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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 MARCH 31, 2004
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 95-2411605
(State or other Jurisdiction (I.R.S. Employer Identification No.)
of Incorporation or Organization)
4000 UNION PACIFIC AVENUE, 90023
CITY OF COMMERCE, CALIFORNIA (zip code)
(Address of Principal Executive Offices)
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, 72,215,780 Shares as of April 28, 2004
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1
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
99 CENTS ONLY STORES
CONSOLIDATED BALANCE SHEETS
(Amounts In Thousands, Except Share Data)
(UNAUDITED)
ASSETS
MARCH 31, DECEMBER 31,
2004 2003
----------- --------------
CURRENT ASSETS:
Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 393 $ 318
Short-term investments. . . . . . . . . . . . . . . . . . . 135,921 145,670
Accounts receivable, net of allowance for doubtful accounts
of $143 as of March 31, 2004 and December 31, 2003. . . . 2,447 2,245
Income tax receivable . . . . . . . . . . . . . . . . . . . - 841
Deferred income taxes . . . . . . . . . . . . . . . . . . . 15,927 15,927
Inventories . . . . . . . . . . . . . . . . . . . . . . . . 116,189 107,409
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,520 2,717
----------- --------------
Total current assets. . . . . . . . . . . . . . . . . . . 274,397 275,127
PROPERTY AND EQUIPMENT, at cost:
Land. . . . . . . . . . . . . . . . . . . . . . . . . . . . 42,645 35,680
Building and improvements . . . . . . . . . . . . . . . . . 57,867 53,590
Leasehold improvements. . . . . . . . . . . . . . . . . . . 107,945 100,666
Fixtures and equipment. . . . . . . . . . . . . . . . . . . 58,051 56,124
Transportation equipment. . . . . . . . . . . . . . . . . . 3,355 3,217
Construction in progress. . . . . . . . . . . . . . . . . . 24,387 35,279
----------- --------------
Total properties, fixtures and equipment. . . . . . . . . 294,250 284,556
Accumulated depreciation and amortization . . . . . . . . . (89,410) (81,991)
----------- --------------
Total net property and equipment. . . . . . . . . . . . . 204,840 202,565
OTHER ASSETS:
Deferred income taxes . . . . . . . . . . . . . . . . . . . 9,717 9,717
Long-term investments in marketable securities. . . . . . . 63,625 52,789
Deposits. . . . . . . . . . . . . . . . . . . . . . . . . . 539 534
Long-term investments in partnerships . . . . . . . . . . . - 4,366
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,036 8,140
----------- --------------
81,917 75,546
----------- --------------
$ 561,154 $ 553,238
=========== ==============
The accompanying notes are an integral part of these consolidated financial statements.
2
99 CENTS ONLY STORES
CONDOLIDATED BALANCE SHEETS
(Amounts In Thousands, Except Share Data)
(UNAUDITED)
LIABILITIES AND SHAREHOLDERS' EQUITY
MARCH 31, DECEMBER 31,
2004 2003
---------- -------------
CURRENT LIABILITIES:
Current portion of capital lease obligation. . . . . . . . $ 40 $ 40
Accounts payable . . . . . . . . . . . . . . . . . . . . . 14,889 27,903
Accrued expenses:
Payroll and payroll-related. . . . . . . . . . . . . . . 4,061 3,592
Sales tax. . . . . . . . . . . . . . . . . . . . . . . . 3,636 4,749
Other. . . . . . . . . . . . . . . . . . . . . . . . . . 11,855 4,622
Worker's compensation. . . . . . . . . . . . . . . . . . . 16,329 16,319
Income taxes payable . . . . . . . . . . . . . . . . . . . 4,255 -
---------- -------------
Total current liabilities. . . . . . . . . . . . . . . . 55,065 57,225
---------- -------------
LONG-TERM LIABILITIES:
Deferred compensation liability. . . . . . . . . . . . . . 2,279 2,114
Deferred rent. . . . . . . . . . . . . . . . . . . . . . . 2,520 2,460
Capitalized lease obligation, net of current portion . . . 1,542 1,553
---------- -------------
Total long-term liabilities. . . . . . . . . . . . . . . 6,341 6,127
---------- -------------
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-100,000,000 shares
Issued and outstanding 72,086,028 at March 31, 2004 and
72,032,788 at December 31, 2003. . . . . . . . . . . . 211,470 210,893
Retained earnings. . . . . . . . . . . . . . . . . . . . . 288,278 278,993
---------- -------------
499,748 489,886
---------- -------------
$ 561,154 $ 553,238
========== =============
The accompanying notes are an integral part of these consolidated financial statements.
