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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 26, 1999
Commission File Number 0-24543
COST-U-LESS, INC.
(Exact Name of Registrant as Specified in its Charter)
Washington 91-1615590
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
12410 S.E. 32nd Street, Bellevue, Washington 98005
(Address of Principal Executive Offices): (Zip Code)
(425) 644-4241
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock
Cumulative Preference Shares, First Series
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Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of the voting and nonvoting stock held by non-
affiliates of the registrant at March 18, 2000 was approximately $5,912,000.
The number of shares of the registrant's Common Stock outstanding at March
18, 2000 was 3,576,858.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of this Report, to the extent not set
forth herein, is incorporated herein by reference from the Registrant's
definitive proxy statement relating to the annual meeting of stockholders to
be held on May 18, 2000, which definitive proxy statement shall be filed with
the Securities and Exchange Commission within 120 days after the end of the
fiscal year to which this Report relates.
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PART I
When used in this Annual Report, the words "believes," "anticipates" and
"intends" and similar expressions are intended to identify forward-looking
statements. Such statements are subject to certain risks and uncertainties
that could cause actual results to differ materially from those projected. See
"Business--Important Factors Regarding Forward-Looking Statements." Readers
are cautioned not to place undue reliance on these forward-looking statements,
which speak only as of the date hereof. The Company undertakes no obligation
to publicly release any revisions to these forward-looking statements that may
be made to reflect events or circumstances after the date hereof or to reflect
the occurrence of unanticipated events. Readers are urged, however, to review
the factors set forth in reports the Company files from time to time with the
Securities and Exchange Commission.
Item 1. Business
Overview
Cost-U-Less operates 13 mid-sized warehouse club-style stores in the U.S.
States, U.S. Territories and foreign island countries. The Company's primary
strategy is to operate on remote island markets, offering predominately U.S.
branded goods.
The Company opened its first retail warehouse store in 1989 in Maui, Hawaii.
In 1992, the Company began to expand by opening stores in relatively remote
island locations, such as Guam. After experiencing success with its mid-sized
store concept, the Company began experimenting in late 1992 with similar
stores in various mainland markets while continuing to open stores in island
markets. Facing increasing competition from larger discount retailers and
warehouse clubs in its mainland markets, management decided in 1995 to return
its focus to its core island markets. In 1996, the Company continued the
process of closing five of its six mainland stores, which was completed in
1997. In 1998, the Company opened two new stores in Fiji.
During 1999, new stores were opened in Curacao, Netherlands Antilles on
March 2, Rotorua, New Zealand on November 18, and Porirua, New Zealand on
December 9. As of December 26, 1999, the Company operated a total of thirteen
stores: two in Hawaii, two in Guam, one in St. Thomas, one in St. Croix, one
in American Samoa, two in Fiji, one in Curacao, Netherlands Antilles, one in
Sonora, California, and two in New Zealand. The Company established buying
offices in Auckland, New Zealand in 1998 and Sydney, Australia in 1999, to
support the New Zealand and Fiji stores. Construction is presently under way
for a 36,000 square-foot store in St. Maarten, which is expected to open in
third quarter 2000.
On September 1, 1999, J. Jeffrey Meder joined the Company as President and
Chief Executive Officer. He replaced Michael J. Rose, the Company's founder
and former Chief Executive Officer, who remained as Chairman of the Board. Mr.
Meder was formerly President and Chief Executive Officer of Western Drug
Distributors, Inc., which operated 20 Drug Emporium retail stores located in
the Pacific Northwest region of the U.S. Also in September 1999, Roy Sorensen
was appointed Vice President and Chief Financial Officer, replacing Allan C.
Youngberg. Mr. Sorensen was formerly Chief Financial Officer and Treasurer of
Western Drug Distributors, Inc., which sold its 20 retail drug stores to Longs
Drugs in July 1998.
Industry Overview
Traditional warehouse clubs such as Costco Companies, Inc. ("Costco"), BJ's
Wholesale Club, Inc. and Sam's Club, a division of Wal-Mart Stores, Inc.
("Wal-Mart"), focus on both retail and small-business customers, with store
formats averaging approximately 115,000 square feet. These retailers typically
(i) offer a range of national brand and selected private label products at low
prices, often in case, carton or multiple-pack quantities, (ii) provide no-
frills, self-service warehouse facilities with pallet-stacked product aisles,
and (iii) charge annual membership fees. Although the Company employs many of
the retailing methods of the larger participants in the warehouse club
industry, the Company operates smaller stores (averaging approximately
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31,000 square feet), does not charge a membership fee, typically locates its
stores in smaller geographic areas with less concentrated population centers,
and relies to a greater degree on long-haul water transportation than do such
companies.
While the typical U.S. warehouse club customer has virtually unlimited
access to popular U.S. brand-name products, the Company believes these
products are carried by relatively few local retailers in a number of island
markets. As a result, a strong yet largely unsatisfied demand for certain U.S.
branded products may exist. Moreover, island markets often demonstrate unique
consumer preferences which typically require retailers to conduct local
research and incorporate flexible merchandise purchasing policies in order to
offer a diverse selection of local products, as well as popular U.S. brand-
name products.
