunction with a sale of Universal in 2000, the Company established a
service agreement and lease agreement with certain shareholders. At each of the
three months period ended September 30, 2003 and 2002, the Company recorded $0.4
million in management fees under the service agreement and $0.4 million in lease
payments under the lease agreement. In 2002, the Company received $1.5 million
in management fees income under the service agreement from Universal and $1.4
million in rental income under the lease agreement. In the first nine months of
2003 and 2002, the Company recorded $1.2 million in management fee income under
the service agreement and $1.1 million in rental income under the lease
agreement. Resolution of Universal post closing business issues has required the
extension of the service agreement and lease arrangement with 99 Cents Only
Stores. It is expected that Universal will terminate its service agreement with
99 Cents Only Stores sometime before the end of 2003.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2002
NET SALES: Net sales increased $39.2 million, or 22.8%, to $211.5 million in the
2003 period from $172.3 million in the 2002 period. Retail sales increased $40.2
million to $200.6 million in the 2003 period from $160.4 million in the 2002
period. The retail net sales increase was primarily attributable to the net
effect of twenty three new stores opened in the first nine months of 2003, the
full quarter effect of 28 net new stores opened in 2002 and the 4.95% increase
10
in same store sales. Bargain Wholesale net sales were $11.0 million in the 2003
period and were $11.8 million in the three months ended September 30, 2002. This
decline in the wholesale business results from generally weaker sales and
economic conditions for the Company's small regional customers.
GROSS PROFIT: Gross profit increased approximately $14.1 million, or 20.5%, to
$82.9 million in the 2003 period from $68.8 million in the 2002 period. The
increase in gross profit dollars was primarily due to higher net retail sales.
Gross margin percentage was 39.2% in 2003 and 39.9% in 2002. This variation in
the gross margin percentage was due to growth in the percentage of grocery
related products carried in our stores, which on average have a slightly lower
margin than the average percentage of all products including non-grocery items.
The growth in the grocery products was primarily due to the expansion of the
frozen and deli departments in the Company's existing stores.
SELLING, GENERAL AND ADMINISTRATIVE: SG&A increased by $16.7 million, or 34.5%,
to $64.8 million in the 2003 period from $48.1 million in the 2002 period. As a
percentage of net sales, total SG&A increased to 30.6% from 28.0% in 2002. This
increase is primarily related to the additional costs associated with the start
up and entry into the Houston, Texas market. Additional costs include the cost
of start up and running of the Texas distribution center as well as initial
costs for the start up of the new Texas retail stores, including depreciation
expense, insurance, property taxes freight, utilities, training and re-location
of workers and labor costs. Other cost increases included distribution costs
attributable to stores outside the Southern California region.
OPERATING INCOME: As a result of the items discussed above, operating income was
$18.1 million in 2003, a decrease of $2.5 million, or 12.1%. Operating margin
was 8.6% in 2003 versus 12.0% in 2002.
OTHER INCOME (EXPENSE): Other income (expense) includes the interest income on
the Company's marketable securities and interest expense on the Company's
capitalized leases. Interest income was $1.3 million in 2003 and $0.8 million in
2002. Investment income increased due to net higher interest yield achieved by
slightly extending general maturities beyond a year. The Company had no bank
debt during the three months ended September 30, 2003 and 2002. The Company's
short-term and long-term investments are comprised primarily of investment grade
securities. The Company generally holds investments until maturity. Also
included in 2003 and 2002 is $0.4 million and $0.4 million, respectively, of
income under a lease agreement with Universal International, Inc., for a
distribution facility.
PROVISION FOR INCOME TAXES: The provision for income taxes was $7.6 million in
the 2003 period compared to $8.5 million in 2002. The effective rate of the
provision for income taxes was approximately 38.7% in 2003 and 39.0% 2002. The
reduction in the effective rate for 2003 reflects a benefit for tax credits,
non-taxable interest and a lower combined state tax rate.
NET INCOME: As a result of the items discussed above, net income decreased $1.2
million to $12.1 million in 2003 from $13.3 million in the 2002 period. Net
income as a percentage of sales was 5.7% in 2003 and 7.7% in 2002.