3
99 CENTS ONLY STORES
CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED MARCH 31, 2004 AND MARCH 31, 2003
(Amounts In Thousands, Except Per Share Data)
(Unaudited)
MARCH 31,
2004 2003
----------- ---------
NET SALES:
99 Cents Only Stores. . . . . . . . . . . . . . . . $ 218,812 $184,713
Bargain Wholesale . . . . . . . . . . . . . . . . . 11,238 11,710
----------- ---------
230,050 196,423
COST OF SALES . . . . . . . . . . . . . . . . . . . . 138,417 117,025
----------- ---------
Gross profit. . . . . . . . . . . . . . . . . . . . 91,633 79,398
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:
Operating expenses. . . . . . . . . . . . . . . . . 70,518 51,349
Depreciation and amortization . . . . . . . . . . . 7,453 5,134
----------- ---------
77,971 56,483
Operating income. . . . . . . . . . . . . . . . . . 13,662 22,915
----------- ---------
OTHER (INCOME) EXPENSE:
Interest income . . . . . . . . . . . . . . . . . . (1,627) (866)
Interest expense. . . . . . . . . . . . . . . . . . 31 32
Other . . . . . . . . . . . . . . . . . . . . . . . - (360)
----------- ---------
(1,596) (1,194)
Income before provision for income taxes. . . . . . 15,258 24,109
PROVISION FOR INCOME TAXES. . . . . . . . . . . . . . 5,973 9,500
----------- ---------
NET INCOME. . . . . . . . . . . . . . . . . . . . . . $ 9,285 $ 14,609
=========== =========
EARNINGS PER COMMON SHARE:
Basic . . . . . . . . . . . . . . . . . . . . . . . $ 0 13 $ 0 21
Diluted . . . . . . . . . . . . . . . . . . . . . . $ 0 13 $ 0 20
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING:
Basic . . . . . . . . . . . . . . . . . . . . . . . 72,064 70,469
Diluted . . . . . . . . . . . . . . . . . . . . . . 72,717 71,536
The accompanying notes are an integral part of these consolidated financial statements.
4
99 CENTS ONLY STORES
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 2004 AND 2003
(Amounts in Thousands)
(Unaudited)
MARCH 31,
2004 2003
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income. . . . . . . . . . . . . . . . . . . . $ 9,285 $ 14,609
Adjustment to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization . . . . . . . . . 7,453 5,134
Tax benefit from exercise of non-qualified
employee stock options . . . . . . . . . . . . 193 847
Changes in assets and liabilities associated with
operating activities:
Accounts receivable . . . . . . . . . . . . . . (202) 83
Inventories . . . . . . . . . . . . . . . . . . (8,780) (3,346)
Other assets. . . . . . . . . . . . . . . . . . 3,662 (273)
Accounts payable. . . . . . . . . . . . . . . . (13,014) (3,565)
Accrued expenses. . . . . . . . . . . . . . . . 6,589 (622)
Worker's compensation . . . . . . . . . . . . . 10 310
Income taxes. . . . . . . . . . . . . . . . . . 5,096 3,389
Deferred rent . . . . . . . . . . . . . . . . . 60 60
Deferred compensation . . . . . . . . . . . . . 165
Due from shareholders . . . . . . . . . . . . . - 497
----------- -----------
Net cash provided by operating activities . . . . . 10,517 17,123
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment . . . . . . . (9,728) (35,385)
Net sales (purchases) of short-term and long-term
investments . . . . . . . . . . . . . . . . . . (1,087) 9,434
Investment in partnerships. . . . . . . . . . . . - 36
----------- -----------
Net cash used in investing activities . . . . . . . (10,815) (25,915)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of capital lease obligation. . . . . . . (11) (11)
Proceeds from exercise of stock options . . . . . 384 1,107
----------- -----------
Net cash provided by financing activities . . . . . 373 1,096
----------- -----------
NET (DECREASE) INCREASE IN CASH . . . . . . . . . . 75 (7,696)
CASH, beginning of period . . . . . . . . . . . . . 318 7,985
----------- -----------
CASH, end of period . . . . . . . . . . . . . . . . $ 393 $ 289
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest. . . . . . . . . . . . . . $ 33 $ 32
----------- -----------
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, 2003 audited financial statements and notes thereto
included in the Company's Form 10-K filed March 15, 2004. 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
All but 47 of our 198, 99 Cents Only Stores are located in California. The
Company operates 10 stores in Las Vegas, Nevada, 16 stores in Arizona and 21
stores in 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 year. "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