Business Strategy
The Company's business strategy is to enter small island markets ahead of
large warehouse club competitors, select markets familiar with the warehouse
club concept, offer U.S. goods where availability of such goods is minimal and
significant demand exists, leverage island-operations expertise, utilize
modern systems and merchandising methods, offer competitive prices while
maintaining attractive margins, and provide a local product mix while
benefiting from low overhead costs.
Expand to New Markets. The Company intends to pursue future growth by
expanding into relatively untapped island markets, particularly in the Pacific
and Caribbean regions. The pace at which the company will open new stores will
be dictated by its strategic planning process, which is currently being re-
examined in light of experiences gained in recent store openings. The Company
plans to refine its expansion efforts to focus on markets with high U.S. brand
awareness and demand, as well as other attributes that typify its most
successful stores. A new store is planned to open in St. Maarten, which the
Company believes meets these key attributes, in third quarter 2000.
The Company's recently opened stores in Fiji and New Zealand have performed
below expectations. In Fiji, a lack of adequate U.S. brand awareness and
acceptance, along with local economic issues, has resulted in weak sales
volume. In New Zealand, the Company introduced what it believed to be the
first warehouse club concept to a significantly larger but more competitive
marketplace, with strong customer loyalty to many regional products that
compete with U.S. brands. As a result, sales in New Zealand have also been
below expectations. While the Company is aggressively taking steps to reduce
overhead expenses, improve product mix, place experienced managers on site,
and increase promotion activity, there is no assurance as to whether or when
these actions may improve sales and profitability.
Become First Warehouse Style Entrant to Market. By focusing its new store
openings in markets that other warehouse clubs and discount retailers have not
yet entered, the Company believes that it will have the opportunity to achieve
significant market share and develop name recognition and customer loyalty,
thus delaying or discouraging entry by large-format discount competition.
Enter Markets Familiar With Warehouse Concept. The Company plans to seek
markets that have some familiarity with the warehouse club concept. Residents
of potential island markets often gain familiarity with the warehouse club
concept through travel to the U.S. and other markets where warehouse clubs are
present. The presence of this attribute appears to have helped accelerate
market acceptance of Company stores in the past.
Offer U.S. Goods to Meet Market Demand. Markets that have awareness and
acceptance of U.S. goods but have limited access to those goods offer
substantial sales and profit potential. The Company believes procuring U.S.
goods in large volumes and shipping them long distances to island stores are
two of its core competencies.
Leverage Island-Operations Expertise. Through its experience in opening and
operating retail warehouse club-style stores in remote U.S. Territories, the
Hawaiian Islands, and foreign island countries, the Company has
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developed a depth of expertise in dealing with the inherent challenges of
island market operations. The Company has refined a mid-sized building
prototype that is designed to endure severe island weather conditions and that
incorporates low construction costs and easily replicated specifications.
Through its long-standing relationships with steamship lines, the Company
negotiates what it believes to be competitive transportation rates while
selecting efficient shipping routes and utilizing cost-effective freight
handling techniques, including the use of both Company-operated cross-dock
depots and independently operated distribution facilities.
Utilize Modern Systems and Merchandising Methods. The Company believes that
many merchants in its most promising target markets have not adopted modern
retail operating efficiencies and do not have access to vendor network and
distribution channels equivalent to those developed by the Company. The
Company plans to continue making significant investments in its information
systems and communication networks, enabling corporate management and store
buyers to receive daily sales and inventory information and maintain regular
contact with in-store management and employees.
Emphasize Strong Margins While Maintaining Everyday Low Prices. In addition
to providing a pleasant shopping atmosphere, the Company strives to sell its
products at prices that it believes are lower than those offered by its local
island competitors, yet are still above those that could be charged in
mainland markets. By leveraging its retail operating efficiencies, access to
volume-purchasing discounts, and distribution capabilities, the Company
believes it is able to acquire some products at a significantly lower cost
than that paid by other local island retailers. These factors have enabled the
Company historically to achieve higher margins than those achieved by mainland
warehouse clubs and discount retailers.
Use Localized Product Sourcing Yet Derive Benefits of Centralized
Purchasing. The Company conducts market research through its vendors, store
managers and resident employees to ascertain the product preferences of each
particular locale, including which U.S. brands are favored and which regional
and ethnic items are desired. To the extent possible, the Company's buyers
then procure these products through its centralized purchasing department,
thus deriving the benefits of volume purchase discounts, streamlined
distribution and enhanced selection. The remaining products, including locally
produced items that are available only in a particular region, are generally
purchased by store managers and Company buyers directly from suppliers located
in the region.
Market and Site Selection
Due to the cost effectiveness of detailed demographic studies by third-party
consultants, the Company's market analysis is performed in-house. The Company
believes that there are certain key attributes for successful stores, such as
acceptance and demand for U.S. goods, familiarity with the warehouse concept,
and absence of large warehouse club competition. If the demographics for a
targeted location compare favorably with those of its successful island
operations, the Company identifies the target location as a potential site for
expansion. Because of the unavailability of current demographics, estimates of
future sales potential can vary significantly from the lack of data. See
"Important Factors Regarding Forward-Looking Statements--Uncertainties
Associated With Expansion Outside U.S. Territories."