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER
30, 2002
NET SALES: Net sales increased $111.8 million, or 22.2%, to $615.0 million in
the 2003 period from $503.2 million in the 2002 period. Retail sales increased
$114.8 million to $580.3 million in the 2003 period from $465.5 million in the
2002 period. The retail net sales increase was primarily attributable to the net
effect of twenty three new stores opened in the first nine months of 2003, the
full nine months effect of 28 net new stores opened in 2002 and the 6.4%
increase in same store sales. Bargain Wholesale net sales were $34.7 million in
the 2003 period and were $37.7 million in the nine months ended September 30,
2002. This decline in the wholesale business results from generally weaker sales
and economic conditions for the Company's small regional customers.
GROSS PROFIT: Gross profit increased approximately $44.5 million, or 22.2%, to
$245.1 million in the 2003 period from $200.6 million in the 2002 period. The
increase in gross profit was primarily due to higher net retail sales. Overall
gross profit margin was 39.9% in 2003 versus 39.8% in 2002. Gross margin percent
on retail sales 41.1% versus 41.5% and was lower due to product mix and cost
variations in grocery related products which on average carry a slightly lower
margin than the average.
11
SELLING, GENERAL AND ADMINISTRATIVE: SG&A increased by $41.4 million, or 29.6%,
to $181.0 million in the 2003 period from $139.6 million in the 2002 period. As
a percentage of net sales, total SG&A increased to 29.4% from 27.7% in 2002.
This increase is primarily related to the additional costs associated with the
start up of the Company's new distribution center in Houston, Texas, costs
associated with the new stores in Texas, and increases in depreciation, freight
and California workers' compensation costs.
OPERATING INCOME: As a result of the items discussed above, operating income was
$64.1 million in 2003, an increase of $3.1 million, or 5.2%. Operating margin
was 10.4% in 2003 versus 12.1% in 2002.
OTHER INCOME (EXPENSE): Other income (expense) includes the interest income on
the Company's marketable securities and interest expense on the Company's
capitalized leases. Interest income was $2.6 million in 2003 and $2.4 million in
2002. Interest income increased as result of overall yield achieved on bonds
with slightly longer maturities. The Company had no bank debt during the nine
months ended September 30, 2003 or 2002. At September 30, 2003, the Company held
$127.3 million in short-term investments and $50.3 million in long-term
investments. The Company's short-term and long-term investments are comprised
primarily of investment grade securities. The Company generally holds
investments until maturity. Also included in 2003 and 2002 is $1.1 million and
$1.1 million, respectively, of rental income under a lease agreement with
Universal International, Inc., for a distribution facility.
PROVISION FOR INCOME TAXES: The provision for income taxes was $26.2 million in
the 2003 period compared to $25.1 million in 2002. The effective rate of the
provision for income taxes was approximately 38.7% in 2003 and 39.1% in 2002.
The reduction in the effective rate for 2003 reflects a benefit for tax credits,
non-taxable interest and a lower combined state tax rate.
NET INCOME: As a result of the items discussed above, net income increased $2.3
million to $41.5 million in 2003 from $39.2 million in the 2002 period. Net
income as a percentage of sales was 6.8% in 2003 and 7.8% in 2002.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company has funded its operations principally from
cash provided by operations, and has not generally relied upon external sources
of financing. The Company's capital requirements result primarily from purchases
of inventory, expenditures related to new store openings and working capital
requirements for new and existing stores. The Company takes advantage of
close-out and other special-situation opportunities, which frequently result in
large volume purchases, and as a consequence, its cash requirements are not
constant or predictable during the year and can be affected by the timing and
size of its purchases.
Net cash provided by operations during the first nine months of 2003 and
2002 was $29.5 and $28.7 million, respectively, consisting primarily of $69.0
million and $55.5 million of net income adjusted for non-cash and working
capital items. During the first nine months of 2003 and 2002, the Company used
$38.5 million and $26.8 million, respectively, in working capital and other
activities. Net cash used in working capital and other activities primarily
reflects the increases in inventories in the amount of $23.1 million and $17.3
million in the first nine months of 2003 and 2002, respectively.