month period ended March 31, 2004 and 2003 follows:
3 MONTHS ENDED
------------------------
MARCH 31,
------------------------
2004 2003
----------- -----------
Weighted average number of common shares
outstanding-Basic. . . . . . . . . . . . . . . 72,064 70,469
Dilutive effect of outstanding stock options . . 653 1,067
-------- ------
Weighted average number of common shares
outstanding-Diluted. . . . . . . . . . . . . . 72,717 71,536
======== ======
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 Statement of Financial
Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation,"
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 month periods ended March
31, 2004 and 2003:
6
(Amounts in thousands, except for per
share data)
3 MONTHS ENDED 3 MONTHS ENDED
MARCH 31, MARCH 31,
2004 2003
--------------- ---------------
Net income, as reported . . . . . $ 9,285 $ 14,609
Additional compensation expense . 2,160 267
--------------- ---------------
Pro forma net income. . . . . . . $ 7,125 $ 14,342
=============== ===============
Earnings per share:
Basic-as reported . . . . . . . . $ 0.13 $ 0.21
Basic-pro forma . . . . . . . . . $ 0.10 $ 0.20
Diluted-as reported . . . . . . . $ 0.13 $ 0.20
Diluted-pro forma . . . . . . . . $ 0.10 $ 0.20
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 ENDED 3 MONTHS ENDED
MARCH 31, MARCH 31,
2004 2003
--------------- ---------------
Risk free interest rate . . . . . 4.01% 1.90%
Expected life . . . . . . . . . . 5.1 Years 10 Years
Expected stock price volatility . 49% 46%
Expected dividend yield . . . . . None None
3. 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 March
31, 2004 and December 31, 2003, the fair value of investments equal the carrying
values and were invested as follows (amounts in thousands):
MATURITY MATURITY
---------- ----------
MARCH 31, WITHIN 1 1 YEAR OR DEC. 31, WITHIN 1 1 YEAR OR
---------- --------- ---------- --------- --------- ----------
2004 YEAR MORE 2003 YEAR MORE
---------- --------- ---------- --------- --------- ----------
Municipal Bonds and
Federal Agency
Bonds . . . . . . . . $ 101,100 $ 62,428 $ 38,672 $ 89,010 $ 59,271 $ 29,739
Corporate Securities. 42,328 17,375 24,953 39,451 16,401 23,050
Commercial Paper. . . 56,118 56,118 - 69,998 69,998 -
---------- --------- ---------- --------- --------- ----------
$ 199,546 $ 135,921 $ 63,625 $ 198,459 $ 145,670 $ 52,789
========== ========= ========== ========= ========= ==========
4. NEW AUTHORITATIVE PRONOUNCEMENTS
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable
Interest Entities." FIN No. 46 establishes a new and far-reaching consolidation
accounting model. Although FIN No. 46 was initially focused on special purpose
entities, the applicability of FIN No. 46 goes beyond such entities, regardless
of whether the Company has voting or ownership control of such entities. In
response to a number of comment letters and implementation questions, in
December 2003 the FASB issued FIN No. 46R, which delays the effective date of
FIN No. 46 for certain entities until March 31, 2004, and provides clarification
regarding other implementation issues. The Company adopted Fin No. 46R in its
quarter ending March 31, 2004. Adoption of Fin No. 46R has not had a significant
impact on the Company's financial position or results of operations.
5. RELATED-PARTY TRANSACTIONS
The Company leases certain retail facilities from its principal
shareholders. Rental expense for these facilities was approximately $1.9
million, $2.2 million, and $2.1 million in 2001, 2002 and 2003, respectively.
Rent expense for the three months ended March 31, 2004 and 2003 was $0.5 million
in both periods. In addition, one of the Company's outside directors is a
trustee of a trust that owns a property on which a single
7
99 Cents Only Store is located. Rent expense on this store amounted to $0.3
million in each of 2001, 2002 and 2003.
Effective September 30, 2000, the Company sold its discontinued operation,
Universal International, Inc. to a company owned 100% by Dave and Sherry Gold,
both significant shareholders of 99 Cents Only Stores. The sale price consisted
of $33.9 million in cash and was collected at closing. These proceeds were
invested in the Company's investment accounts. Mr. Gold is also CEO and
Chairman of 99 Cents Only Stores. In connection with this sale a management
services and lease agreement was entered into between Universal and the Company.