Once the Company identifies a target location as a possible site for its
expansion and is satisfied with the political and regulatory environment in
the target location, the Company compares the prices charged by local
competitors to the prices the Company would need to charge in order to achieve
an acceptable return on its investment (after factoring in cost of the
product, cost of freight, duties, port charges, transportation and taxes). If
the Company's market research indicates that the Company would be able to
charge an adequate price for its products, the Company commences a formal
search for a suitable store site. Desirable attributes of suitable sites
include a central location in a population center, sufficient space for the
Company's facility, including parking and loading docks, access to utilities
and acceptable geological conditions for successful construction.
The Company generally does not intend to own the land or buildings for its
stores. To the extent, however, that the Company believes it to be
advantageous to purchase land for new store sites or to construct new store
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buildings, the Company may use its cash resources or existing financing
sources during the construction period and subsequently attempt to obtain
permanent financing after the stores are opened. The ability of the Company or
its potential future landlords to secure financing for new stores is subject
to the availability of commercial real estate loans; failure to secure
adequate financing on a timely basis would delay or potentially prevent new
store openings.
Store Economics
The Company benefits from attractive store-level economics and favorable
returns on investment at most of its island stores, which it believes will
help drive and support its planned expansion. The Company's nine island stores
that were open during all of fiscal 1999 generated annual average net sales of
approximately $15.5 million, average net sales per square foot of $534,
average annual per store contribution of approximately $860,000, and average
annual per store contribution before depreciation of approximately $968,000.
Store contribution is store gross profit less direct store operating expenses.
The average investment in buildings, equipment and leasehold improvements as
of December 26, 1999 in these nine island stores was approximately $950,000.
The average investment in inventory, net of accounts payable of approximately
50%, was $840,000 at December 26, 1999. The store contribution return on
average island investment for fiscal 1999 was 48%.
Store Layout
The Company has incorporated into its prototype store many standard features
found in domestic warehouse clubs that had not been previously used in many
island markets. Store layout and interior designs were planned and calculated
using computer models, with the goal of maximizing the sales per square foot
and providing uniformity among the stores. Further, the Company believes that
its use of loading docks, comparatively large freezer and refrigeration space
with state-of-the-art equipment, efficient shelving and display racks,
computerized cash registers and inventory tracking systems, and multiple
checkout lanes helps give it a competitive advantage over many island
competitors. Each Company store is outfitted with adjustable metal shelving
that allows the Company to vary the display of its product based on each
location's specific consumer needs. Each island store has backup generators
designed to protect perishables and the store's security system during
disruption of electric service caused by severe weather conditions that can
occur in island markets. Additionally, the Company has designed its prototype
to withstand the severe wind and heavy rain associated with hurricanes,
typhoons and tropical storms.
The Company has used considerable care in developing its store layout, which
features a logical flow to encourage shopping of all departments. When ready
for check out, the customer proceeds to the check-out area in the front of the
store, which usually features 10 lanes. During a typical store visit, the
average customer will spend approximately $47. Various forms of payment are
accepted, including food stamps and debit and credit cards, and credit is
extended to some local businesses and government agencies. Utilizing a no-
frills approach, the stores display items in steel racking, usually on the
vendor's pallets or in open cases, to maximize warehouse space and minimize
labor costs. In-store signage reinforces the basic value image, while stores
generate customer excitement through the use of end-cap displays featuring new
merchandise and special promotions, food demonstrators offering product
samples, and ongoing introduction of new items.
The Company has also attempted to minimize costs through the design of its
prototype. The Company does not use expensive fixtures such as floor tiles and
false ceilings, and thereby lowers construction and maintenance costs. In
addition, the Company's refrigeration supplier has designed specialized
refrigeration units using modern equipment that allows for cost-effective
monitoring, maintenance and repair, and keeps energy costs to a minimum. The
Company has also developed standardized construction specifications. As a
result of the Company's planned expansion and through extensive negotiations
with suppliers, the Company has achieved competitive prices on its building
materials, such as metal exterior panels, building components, store equipment
and shelving, thus allowing the Company to control material costs on a per-
facility basis and help ensure uniformity of materials throughout its
facilities while reducing the Company's lease expenses.
5
Merchandising
The Company typically carries approximately 2,500 stock-keeping units
("SKUs"), compared to the 3,500 to 5,000 SKUs estimated by industry sources to
be carried by traditional warehouse clubs. The stores do not have certain
departments found in most large-format warehouse clubs, such as apparel,
automobile tires and prescription drugs. All stores feature the following main
product categories:
Food-Perishables. Meat, produce, deli, dairy and frozen items represent
approximately 29% of a typical store's net sales. The "reach-in" freezers
and coolers are substantially larger than those found in the stores of most
of the Company's local island competitors.
Food-Non-perishables. Dry grocery goods, including soda, wine, beer,
liquor, candy and snacks, represent approximately 40% of a typical store's
net sales. Also included in this area are ethnic and specialty items
catering to local consumer demands.