Net cash used in investing activities during the first nine months of 2003
and 2002 was $59.8 and $34.3 million. Net cash used in investing activities
represents the following: In the first nine months of 2003, the Company used
$66.4 million for the purchase of property and equipment (including $23.1
million used for the purchase of a new distribution center in Houston, Texas),
offset by the net redemption of $6.5 million of marketable securities. In the
first nine months of 2002, the Company used $27.3 million for the purchase of
property and equipment and used $7.0 million for the purchase of marketable
securities.
Net cash provided by financing activities during the first nine months of
2003 and 2002 was $24.4 million and $8.7 million, respectively, which represents
the proceeds from the exercise of non-qualified stock options. The Company does
not maintain any credit facilities with any bank. The Company had previously
maintained a cash deposit of approximately $5.1 million for self-insured
workers' compensation in California. This deposit restriction was removed in
August 2003 pursuant to California Department of Industrial Relations
Self-Insurance Plans regulations and was transferred to the Company's investment
accounts.
12
The Company opened 23 stores in the first nine months of 2003 and plans to
open 15 additional new 99 Cents Only Stores in the remaining three months of
2003. The average investment per new store opened including leasehold
improvements, furniture, fixtures and equipment, inventory and pre-opening
expenses, was approximately $865,000. The Company's cash needs for new store
openings are expected to total approximately $37.0 million in 2003 including
acquired properties. The Company's total planned expenditures in 2003 for
additions to fixtures and leasehold improvements of existing stores as well as
for distribution, systems, expansion and replacement will be approximately $10.0
million. The Company believes that its total capital expenditure requirements
including new store openings, and the $23.1 million purchase of the Houston
distribution facility, will approximate $81.0 million in 2003. The Company
intends to fund its liquidity requirements in 2003 out of net cash provided by
operations, short-term investments and cash on hand. As previously indicated,
the Company purchased a 741,000 square foot distribution center in Houston,
Texas to service its planned store expansion in Texas in 2003 and beyond. The
facility was acquired for $23.1 million in cash and is fully racked including a
pick to belt conveyor system. As of September 30, 2003 the Company had 10 stores
open in Houston and the surrounding areas, and plans to open 7 more by the end
of the year. The Company's strategy for the expansion of its operations in Texas
is expected to incorporate the distribution and retail concepts applied in its
operations in California, Nevada and Arizona.
CONTRACTUAL OBLIGATIONS
The following table summarizes our consolidated contractual obligations (in
thousands). This table represents the full year expected payments.
Contractual Obligations 2003 2004 2005 2006 2007 Thereafter Total
------- ------- ------- ------- ------- ----------- --------
Capital Lease
Obligations . . . . . . $ 169 $ 169 $ 169 $ 169 $ 169 $ 1,525 $ 2,370
Operating Lease
Obligations . . . . . . 23,318 25,094 22,598 19,826 16,044 55,589 162,469
------- ------- ------- ------- ------- ----------- --------
$23,487 $25,263 $22,767 $19,995 $16,213 $ 57,114 $164,839
======= ======= ======= ======= ======= =========== ========
LEASE COMMITMENTS
The Company leases various facilities under operating leases except for
two, which were classified as capital leases and will expire at various dates
through 2019. Some of the lease agreements contain renewal options and/or
provide for scheduled increases or increases based on the Consumer Price Index.
Total minimum lease payments under each of these lease agreements, including
scheduled increases, are charged to operations on a straight-line basis over the
life of each respective lease. Certain leases require the payment of property
taxes, maintenance and insurance. Rental expense charged to operations for the
three months period ended September 30, 2003 and 2002 were $8.3 million and $6.1
million, respectively. The Company typically seeks leases with an initial
five-year to ten-year term and with one or more five-year renewal options. Most
leases have renewal options ranging from three to ten years.