The service agreement provided for the Company to render certain administrative
services to Universal, including information technology support, accounting,
buying and human resource functions. The Company charged Universal management
fees for these services. The lease agreement involved the property that served
as Universal's primary warehouse and distribution facility. The lease was
structured on a triple net basis and provided for rental payments of $120,000
per month. Resolution of Universal post closing business issues required the
extension of the service agreement and lease arrangement with 99 Cents Only
Stores to December 2003. The service and lease agreements with Universal ended
as of December 15, 2003 and there are no remaining amounts due to or from
Universal under these agreements.
The following is a summary of the transactions between the Company and
Universal for 2001, 2002 and 2003 and a reconciliation of amounts due to/from
shareholder resulting from such transactions (amounts in thousands):
BALANCE (TO)
MANAGEMENT RENTAL INVENTORY INVENTORY PAYMENTS FROM
YEAR FEES INCOME SALES TO PURCHASES FROM RECEIVED SHAREHOLDER END
UNIVERSAL UNIVERSAL OF PERIOD
2001 $ 3,695 $ 1,440 $ 4,693 - ($11,483) ($1,655)
2002 $ 1,500 $ 1,440 - ($460) $ 407 $ 1,232
2003 $ 1,440 $ 1,380 - - ($4,052) -
2004 - - - - - -
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 and exporters.
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, 2003. 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 transfer at cost through its
inventory accounts.
At March 31, 2004, the Company had no customers representing more than 4.0%
of Bargain Wholesale's net sales. Substantially all of the Company's net sales
were to customers located in the United States.
8
Reportable segment information for the three month periods ended March 31,
2004 and 2003 follows (amounts in thousands):
THREE MONTHS ENDED
MARCH 31 RETAIL WHOLESALE TOTAL
-------- ---------- --------
2004
- -----
Net sales. . . . . $218,812 $ 11,238 $230,050
Gross margin . . . 89,406 2,227 91,633
2003
- -----
Net sales. . . . . $184,713 $ 11,710 $196,423
Gross margin . . . 77,084 2,314 79,398
7. CONTINGENCIES
A lawsuit is pending, filed by the Gillette Company against the Company,
arising out of a dispute over the interpretation of a contract between the
parties. Gillette, which is suing for breach of contract, alleges that the
Company owes Gillette an additional principal sum of approximately $2.1 million
(apart from the approximately $1 million already paid to Gillette), plus fees,
costs and interest. Also pending is a cross-complaint by the Company against
Gillette, alleging breach of contract, fraud and unfair business acts. The
Company expects a decision in this matter some time in the second quarter of
2004. It also expects that the decision will be appealed by one or both sides.
In view of the inherent difficulty of predicting the outcome of legal
matters of this nature, the Company cannot state with confidence what the
eventual outcome of this matter will be. Based on current knowledge, this matter
is not presently expected to have a material adverse effect on the Company's
financial condition or liquidity, but it could have a material adverse effect on
the Company's results of operations for the accounting period or periods in
which it might be resolved.
On May 7, 2003, the plaintiff, a former Store Manager, filed a putative
class action on behalf of himself and others similarly situated. The suit
alleges that the Company improperly classified Store Managers in the Company's
California stores as exempt from overtime requirements as well as meal/rest
period and other wage and hour requirements imposed by California law. Each
store typically has one Store Manager and two or three Assistant Store
Managers. Pursuant to the California Labor Code, the suit seeks to recover
unpaid overtime compensation, penalties for failure to provide meal and rest
periods, waiting time penalties for former employees, interest, attorney fees,
and costs. The suit also charges, pursuant to California's Business and
Professions Code section 17200, that the Company engaged in unfair business
practices by failing to make such payments, and seeks payment of all such wages
(in the form of restitution) for the four-year period preceding the filing of
the case through the present. Plaintiff is now seeking leave to file an amended
complaint that would (1) expand the class to include not only all current and
former Store Managers who worked for the Company from May 7, 1999 but also
all current and former Assistant Managers who worked for the Company during the
same period; and (2) add claims for additional penalties on behalf of all
purported class members under California's new Labor Code Private Attorney
General Act of 2004. The parties are currently in settlement negotiations, and
the Company has provided a reserve of $6.0 million for this matter in the
quarter ending March 31, 2004.