Nonfood. Other nonfood items comprise the remaining 31% of a typical
store's net sales, and include tobacco, sundries, health and beauty,
office, hardware, electronics, housewares, furniture and sporting goods.
Purchasing. The Company balances its product mix by providing popular U.S.
brand names together with local ethnic items found in each island region.
Approximately one-third of the Company's items are produced locally or
purchased through local suppliers in each market. The Company has found it
necessary to source a larger percent of product locally for New Zealand and
Fiji stores through local buying offices, so they can carry a larger
assortment of regional and local goods. Offering locally purchased merchandise
enables the Company to better serve its island customers and offer an
innovative variation to the warehouse store format. Store managers are able to
purchase product that may be available only on their particular islands. The
Company's buyers monitor sales and inventory levels on a daily basis from all
of the Company's stores. In an effort to cater to retail customers who
generally purchase products for home use, the Company carries products in
various product sizes, including single packages, "bulk packages" and mid-
sized "value-packs." The Company purchases merchandise from manufacturers and
suppliers on a purchase order basis exclusively.
Pricing. The Company strives to be the "low price leader" for the markets it
serves. The Company does not charge its customers a membership fee, thereby
allowing all consumers to receive the benefits of the Company's value-pricing
philosophy. The Company provides everyday low prices that are often lower than
regular prices offered at most retailers, such as grocery stores, and are
generally intended to be slightly lower than those offered by mass merchant
discount retailers, such as Wal-Mart and Kmart Corporation ("Kmart"), that
operate in some of the Company's island markets. In an effort to achieve the
lowest prices available in a particular market, the Company regularly compares
prices and products being offered by the Company's local competitors.
Generally, given the economic efficiencies the Company can bring to bear with
its ability to purchase product at larger quantities as well as its efficient
distribution system that allows it to take advantage of optimal freight and
transportation costs, the Company has a competitive advantage when pricing
most of its products compared to local competition. However, if the comparison
of local competitors' prices discloses that the Company's prices exceed those
of its local competition, store managers have the authority to reduce prices
to remain competitive. This decentralization of pricing decisions allows the
Company to respond quickly and efficiently to competitive challenges in each
of its island markets.
Distribution
The Company typically buys directly from manufacturers in large quantities
(full truck loads whenever possible). The Company currently uses five
distribution facilities: a Company-operated facility in San Leandro,
California and independently operated facilities in Port Everglades, Florida,
Sacramento, California, Auckland, New Zealand, and Sydney Australia. The
Company has no written agreements with the independently operated distribution
facilities, but instead has month-to-month service relationships. At each
distribution facility, merchandise is received, consolidated and cross-docked,
and ultimately shipped in fully loaded containers to the Company's stores.
Each store has a "lane" designated to it in the depot; when a full container
load is queued
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into the lane, it is loaded by forklift into a cargo container, which, when
filled, is then delivered to the closest port for shipment to the designated
store. Management has significant experience and long-term relationships with
steamship lines and, with its present volume, has negotiated what it believes
to be competitive transportation rates. The Company does not have a warehouse,
but controls inventory levels in stores by maintaining sufficient back stock
in stores combined with efficient cross-dock facilities. For perishable items,
the Company uses independently operated consignment depots that are for the
Company's exclusive use. Each supplier of perishable items, such as meats,
frozen foods, fruits and vegetables, pays a storage charge for use of such
depots based upon the amount of space used for storage of each supplier's
goods. The Company gives its suppliers of perishable items notice of its
projected supply needs, and these suppliers deliver product to the depots.
However, the Company does not accept delivery of the product, nor is it
responsible for payment, until it places a final order. Once the final order
is placed, the goods are removed from the consignment depot and loaded onto
refrigerated shipping containers located at the consignment depots, at which
point the goods are deemed delivered. The Company then transports the shipping
containers to the nearest port for shipment to its island stores. By using
this procedure, the Company minimizes loss of perishable product due to over-
orders because it does not "purchase" the goods until it is certain of the
needs of its stores.
Management Information Systems
The Company considers management information systems to be a key component
of its strategic plan. The Company tracks all inventory movement, sales and
purchase orders by SKU number, vendor number, store and date. The Company
currently uses electronic point-of-sale equipment in all stores. All data and
communications from each location are sent via the Company's wide area
network, to the computer system located at the corporate headquarters in
Bellevue, Washington. The Company installed new computer hardware to operate
its inventory control system on January 31, 1999, which has enhanced, extended
and improved the data capabilities of its systems. The Company is developing
the specifications for systems to support automatic replenishment of inventory
and supplies, and to further improve profiling sales and purchasing trends.
The Company plans to acquire and implement these inventory systems during
fiscal 2000 and 2001. The Company believes that its current computer systems
will support anticipated growth at least through fiscal 2001. The Company's
wide area network provides communications capabilities that allow for quick
responses to ever-changing customer needs and local retail opportunities. The
ability to quickly and consistently communicate between headquarters and store
locations is necessary when stores are located in such remote locations.