RISK FACTORS
INFLATION MAY AFFECT OUR ABILITY TO SELL MERCHANDISE AT THE 99 CENTS PRICE POINT
Our ability to provide quality merchandise at the 99 Cents price point is
subject to certain economic factors, which are beyond our control, including
inflation. Inflation could have a material adverse effect on our business and
results of operations, especially given the constraints on our ability to pass
on any incremental costs due to price increases or other factors. We believe
that we will be able to respond to ordinary price increases resulting from
inflationary pressures by adjusting the number of items sold at the single price
point (e.g., two items for 99 Cents instead of three items for 99 Cents) and by
changing our selection of merchandise. Nevertheless, a sustained trend of
significantly increased inflationary pressure could require us to abandon our
single price point of 99 Cents per item, which could have a material adverse
effect on our business and results of operations. See also "We are vulnerable to
uncertain economic factors, changes in the minimum wage and workers'
compensation" for a discussion of additional risks attendant to inflationary
conditions.
13
WE DEPEND ON NEW STORE OPENINGS FOR FUTURE GROWTH
Our operating results depend largely on our ability to open and operate new
stores successfully and to manage a larger business profitably. In 2001 and
2002, we opened 26 and 28 99 Cents Only Stores, respectively (25 and 28 stores,
respectively, net of relocated stores). As of September 30, 2003, we opened 23
stores and expect to open 15 additional stores during the remainder of 2003 to
meet a growth rate of 25%. We also plan to grow retail square footage at a rate
of approximately 25% per year. Our strategy depends on many factors, including
our ability to identify suitable markets and sites for our new stores, negotiate
leases with acceptable terms, refurbish stores, upgrade our financial and
management information systems and controls and manage our operating expenses.
In addition, we must be able to continue to hire, train, motivate and retain
competent managers and store personnel. Many of these factors are beyond our
control. As a result, we cannot assure you that we will be able to achieve our
expansion goals. Any failure by us to achieve our expansion goals on a timely
basis, obtain acceptance in markets in which we currently have limited or no
presence, attract and retain management and other qualified personnel,
appropriately upgrade our financial and management information systems and
controls or manage operating expenses could adversely affect our future
operating results and our ability to execute our business strategy.
We also cannot assure you that we will improve our results of operations
when we open new stores. A variety of factors, including store location, store
size, rental terms, the level of store sales and the level of initial
advertising influence if and when a store becomes profitable. Assuming that our
planned expansion occurs as anticipated, our store base will include a
relatively high proportion of stores with relatively short operating histories.
We cannot assure you that our new stores will achieve the sales per saleable
square foot and store-level operating margins currently achieved at our existing
stores. If our new stores on average fail to achieve these results, our planned
expansion could produce a decrease in our overall sales per saleable square foot
and store-level operating margins. Increases in the level of advertising and
pre-opening expenses associated with the opening of new stores could also
contribute to a decrease in our operating margins. Finally, the opening of new
stores in existing markets has in the past and may in the future reduce retail
sales of existing stores in those markets, negatively affecting comparable store
sales.
OUR OPERATIONS ARE CONCENTRATED IN CALIFORNIA
Currently, all but 32 of our 174, 99 Cents Only Stores are located in
California. We operate ten stores in Las Vegas, Nevada, twelve stores in Arizona
and ten stores in Houston, Texas. We expect that we will continue to open
additional stores in California, as well as in Nevada, Arizona and Texas.
Accordingly, our results of operations and financial condition largely depend
upon trends in the California economy. If retail spending declines due to an
economic slow-down or recession in California, we cannot assure you that our
operations will not be negatively impacted.
In addition, California historically has been vulnerable to certain natural
disasters and other risks, such as earthquakes, fires, floods and civil
disturbance. At times, these events have disrupted the local economy. These
events could also pose physical risks to our properties.
WE COULD EXPERIENCE DISRUPTIONS IN RECEIVING AND DISTRIBUTION
Our success depends upon whether our receiving and shipment schedules are
organized and well managed. As we continue to grow, we may face unexpected
demands on our warehouse operations, as well as unexpected demands on our
transportation network, which could cause delays in delivery of merchandise to
or from our warehouses to our stores. A fire, earthquake or other disaster at
our warehouses could hurt our business, financial condition and results of
operations, particularly because much of our merchandise consists of closeouts
and other irreplaceable products. Although we maintain standard property and
business interruption insurance, we do not have earthquake insurance on our
properties. Although we try to limit our risk of exposure to potential product
liability claims, we do not know if the limitations in our agreements are
enforceable. We maintain insurance covering damage from use of our products. If
any product liability claim is successful and large enough, our business could
suffer.