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. During the three month period
ended March 31, 2004, 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 increased its net sales, operating income and income
from continuing operations in each year from 1999 to 2002. In 2003, 99 Cents
Only Stores had net sales of $862.5 million, operating income of $87.4 million
and net income of $56.5 million. Sales increased 20.8% over 2002. Operating
income and net income decreased 3.4% and 4.1% respectively from 2002. From 2000
through 2003, the Company had a compound annual growth rate in net sales,
operating income and net income of 24.0%, 13.4% and 14.3%, respectively. For the
three months ended March 31, 2004, 99 Cents Only Stores had net sales of $230.1
million, operating income of $13.7 million and net income of $9.3 million.
Operating income and net income decreased 40.4% and 36.4%, respectively, for the
first quarter of 2004 compared to the first quarter of 2003.
During the three year period ending December 31, 2003, average net sales
per estimated saleable square foot (computed for 99 Cents Only Stores open for
the full year) declined from $318 per square foot to $308 per square foot. This
trend reflects the Company's determination to target larger locations for new
store development. Existing stores average approximately 21,500 gross square
feet. From January 1, 2001 through December 31, 2003, the Company opened 92 new
stores (including one relocation in 2001) that average approximately 24,700
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. During the three years ending December 31, 2003,
average net sales per store (computed for 99 Cents Only Stores open for the full
year) increased from $4.5 million to $4.9 million.
The Company's management believes that future growth will primarily result
from new store openings facilitated by growth in our existing territories and
expansion into new territories. The Company has now expanded into Texas, and
expects to continue to open new stores in Texas as well as in California, Nevada
and Arizona. The Company believes that its concept of consistently offering a
broad selection of name-brand consumables, at value pricing, in a convenient
store format is portable to most other densely populated areas of the country.
The Company considers lease acquisitions or purchase opportunities as they
become known to the Company and may make acquisitions of a chain, or chains, of
clustered retail sites in densely populated regions, primarily for the purpose
of acquiring favorable store locations. See Risk Factor "We depend mainly on
new store openings outside of our traditional core market of Southern California
for future growth."
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, long-lived asset impairments, 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:
LONG-LIVED ASSET IMPAIRMENTS: The Company records impairments when the
carrying amounts of long-lived assets are determined not to be recoverable.
Impairment is assessed and measured by an estimate of undiscounted 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 impairment charges may be required should such changes occur.
SELF-INSURANCE RESERVES: The Company is self-insured in relation to
worker's compensation claims in California. The Company provides for losses of
estimated known and incurred but not reported claims and actuarial valuations.
Should a greater amount of claims occur compared to the estimates, reserves
recorded may not be sufficient and additional expenses, which may be
significant, could be incurred. The Company does not discount for the time value
of money in its projected future cash outlays for its existing workers
compensation claims.
10
UNIVERSAL INTERNATIONAL (DISCONTINUED OPERATIONS)
In December 1999, the Company determined it would be in its best interest,
and that of its shareholders, to focus its efforts on increasing the growth rate
of 99 Cents Only Stores. In conjunction with its revised growth strategy, the
Company decided to sell its Universal International, Inc. and Odd's-n-End's,
Inc. subsidiaries (together "Universal"). Universal operated a multi-price point
variety chain, with 65 stores located in the Midwest, Texas and New York, under
the trade names Only Deals and Odd's-N-End's. Among other factors at that time,
the Company considered its successful opening of its first 99 Cents Only Stores
outside of Southern California, in Las Vegas, Nevada. Given the success of the
Las Vegas, Nevada stores, the Company believed that the 99 Cents Only Stores
concept was portable to areas outside of Southern California. As a result, the
Company has focused greater management resources to increasing its store growth
rate and expanding aggressively into Nevada, Arizona and, in 2003, Texas.
The Company adopted a definitive plan to sell Universal within one year, as
set forth by guidelines for the accounting treatment of discontinued operations.