Employee Organization, Training and Compensation
Management of each store generally consists of a store manager, two
assistant managers and one or more department managers, depending on the
store. Typically, the department managers are assigned to two categories:
merchandising and administrative. The merchandising manager oversees the
training and day-to-day operations of the stockers, forklift operators and
receiving clerks. The administrative manager oversees the training and day-to-
day operations of the vault clerks, cashiers and security personnel, if
applicable.
The Company's goal is to hire most of those employees from the island
markets, thus creating job opportunities for local residents. The Company
attempts to promote its store managers internally. The Company requires its
store managers to complete an approximately six-month training program in a
Company store. New store employees initially receive one to two weeks of
training, which typically includes working alongside individuals in comparable
positions before working without direct supervision. The Company has found
that such on-the-job training, together with the use of detailed operating and
training manuals, is an effective way to introduce new employees and managers
to the Company's systems and procedures.
The Company strives to attract and retain highly motivated, performance-
oriented employees and managers by offering competitive compensation,
including bonus programs based on their performance. Store managers
participate in a manager bonus program that ties compensation awards to the
Company's overall profits. In addition, all store employees are eligible to
participate in an incentive plan whereby they receive monthly
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bonuses for increased store sales and control of inventory shrink expense.
Although the Company believes that it generally pays its employees above-
market wages and is thereby able to attract and retain high-quality employees,
it further believes that island wages are generally lower than mainland wages
and thus result in comparatively lower labor costs.
Customer Service
The Company brings to its island markets a commitment to customer service
that it believes gives it a competitive advantage in each of the local markets
it serves. The Company's store layout is designed to maximize floor space used
for selling product as well as to give customers a spacious feel while
shopping. Various forms of payments are accepted, including food stamps and
credit and debit cards, and credit is extended to some local businesses and
government agencies. The Company has a 30-day, no-questions-asked return
policy. Each of the Company's stores has approximately 10 checkout lanes,
which allows for quick and efficient shopping. Each store features a customer
desk where customers can have questions answered, usually by a management team
member. In addition, employees are trained to help customers locate store
products.
Marketing and Advertising
The Company generally relies on word-of-mouth advertising in order to save
on advertising and marketing costs and pass on the savings to its customers.
The Company has historically spent less than 0.2% of net sales on advertising.
However, in more competitive markets such as New Zealand, the Company may
experience higher marketing and advertising costs.
Competition
The warehouse club and discount retail businesses are highly competitive.
The Company historically has faced significant competition from warehouse
clubs and discount retailers such as Wal-Mart, Kmart and Costco in Hawaii, and
from Kmart in the U.S. Virgin Islands and Guam. The Company's competition also
consists of regional and smaller discount retailers and other national and
international grocery store chains. Some of the Company's competitors have
substantially greater resources, buying power and name recognition than the
Company. The Company plans to target its future expansion in additional island
markets that it believes are underserved by existing retailers and not yet
penetrated by large warehouse clubs and discount retailers. The cost of doing
business in island markets is typically higher than on the U.S. mainland
because of ocean freight
and duty costs and higher facility costs. While the Company expects that the
size of many of the markets in which it operates or expects to enter will
delay or deter entry by many of its larger competitors, there can be no
assurance that the Company's larger competitors will not decide to enter these
markets or that its smaller competitors will not compete more effectively
against the Company. Recently, a membership warehouse club announced its
intent to enter the St. Thomas market, where the Company has an established
presence. The Company's gross margin and operating income are generally lower
for those stores in markets where traditional warehouse clubs and discount
retailers also operate stores, due to increased price competition and reduced
market share. The Company may be required to implement price reductions in
order to remain competitive should any of its competitors reduce prices in any
of its markets. The Company's ability to expand into and operate profitably in
new markets, particularly small markets, may be adversely affected by the
existence or entry of competing warehouse clubs or discount retailers. See
"Important Factors Regarding Forward-Looking Statements--Competition."
Trademarks
The Company has been granted federal registration of the name and stylized
logo "Cost-U-Less."
Governmental Regulation
The Company is subject to various applicable laws and regulations
administered by federal, state and foreign regulatory authorities, including,
but not limited to, laws and regulations regarding tax, tariffs, zoning,
8
employment and licensing requirements. Additionally, as the Company pursues
future expansion in foreign countries, the Company's operations will be
subject to additional foreign regulatory standards involving corresponding
laws and regulations, in addition to customs, duties and immigration laws and
regulations. Changes in the foregoing laws and regulations, or their
interpretation by agencies and the courts, occur from time to time. While the
Company believes that it presently complies in all material respects with such
laws and regulations, there can be no assurance that future compliance will
not have a material adverse effect on the Company's business, financial
condition and operating results. See "Important Factors Regarding Forward-
Looking Statements--Risks Associated With Island and International
Operations."
Employees
As of March 18, 2000, the Company had 41 full-time employees at its
corporate headquarters in Bellevue, Washington, and 13 employees at its main
distribution facility in San Leandro, California. In total, the Company
employs approximately 550 people worldwide. None of the Company's employees
are covered by collective bargaining agreements.
Important Factors Regarding Forward-Looking Statements
You should carefully consider the following factors regarding forward-
looking statements and other information included in this Annual Report. The
risks and uncertainties described below are not the only ones we face.