14
WE DEPEND UPON OUR RELATIONSHIPS WITH OUR SUPPLIERS AND THE AVAILABILITY OF
CLOSE-OUT AND SPECIAL-SITUATION MERCHANDISE
Our success depends in large part on our ability to locate and purchase
quality close-out and special-situation merchandise at attractive prices. This
helps us maintain a mix of name-brand and other merchandise at the 99 Cents
price point. We cannot be certain that such merchandise will continue to be
available in the future at a price that will be consistent with historical
costs. Further, we may not be able to find and purchase merchandise in
quantities necessary to accommodate our growth. Additionally, our suppliers
sometimes restrict the advertising, promotion and method of distribution of
their merchandise. These restrictions in turn may make it more difficult for us
to quickly sell these items from our inventory. Although we believe our
relationships with our suppliers are good, we do not have long-term agreements
with any supplier. As a result, we must continuously seek out buying
opportunities from our existing suppliers and from new sources. We compete for
these opportunities with other wholesalers and retailers, discount and
deep-discount chains, mass merchandisers, food markets, drug chains, club stores
and various privately-held companies and individuals. Although we do not depend
on any single supplier or group of suppliers and believe we can successfully
compete in seeking out new suppliers, a disruption in the availability of
merchandise at attractive prices could impair our business.
WE PURCHASE IN LARGE VOLUMES AND OUR INVENTORY IS HIGHLY CONCENTRATED
To obtain inventory at attractive prices, we take advantage of large volume
purchases, close-outs and other special situations. As a result, our inventory
levels are generally higher than other discount retailers. At December 31, 2001
and 2002, we recorded net inventory value of $66.5 million and $83.2 million,
respectively. At September 30, 2003, we recorded net inventory value of $106.2
million. We periodically review the net realizable value of our inventory and
make adjustments to its carrying value when appropriate. The current carrying
value of our inventory reflects our belief that we will realize the net values
recorded on our balance sheet. However, we may not be able to do so. If we sell
large portions of our inventory at amounts less than their carrying value or if
we write down a significant part of our inventory, our cost of sales, gross
profit, operating income and net income could suffer greatly during the period
in which such event or events occur. Margins could also be negatively affected
should the grocery category sales continue to expand in importance and become a
larger percentage of total sales in the future.
WE FACE STRONG COMPETITION
We compete in both the acquisition of inventory and sale of merchandise
with other wholesalers, discount and deep-discount stores, single price point
merchandisers, mass merchandisers, food markets, drug chains, club stores and
other retailers. Our industry competitors also include many privately held
companies and individuals. At times, these competitors are also customers of our
Bargain Wholesale division. In the future, new companies may also enter the
deep-discount retail industry. Additionally, we currently face increasing
competition for the purchase of quality close-out and other special-situation
merchandise. Some of our competitors have substantially greater financial
resources and buying power than us. Our capability to compete will depend on
many factors including our ability to successfully purchase and resell
merchandise at lower prices than our competitors. We cannot assure you that we
will be able to compete successfully against our current and future competitors.
WE ARE VULNERABLE TO UNCERTAIN ECONOMIC FACTORS, CHANGES IN THE MINIMUM WAGE AND
WORKERS' COMPENSATION
Our ability to provide quality merchandise at our 99 Cents price point
could be hindered by certain economic factors beyond our control, including but
not limited to:
- - increases in inflation;
- - increases in operating costs;
- - increases in employee health care costs;
- - increases in workers' compensation benefits;
- - increases in prevailing wage levels; and
- - decreases in consumer confidence levels.
In January 2001, California enacted a minimum wage increase of $0.50 per
hour with an additional $0.50 increase required in January 2002. In 2001 and
2002, annual payroll expenses as a percentage of sales increased less than 1.0%.