The Company engaged an investment-banking firm to evaluate and identify
potential buyers for the Universal business and expected to sell Universal
within the one-year time frame from when the Company classified Universal as a
discontinued operation. The investment banking firm's marketing process focused
upon selling the business as a going concern. From June 2000 through August
2000, sales presentations were delivered to both strategic buyers and financial
buyers. This process did not generate the expected interest level from potential
buyers that had been anticipated. The highest offer for the Universal business
was significantly less than the Company's expectations. As a result of the
difficulties encountered in trying to sell Universal and the necessity to
complete the process by December 31, 2000, it was decided by the Board of
Directors to be in the Company's and the shareholders' best interest to sell
Universal for the Company's carrying value as of the close of business on
September 30, 2000 to Universal Deals, Inc. and Universal Odd's-n-End's, Inc.,
both of which are owned 100% by David and Sherry Gold, both significant
shareholders of 99 Cents Only Stores. Mr. Gold is also Chairman and CEO of 99
Cents Only Stores. The sale was effective as of the close of business on
September 30, 2000. The purchase price for Universal was paid in cash and was
equal to the Company's carrying book value of the assets of Universal at
September 30, 2000 or $33.9 million. The net assets at September 30, 2000
included $29.2 million in inventory, net fixed assets of $7.6 million and $0.6
million of other assets. These assets were offset by $3.5 million of accounts
payable, accrued and other liabilities. In connection with this transaction, 99
Cents Only Stores provided certain ongoing administrative services to Universal
in 2000 and 2001 pursuant to a service agreement for a management fee of 6% of
Universal sales revenues. During fiscal year 2000, the Company recorded an
additional net loss from discontinued operations of $1.1 million, net of tax
benefit of $0.7 million, for operating losses incurred through the date of sale,
in excess of the amounts originally provided in 1999. In the fourth quarter of
2000, the Company received $1.3 million in management fees under the service
agreement with Universal. The Company also received $0.4 million in lease
payments for rental of a distribution facility to Universal. During 2001, the
Company received $3.7 million in fees under the service agreement, $1.4 million
in lease payments and sold $4.7 million in merchandise at a 10% mark-up. In 2002
the Company received $1.5 million in management fees under the service agreement
from Universal and $1.4 million in lease payments. It also purchased $0.4
million of closeout inventory from Universal. During 2003 the Company received
$1.4 million in management fees under the service agreement from Universal and
$1.4 million in lease payments. The service and lease agreements with Universal
ended as of December 15, 2003 and there are no remaining amounts due to or from
Universal under these agreements.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2004 COMPARED TO THREE MONTHS ENDED MARCH 31, 2003
NET SALES: Net sales increased $33.6 million, or 17.1%, to $230.1 million
in the first quarter of 2004, from $196.4 million in the first quarter 2003.
Retail sales increased $34.1 million to $218.8 million in the 2004 period from
$184.7 million in the 2003 period. The nine net new stores opened in the first
three months of 2004 added $6.2 million in sales. The full quarter effect of 38
net new stores opened in 2003 increased sales $27.5 million in the first quarter
of 2004. Comparable store sales increased 0.2% in the quarter. Bargain Wholesale
first quarter 2004 net sales were $11.2 and were $0.5 million less than the
quarter ended March 31, 2003. This decline in the wholesale business results
from generally weaker sales and economic conditions for the Company's small
regional retail customers.
GROSS PROFIT: Gross profit increased approximately $12.2 million, or 15.4%,
to $91.6
11
million in the 2004 period from $79.4 million in the 2003 period. Overall gross
profit margin was 39.8% in the 2004 period versus 40.4% in the 2003 period.
Gross margin percentage was impacted by 0.4% due to the increase in the grocery
sales mix. Volume variances on health and beauty care and on import items
including house-wares had a 0.4% impact on gross margin. Wholesale gross margin
declined $0.1 million on lower sales volume.
OPERATING EXPENSES: SG&A increased by $19.2 million, or 37.3%, to $70.5
million in the 2004 period from $51.3 million in the 2003 period. Retail store
expenses increased $9.7 million on the addition of 44 more stores over first
quarter 2003. Distribution costs increased $3.2 million. Distribution costs
include $1.0 million for the Texas operation, a $1.2 million increase in
delivery costs to the stores and a $1.0 million increase in labor. Other
administrative costs increased $6.3 million, which includes a $6.0 million
litigation reserve. As a percentage of net sales, total SG&A increased to 30.7%
from 26.2% in the 2003 period.
DEPRECIATION AND AMORTIZATION: Depreciation and amortization increased $2.3
million on the addition of 44 more stores over first quarter 2003 and the
addition of the Texas warehouse and the frozen and refrigerated facility.
OPERATING INCOME: As a result of the items discussed above, operating
income was $13.7 million in the 2004 period, a decrease of $9.2 million.
Operating margin was 5.9% in the 2004 period versus 11.6% in the 2003 period.