Additional risks and uncertainties not presently known to us or that we
currently deem immaterial also may impair our business operations. If any of
the following risks actually occur, our business, financial condition and
operating results could be materially adversely affected.
Risks Associated With Island and International Operations. The Company's net
sales from island operations represented approximately 92% of the Company's
total net sales for fiscal 1999. The Company expects that its island and
future international operations together will continue to account for nearly
all of its total net sales. The distance, as well as the time-zone
differences, involved with island locations impose significant challenges to
the Company's ability to manage its operations. Logistical challenges are
presented by operating individual store units in remote locations, whether in
terms of information flow or transportation of goods.
Ability to Manage Growth. The Company intends to pursue a growth strategy,
the success of which will depend to a significant degree on the Company's
ability to (i) expand its operations through the opening of new stores, (ii)
operate new stores on a profitable basis, (iii) maintain positive comparable
store net sales, (iv) properly identify and enter new markets, (v) locate
suitable store sites, (vi) negotiate acceptable lease terms, (vii) construct
or refurbish sites, and (viii) obtain necessary funds on satisfactory terms.
The Company has not opened stores in foreign island markets at a rapid pace,
never having opened more than four stores in any given fiscal year. The
Company has no operating experience in many of the markets in which it may
open new stores. In fact, the recently opened stores in New Zealand and Fiji
have performed below expectations, due in part to competitive and
merchandising challenges that are different from other Company stores. These
new markets may present operational, competitive, regulatory and merchandising
challenges that are different from those currently encountered by the Company.
There can be no assurance that the Company will be able to adapt its
operations to support these expansion plans or that the Company's new stores
will be profitable.
Additionally, the Company relies significantly on the skill and expertise of
its on-site store managers. The Company will be required to hire, train and
retain skilled managers and personnel to support its growth, and may
experience difficulties locating store managers and employees who possess the
training and experience necessary to operate the Company's new stores,
including the Company's management information and communications systems,
particularly in island markets where language, education and cultural factors
may impose additional challenges. Further, the Company has encountered, and
may continue to encounter, substantial delays, increased expenses or loss of
potential sites due to the complexities, cultural differences, and local
political issues associated with the regulatory and permitting processes in
the island markets in which the
9
Company intends to locate its stores. There can be no assurance that the
Company will be able to open new stores according to its business plans, or
that it will be able to continue to attract, develop and retain the personnel
necessary to pursue its growth strategy. Failure to do so could have a
material adverse effect on the Company's business, financial condition and
operating results.
The Company also will need to continually evaluate the adequacy of its
existing systems and procedures, including store management, financial and
inventory control and distribution systems. As the Company grows, it will need
to continually analyze the sufficiency of its distribution depots and
inventory distribution methods and may require additional facilities in order
to support its planned growth. There can be no assurance that the Company will
anticipate all the changing demands that its expanding operations will impose
on such systems. Failure to adequately update its internal systems or
procedures as required could have a material adverse effect on the Company's
business, financial condition and operating results. See "Business--Business
Strategy".
Difficult Transportation Environment. The Company's island locales require
the transportation of products over great distances on water, which results in
(i) substantial lags between the procurement and delivery of product, thus
complicating merchandising and inventory control methods, (ii) the possible
loss of product due to potential damage to, or destruction of, ships or
containers delivering the Company's goods, (iii) tariff, customs and shipping
regulation issues, and (iv) substantial ocean freight and duty costs.
Moreover, only a limited number of transportation companies service the
Company's regions, none of which has entered into a long-term contract with
the Company. The inability or failure of one or more key transportation
companies to provide transportation services to the Company, any collusion
among the transportation companies regarding shipping prices or terms, changes
in the regulations that govern shipping tariffs or any other disruption in the
Company's ability to transport its merchandise could have a material adverse
effect on the Company's business, financial condition and operating results.
See "--Business--Distribution."
Competition. The warehouse club and discount retail businesses are highly
competitive. The Company historically has faced significant competition from
warehouse clubs and discount retailers, such as Wal-Mart, and Costco in
Hawaii, and from Kmart in the U.S. Virgin Islands and Guam. The Company's
competition also consists of regional and smaller discount retailers and other
national and international grocery store chains. Some of the Company's
competitors have substantially greater resources, buying power and name
recognition than the Company. The cost of doing business in island markets is
typically higher than on the U.S. mainland because of ocean freight and duty
costs and higher facility costs. While the Company expects that the size of
many of the markets in which it operates or expects to enter will delay or
deter entry by many of its larger competitors, there can be no assurance that
the Company's larger competitors will not decide to enter these markets or
that its smaller competitors will not compete more effectively against the
Company. Recently, a membership warehouse club announced its intent to enter
the St. Thomas market, where the Company has an established presence. The
Company's gross margin and operating income are generally lower for those
stores in markets where traditional warehouse clubs and discount retailers
also operate stores, due to increased price competition and reduced market
share. The Company may be required to implement price reductions in order to
remain competitive should any of its competitors reduce prices in any of its
markets. Moreover, the Company's ability to expand into and operate profitably
in new markets, particularly small markets, may be adversely affected by the
existence or entry of competing warehouse clubs or discount retailers. See "--
Business--Competition."