Self-insured workers' compensation reserves are subject to actuarial reviews,
which could increase the overall cost of workers' compensation benefits. Because
we provide consumers with merchandise at a 99 cents fixed price point, we
typically cannot pass on cost increases to our customers.
15
WE FACE RISKS ASSOCIATED WITH INTERNATIONAL SALES AND PURCHASES
Although international sales historically have not been important to our
overall net sales, they have contributed to historical growth in Bargain
Wholesale's net sales. In addition, some of the inventory we purchase is
manufactured outside the United States. There are many risks associated with
doing business internationally. Our international transactions may be subject to
risks such as:
- - political instability;
- - currency fluctuations;
- - exchange rate controls;
- - changes in import and export regulations; and
- - changes in tariff and freight rates.
The United States and other countries have also proposed various forms of
protectionist trade legislation. Any resulting changes in current tariff
structures or other trade policies could lead to fewer purchases of our products
and could adversely affect our international operations.
WE COULD ENCOUNTER RISKS RELATED TO TRANSACTIONS WITH OUR AFFILIATES
We currently lease 12 of our 99 Cents Only Stores and a parking lot for one
of these stores from certain members of the Gold family and their affiliates.
Our annual rental expense for these facilities totaled approximately $1.9 and
$2.2 million in each of 2001 and 2002. In addition, one of our directors, Ben
Schwartz, is a trustee of a trust that owns a property on which a single 99
Cents Only Store is located. We believe that our lease terms are just as
favorable to us as they would be for an unrelated party. Under our current
policy, we enter into real estate transactions with our affiliates only for the
renewal or modification of existing leases and on occasions where we determine
that such transactions are in our best interests. Moreover, the independent
members of our Board of Directors must unanimously approve all real estate
transactions between the Company and our affiliates. They must also determine
that such transactions are equivalent to a negotiated arm's-length transaction
with a third party. We cannot guarantee that we will reach agreements with the
Gold family on renewal terms for the properties we currently lease from them.
Also, even if we agree to such terms, we cannot be certain that our independent
directors will approve them. If we fail to renew one of these leases, we could
be forced to relocate or close the leased store. Any relocations or closures we
experience will be costly and could adversely affect our business.
WE RELY HEAVILY ON OUR MANAGEMENT TEAM
Our success depends substantially on David Gold and Eric Schiffer, our
Chief Executive Officer and President, respectively. We also rely on the
continued service of our executive officers and other key management. We have
not entered into employment agreements with any of our executive officers and we
do not maintain key person life insurance on them. As we continue to grow, our
success will depend on our ability to identify, attract, hire, train, retain and
motivate other highly skilled management personnel. Competition for such
personnel is intense, and we may not be able to successfully attract, assimilate
or retain sufficiently qualified candidates.
OUR OPERATING RESULTS MAY FLUCTUATE AND MAY BE AFFECTED BY SEASONAL BUYING
PATTERNS
Historically, our highest net sales and operating income have occurred
during the fourth quarter, which includes the Christmas and Halloween selling
seasons. During 2001 and 2002, we generated approximately 29.9% and 29.5%,
respectively, of our net sales and approximately 35.3% and 32.7%, respectively,
of our operating income during the fourth quarter. If for any reason the
Company's net sales were to fall below norms during the fourth quarter it could
have an adverse impact on our profitability and impair our results of operations
for the entire year. Adverse weather conditions or other disruptions during the
peak holiday season could also affect our net sales and profitability for the
year.
In addition to seasonality, many other factors may cause our results of
operations to vary significantly from quarter to quarter. Some of these factors
are beyond our control. These factors include:
- - the number of new stores and timing of new store openings;
- - the level of advertising and pre-opening expenses associated with new stores;
- - the integration of new stores into our operations;
- - general economic health of the deep-discount retail industry;
- - changes in the mix of products sold;
16
- - unexpected increases in shipping costs;
- - ability to successfully manage our inventory levels;
- - changes in our personnel;
- - fluctuations in the amount of consumer spending;
- - the amount and timing of operating costs and capital expenditures relating to
the growth of our business.