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 $1.6 million in the 2004 period and $0.9
million in the 2003 period. This difference in interest income results from
valuation gains and interest rate variations. The Company had no bank debt
during the three months ended March 31, 2004 or 2003. At March 31, 2004, the
Company held $135.9 million in short-term investments and $63.6 million in
long-term investments. The Company's short-term and long-term investments are
comprised primarily of investment grade federal and municipal bonds and
commercial paper. Also included in the 2003 period is $0.4 million of income
under a lease agreement with Universal International, Inc., for a distribution
facility. The lease agreement expired as of December 15, 2003.
PROVISION FOR INCOME TAXES: The provision for income taxes was $6.0 million
in the 2004 period compared to $9.5 million in the 2003 period. The effective
rate of the provision for income taxes was approximately 39.2% in 2004 and 39.4%
2003.
NET INCOME: As a result of the items discussed above, net income decreased
$5.3 million to $9.3 million in the 2004 period from $14.6 million in the 2003
period. Net income as a percentage of sales was 4.0% in the 2004 period and 7.4%
in the 2003 period.
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 quarter of 2004 and 2003
was $10.5 and $17.1 million, respectively, consisting primarily of $16.9 million
and $20.6 million of net income, respectively, adjusted for non-cash items. In
the first quarter of 2004, the Company used $6.4 million in working capital and
other activities and in the first quarter of 2003 the Company used $3.5 million
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 $8.8 million and $3.3 million and the reduction of accounts payable of $13.0
million and $3.6 million in the first quarter 2004 and 2003, respectively.
Net cash used in investing activities during the first quarter of 2004 and
2003 was $10.8 and $25.9 million, respectively. In the first quarter of 2004,
the Company used $9.7 million for the purchase of property and equipment and
purchased $1.1 million of investments. In the first quarter of 2003, the Company
used $23.1 million for the purchase
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of a new distribution center in Houston, Texas and $12.3 million for the
purchase other property and equipment for new 2003 stores offset by $9.4 million
from the sale of investments in marketable securities.
Net cash provided by financing activities during the first quarter of 2004
and 2003 was $0.4 million and $1.1 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 opened 10 new 99 Cents Only Stores in the first quarter of
2004. The Company plans to open 38 additional new 99 Cents Only Stores in the
remainder of 2004, with 13 in the second quarter, 15 in the third quarter and 10
in the fourth quarter. The average investment per new store opened in 2003,
including leasehold improvements, furniture, fixtures and equipment, inventory
and pre-opening expenses, was approximately $1.1 million and includes 6 stores
that were purchased. The Company does not capitalize pre-opening expenses. The
Company's cash needs for new store openings including acquired properties are
expected to total approximately $54.0 million in 2004. The Company's total
planned capital expenditures in 2004 for additions to fixtures and leasehold
improvements of existing stores as well as for distribution and transportation
equipment, information systems, expansion and replacement will be approximately
$26.0 million. The Company believes that its total capital expenditure
requirements (including new store openings) will approximate $80.0 million in
2004. The Company intends to fund its liquidity requirements in 2004 out of net
cash provided by operations, short-term investments and cash on hand.
CONTRACTUAL OBLIGATIONS
The following table summarizes our consolidated contractual obligations (in
thousands) as of March 31, 2004.
Less 1-3 3-5 More
------- ------- ------- --------
than Years Years than
------- ------- ------- --------
Contractual obligations Total 1 Year 5 Years
-------- ------- --------
Capital lease obligations $ 1,582 $ 40 $ 490 $ 398 $ 654
Operating lease obligations 147,070 20,126 46,174 34,408 46,362
Other long-term liabilities
reflected on the Company's
balance sheet under GAAP 2,279 - - - 2,279
-------- ------- ------- ------- --------
Total $150,931 $20,166 $46,664 $34,806 $ 49,295
======== ======= ======= ======= ========
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 2018. 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 month period ended March 31, 2004 and 2003 were $9.4 million and $7.3
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
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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 and healthcare costs" for a discussion of additional risks
attendant to inflationary conditions.
WE DEPEND MAINLY ON NEW STORE OPENINGS OUTSIDE OF OUR TRADITIONAL CORE MARKET OF
SOUTHERN CALIFORNIA FOR FUTURE GROWTH
Our sales and operating income growth results depend largely on our ability
to open and operate new stores outside of our traditional core market of
Southern California successfully and to manage a larger business profitably. In
2002 and 2003, we opened 28 and 38 99 Cents Only Stores, respectively. 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, successfully compete against local competition, 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, competition, 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 47 of our 198, 99 Cents Only Stores are located in
California. We operate 10 stores in Las Vegas, Nevada, 16 stores in Arizona and
21 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
14
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.