Isolation of Store Operations From Corporate Management; Increased
Dependence on Local Managers. The Company's headquarters and administrative
offices are located in Bellevue, Washington; however, twelve of the Company's
thirteen stores and a majority of its employees are located on remote islands.
Although the Company invests resources to hire and train its on-site managers,
the inability of the Company's executives to be physically present at the
Company's current and planned store sites on a regular basis may result in (i)
an isolation of store operations from corporate management and an increased
dependence on store managers, (ii) a diminished ability to oversee employees,
which may lead to decreased productivity or other operational problems, (iii)
construction delays or difficulties caused by inadequate supervision of the
construction process, and (iv) communication challenges. The Company will need
to invest significant resources to update
10
and expand its communications systems and information networks and to devote a
substantial amount of time, effort and expense to national and international
travel in order to overcome these challenges; failure to do so could have a
material adverse effect on the Company's business, financial condition and
operating results. See "--Business--Employee Organization, Training and
Compensation."
Weather and Other Risks Associated With Island Operations. The Company's
operations are subject to the volatile weather conditions and natural
disasters characteristic of the island markets in which the Company's stores
are located, which could result in delays in construction or result in
significant damage to, or destruction of, the Company's stores. In addition,
island operations involve uncertainties arising from (i) local business
practices, language and cultural considerations, including the capacity or
willingness of local business and government officials to provide necessary
services, (ii) the ability to acquire, install and maintain modern
capabilities such as dependable and affordable electricity, telephone,
computer, Internet and satellite connections in remote and often undeveloped
regions, (iii) political, military and trade tensions, (iv) currency exchange
rate fluctuations, (v) local economic conditions, (vi) longer payment cycles,
(vii) difficulty enforcing agreements or protecting intellectual property, and
(viii) collection of debts and other obligations in foreign countries. There
can be no assurance that the Company will be able to devote the resources
necessary to meet the challenges posed by island operations, or that losses
from business interruption will be adequately compensated by insurance; any
failure to do so would have a material adverse effect on the Company's
business, financial condition and operating results. See "--Business--Business
Strategy."
Uncertainties Associated With Expansion Outside U.S. Territories. As of
December 26, 1999, ten of the Company's stores are located in U.S. territories
(the "U.S. Territories") and foreign island countries throughout the Pacific
and Caribbean. The remaining three stores are in Hawaii and California. The
Company's future expansion plans may involve entry into additional foreign
countries, which may involve additional or heightened risks and challenges
that are different from those currently encountered by the Company, including
risks associated with being further removed from the political and economic
systems in the United States. The Company does not currently engage in
currency hedging activities. The Company operates two new stores in Fiji,
which was subject to a nonviolent military coup in 1987, led by the country's
current Prime Minister and experienced a 30% devaluation of its currency
during 1998 in relation to the U.S. dollar. Although the Fijian government
adopted a new constitution in 1997, there can be no assurance that further
political and economic changes in Fiji will not have a material adverse effect
on the Company's business, financial condition and operating results. The
failure to adequately address the additional challenges involved with
international operations, and specifically those associated with the Company's
Fijian stores, could have a material adverse effect on the Company's business,
financial condition and operating results. See "--Business--Business
Strategy."
Governmental Regulations. Governmental regulations in foreign countries
where the Company plans to expand its operations might prevent or delay entry
into the market or prevent or delay the introduction, or require modification,
of certain of the Company's operations. Additionally, the Company's ability to
compete may be adversely affected by foreign governmental regulations that
encourage or mandate the employment of citizens of, or purchase of supplies
from vendors in a particular jurisdiction. The Company may also be subject to
taxation in these foreign jurisdictions, and the final determination of its
tax liabilities may involve the interpretation of the statutes and
requirements of the various domestic and foreign taxing authorities. There can
be no assurance that any of these risks will not have a material adverse
effect on the Company's business, financial condition and operating results.
See "--Business--Governmental Regulation."
Small Store Base. The Company opened its first store in 1989, opened a total
of 20 stores through December 1999, and presently operates thirteen stores.
From December 1994 to June 1998, the Company closed seven stores, which
adversely affected the Company's operating results. Should (i) any new store
be unprofitable, (ii) any existing store experience a decline in
profitability, or (iii) the Company's general and administrative expenses
increase to address the Company's expanded operations, the effect on the
Company's operating results would be more significant than would be the case
if the Company had a larger store base, and could have a
11
material adverse effect on the Company's business, financial condition and
operating results. Although the Company intends to carefully plan for the
implementation of additional stores, there can be no assurance that such plans
can be executed as envisioned or that the implementation of those plans will
not have a material adverse effect on the Company's business, financial
condition and operating results. See "--Business--Business Strategy."
Dependence on Key Personnel. The Company's success depends in large part on
the abilities and continued service of its executive officers and other key
employees. In addition, the Company does not currently carry key-man life
insurance. There can be no assurance that the Company will be able to retain
the services of such executive officers and other key employees, the loss of
any of whom could have a material adverse effect on the Company's business,
financial condition and operating results.