WE ARE SUBJECT TO ENVIRONMENTAL REGULATIONS
Under various federal, state and local environmental laws and regulations,
current or previous owners or occupants of property may become liable for the
costs of removing any hazardous substances found on the property. These laws and
regulations often impose liability without regard to fault. As of September 30,
2003, we leased all but 24 of our stores and own two distribution facilities.
However, in the future we may be required to incur substantial costs for
preventive or remedial measures associated with the presence of hazardous
materials. In addition, we operate one underground diesel storage tank and one
above-ground propane storage tank at our Southern California warehouse. Although
we have not been notified of, and are not aware of, any current environmental
liability, claim or non-compliance, we could incur costs in the future related
to our leased properties and our storage tanks. In the ordinary course of our
business, we sometimes handle or dispose of commonplace household products that
are classified as hazardous materials under various environmental laws and
regulations. We have adopted policies regarding the handling and disposal of
these products, and we train our employees on how to handle and dispose of them.
We cannot assure you that our policies and training will successfully help us
avoid potential violations of these environmental laws and regulations in the
future.
ANTI-TAKEOVER EFFECT; CONCENTRATION OF OWNERSHIP BY OUR EXISTING OFFICERS AND
PRINCIPAL STOCKHOLDERS
In addition to some governing provisions in our Articles of Incorporation
and Bylaws, we are also subject to certain California laws and regulations which
could delay, discourage or prevent others from initiating a potential merger,
takeover or other change in our control, even if such actions would benefit our
shareholders and us. Moreover David Gold, our Chairman and Chief Executive
Officer, and members of his immediate family and certain of their affiliates
beneficially own as of September 30, 2003, 22,736,242 or 31.9% of shares
outstanding. As a result, they have the ability to influence all matters
requiring the vote of our shareholders, including the election of our directors
and most of our corporate actions. They can also control our policies and
potentially prevent a change in our control. This could adversely affect the
voting and other rights of our other shareholders and could depress the market
price of our common stock.
OUR STOCK PRICE COULD FLUCTUATE WIDELY
The market price of our common stock has risen substantially since our
initial public offering on May 23, 1996. Trading prices for our common stock
could fluctuate significantly due to many factors, including:
- - the depth of the market for our common stock;
- - changes in expectations of our future financial performance, including
financial estimates by securities analysts and investors;
- - variations in our operating results;
- - conditions or trends in our industry or industries of any of our
significant clients;
- - the conditions of the market generally;
- - additions or departures of key personnel; and
- - future sales of our common stock.
RISKS COULD ARISE DUE TO OUR USE OF ARTHUR ANDERSEN LLP AS OUR INDEPENDENT
AUDITORS
There may be no effective remedy against Arthur Andersen LLP, which audited
our financial statements for the years ended December 31, 2000 and 2001, in
connection with a material misstatement or omission in those financial
statements, or in connection with any other claim arising from its provision of
auditing and other services to us. On September 15, 2002, Arthur Andersen was
convicted of obstructing justice in connection with investigations of their
former client Enron Corp. Arthur Andersen ceased practicing before the SEC
effective August 31, 2002. Our inability to include in future registration
statements or reports financial statements for one or more years audited by
Arthur Andersen LLP or to obtain Arthur Andersen LLP's consent to the inclusion
of their report on our 2000 and 2001 financial statements may impede our access
to the capital markets. Should we seek to access the public capital markets, SEC
rules will require us to include or incorporate by reference in any prospectus
17
three years of audited financial statements. Until our audited financial
statements for the fiscal year ending December 31, 2004 become available, the
SEC's current rules would require us to present audited financial statements for
one or more fiscal years audited by Arthur Andersen LLP. Prior to that time the
SEC may cease accepting financial statements audited by Arthur Andersen LLP, in
which case we would be unable to access the public capital markets unless
PricewaterhouseCoopers LLP, our current independent accounting firm, or another
independent accounting firm, is able to audit the financial statements
originally audited by Arthur Andersen LLP. In addition, as a result of the
departure of our former engagement team leaders, Arthur Andersen LLP is no
longer in a position to consent to the inclusion or incorporation by reference
in any prospectus of their report on our audited financial statements for the
years ended December 31, 2000 and December 31, 2001, and investors in any
subsequent offerings for which we use their audit report will not be entitled to
recovery against them under Section 11 of the Securities Act of 1933 for any
material misstatements or omissions in those financial statements. Consequently,
our financing costs may increase or we may miss attractive market opportunities
if either our annual financial statements for 2000 and 2001 audited by Arthur
Andersen LLP should cease to satisfy the SEC's requirements or those statements
are used in a prospectus but investors are not entitled to recovery against our
auditors for material misstatements or omissions in them.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to interest rate risk for its investments in
marketable securities. At September 30, 2003, the Company had $177.6 million in
marketable securities maturing at various dates through February 2004. The
Company's investments are comprised primarily of investment grade securities.