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. We recorded net
inventory value of $116.2 million and $107.4 million at March 31, 2004 and
December 31, 2003, respectively. 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. 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 we do. 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 AND HEALTHCARE COSTS
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 healthcare costs;
- - increases in workers' compensation benefits;
- - increases in prevailing wage levels;
- - increases in legal costs;
- - increases in government regulatory cost and
- - decreases in consumer confidence levels.
In January 2001, California enacted a minimum wage increase of $0.50 per
hour with
15
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.
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 $2.2 and
$2.1 million in each of 2002 and 2003. 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 2002 and 2003, we generated approximately 29.5% and 28.7%,
respectively, of our net sales and approximately 32.7% and 26.6% 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:
16
- - 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;
- - 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 March 31,
2004, we leased all but 30 of our stores and own three 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 December 31, 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to interest rate risk for its investments in
marketable securities. At March 31, 2004, the Company had $199.5 million in
marketable securities maturing at various dates through November 2009. The
Company's investments are comprised
17
primarily of investment grade federal and municipal bonds and commercial paper.
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 March 31, 2004, 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 March 31, 2004. 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 AND FINANCIAL REPORTING PROCEDURES
There have been no changes in our internal controls over financial
reporting that materially affected or are reasonably likely to materially affect
our internal control over financial reporting during the quarter ended March 31,
2004.
SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION
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
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" (including, without limitation, the section titled "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, 2003.
18
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
A lawsuit is pending, filed by the Gillette Company against the Company,
arising out of a dispute over the interpretation of a contract between the
parties. Gillette, which is suing for breach of contract, alleges that the
Company owes Gillette an additional principal sum of approximately $2.1 million
(apart from the approximately $1 million already paid to Gillette), plus fees,
costs and interest. Also pending is a cross-complaint by the Company against
Gillette, alleging breach of contract, fraud and unfair business acts. The
Company expects a decision in this matter some time in the second quarter of
2004. It also expects that the decision will be appealed by one or both sides.
In view of the inherent difficulty of predicting the outcome of legal
matters of this nature, the Company cannot state with confidence what the
eventual outcome of the preceding matter will be. Based on current knowledge,
this matter is not presently expected to have a material adverse effect on the
Company's financial condition or liquidity, but it could have a material adverse
effect on the Company's results of operations for the accounting period or
periods in which it might be resolved.
On May 7, 2003, the plaintiff, a former Store Manager, filed a putative
class action on behalf of himself and others similarly situated. The suit
alleges that the Company improperly classified Store Managers in the Company's
California stores as exempt from overtime requirements as well as meal/rest
period and other wage and hour requirements imposed by California law. Each
store typically has one Store Manager and two or three Assistant Store
Managers. Pursuant to the California Labor Code, the suit seeks to recover
unpaid overtime compensation, penalties for failure to provide meal and rest
periods, waiting time penalties for former employees, interest, attorney fees,
and costs. The suit also charges, pursuant to California's Business and
Professions Code section 17200, that the Company engaged in unfair business
practices by failing to make such payments, and seeks payment of all such wages
(in the form of restitution) for the four-year period preceding the filing of
the case through the present. Plaintiff is now seeking leave to file an amended
complaint that would (1) expand the class to include not only all current and
former Store Managers who worked for the Company from May 7, 1999 but also
all current and former Assistant Managers who worked for the Company during the
same period; and (2) add claims for additional penalties on behalf of all
purported class members under California's new Labor Code Private Attorney
General Act of 2004. The parties are currently in settlement negotiations and
the Company has provided a reserve of $6.0 million for this matter in the
quarter ending March 31, 2004.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF 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.
19
b. Reports on Form 8-K
Report on Form 8-K filed January 9, 2004; Item 12 reported.
Report on Form 8-K filed February 4, 2004; Item 12 reported.
Report on Form 8-K filed March 12, 2004; Item 12 reported.
Amendment to Report on Form 8-K filed March 12, 2004; Item
12 reported, amending Form 8-K filed March 12, 2004.
Report on Form 8-K filed March 18, 2004; Item 12 reported.
20
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: April 29, 2004 /s/ Andrew A. Farina
--------------------
Andrew A. Farina
Chief Financial Officer
(Duly Authorized Officer)
21