The Company generally holds investments until maturity, and therefore should not
bear any interest risk due to early disposition. We do not enter into any
derivative or interest rate hedging transactions. Any premium or discount
recognized upon the purchase of an investment is amortized over the term of the
investment. At September 30, 2003, the fair value of investments approximated
the carrying value.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the
participation of the Company's management, including David Gold (Chief Executive
Officer) and Andrew Farina (Chief Financial Officer), of the effectiveness of
the design and operation of the Company's disclosure controls and procedures as
of September 30, 2003. Based on that evaluation, Mr. Gold and Mr. Farina
concluded that the Company's disclosure controls and procedures are effective in
ensuring that information required to be disclosed by the Company in reports it
files or submits under the Securities Exchange Act of 1934, as amended, is
recorded, processed, summarized and reported as specified in the rules and forms
of the Securities and Exchange Commission.
CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING
There have been no material changes in the Company's internal controls over
financial reporting or in other factors reasonably likely to affect the internal
controls over financial reporting during the quarter ended September 30, 2003.
LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS
Our management, including our CEO and CFO, does not expect that our
disclosure controls and internal controls will prevent all error and fraud. A
control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system
can be met. Further, the design of a control system must reflect the fact that
there are resource constraints, and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, within the Company have been
detected. These inherent limitations include the realities that judgements in
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control.
SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION
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This report on Form 10-Q contains statements that constitute
"forward-looking statements" within the meaning of Section 21E of the Exchange
Act and Section 27A of the Securities Act. The words "expect", "estimate",
"anticipate", "predict", "believe" and similar expressions and variations
thereof are intended to identify forward-looking statements. Such statements
appear in a number of places in this filing and include statements regarding the
intent, belief or current expectations of 99 Cents Only Stores and its directors
or officers with respect to, among other things, (a) trends affecting the
financial condition or results of operations of the Company and (b) the business
and growth strategies of the Company. The shareholders of the Company are
cautioned not to put undue reliance on such forward-looking statements. Such
forward-looking statements are not guarantees of future performance and involve
risks and uncertainties, and actual results may differ materially from those
projected in this Report, for the reasons, among others, discussed in the
Sections - "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Risk Factors". The Company undertakes no obligation
to publicly revise these forward-looking statements to reflect events or
circumstances that arise after the date hereof. Readers should carefully review
the risk factors described in this Form 10-Q and other documents the Company
files from time to time with the Securities and Exchange Commission, including
the Company's Annual Report on Form 10-K for the fiscal year ended December 31,
2002.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to section
906 of the Sarbanes-Oxley Act of 2002.
b. Reports on Form 8-K
Current Report on Form 8-K filed on July 11, 2003; Item 9 was
reported
Current Report on Form 8-K filed on July 22, 2003; Item 9 was
reported
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
99 CENTS ONLY STORES
Date: November 4, 2003 /s/ Andrew A. Farina
-----------------------
Andrew A. Farina
Chief Financial Officer
(Duly Authorized Officer)
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EXHIBIT INDEX
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 dated November 4, 2003.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 dated November 4, 2003.
32.1 Certification of Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 dated November 4, 2003.
32.2 Certification of Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 dated November 4, 2003.
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