Decreases in Sales. Fluctuations in Comparable Store Sales. Although sales
increased 24.8% in 1999 over 1998, and increased 7.2% in 1998 over 1997, net
sales in fiscal 1997 declined $9.9 million, or 7.4%, to $124.9 million from
$134.8 million in the prior year. The decline in 1997 was primarily due to
store closures in the continental United States and to a slight decline in
comparable store sales, largely attributable to the Hawaii market. The
increase in 1999 was primarily due to additional stores, and an increase in
comparable store sales of 6.8%.
A variety of factors affect the Company's comparable store sales, including,
among others, actions of competitors (including the opening of additional
stores in the Company's markets), the retail sales environment, general
economic conditions, weather conditions and the Company's ability to execute
its business strategy effectively. In addition, the Company's expansion may
result in opening additional stores in markets where the Company already does
business. The Company has experienced a reduction in sales at an existing
Company store when a new Company store was opened in the same market. The
Company's comparable store sales increases (decreases) over the prior period
were, (0.5)%, 9.9%, and 6.8% in fiscal 1997, 1998, and 1999, respectively.
These factors may result in future comparable store sales increases that are
lower than those experienced in fiscal 1999. Moreover, there can be no
assurance that comparable store sales for any particular period will not
decrease in the future. Changes in the Company's comparable store sales could
cause the price of the Common Stock to fluctuate substantially. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations."
Utilization of Tax Benefits. The Company's ability to utilize various tax
benefits and credits is dependent on its ability to generate adequate taxable
income in foreign jurisdictions. As of December 26, 1999, the Company had
recognized an aggregate U.S. federal tax benefit of $1.1 million on foreign
operating losses dependent on the Company generating future taxable income in
the U.S. There can be no assurance that the Company will be able to produce
adequate future taxable income in the U.S. to utilize this tax benefit, and
failure to generate such income may have a material adverse effect on the
Company's business, financial condition and operating results. See "Notes to
Consolidated Financial Statements--Income Taxes."
Impact of General Economic Conditions. The success of the Company's
operations depends to a significant extent on a number of factors relating to
discretionary consumer spending, including employment rates, business
conditions, interest rates, inflation, population and Gross Domestic Product
levels in each of its island markets, taxation, consumer spending patterns and
customer preferences. There can be no assurance that consumer spending in the
Company's markets will not be adversely affected by these factors, thereby
affecting the Company's growth, net sales and profitability. A decline in the
national or regional economies of the United States and the U.S. Territories
where the Company currently operates or any foreign countries in which the
Company currently or will operate could have a material adverse effect on the
Company's business, financial condition and operating results. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations."
Dependence on Systems. As the Company expands, it will need to upgrade or
reconfigure its management information systems. While the Company has taken a
number of precautions against certain events that could
12
disrupt the operation of its management information systems, it may experience
systems failures or interruptions which could have a material adverse effect
on its business, financial condition and operating results. The Company's
business is highly dependent on communications and information systems,
primarily systems provided by third-party vendors. Any failure or interruption
of the Company's systems or systems provided by third-party vendors could
cause delays or other problems in the Company's operations, which could have a
material adverse effect on the Company's business, financial condition and
operating results. The Company experienced no negative impact from Year 2000
systems issues. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Year 2000 Compliance" and "--Business--
Management Information Systems."
Control by Directors and Executive Officers. The Company's directors and
executive officers and their affiliates beneficially own, in the aggregate,
approximately 34% of the outstanding shares of Common Stock. As a result, the
Company's directors and executive officers, acting together, are able to
significantly influence and may be able to control many matters requiring
approval by the Company's shareholders, including, without limitation, the
election of directors and approval of significant corporate transactions. In
addition, this concentration of ownership and voting power may have the effect
of accelerating, delaying or preventing a change in control of the Company or
otherwise affect the ability of other shareholders to influence the policies
of the Company.
Anti-takeover Considerations. Pursuant to the Company's Restated Articles of
Incorporation (the "Restated Articles"), the Company's Board of Directors has
the authority, without shareholder approval, to issue up to 2,000,000 shares
of Preferred Stock and to fix the rights, preferences, privileges and
restrictions of such shares without any further vote or action by the
Company's shareholders. The Company's Restated Articles and Bylaws also
provide for a classified board and special advance notice provisions for
proposed business at annual meetings. These provisions, among others, may have
the effect of making it more difficult for a third party to acquire, or
discouraging a third party from attempting to acquire, control of the Company,
even if shareholders may consider such a change in control to be in their best
interests. In addition, Washington law contains certain provisions that may
have the effect of delaying, deferring or preventing a hostile takeover of the
Company.
On February 23, 1999, the Company's Board of Directors declared a dividend
distribution of preferred share purchase rights (the "Rights") pursuant to a
Shareholder Rights Plan. The Rights initially trade with shares of the
Company's Common Stock and have no impact upon the way in which shareholders
can trade the Company's common stock. However, ten days after a person or
group acquires 15% or more of the Company's common stock, or such date, if
any, as the Board of Directors may designate after a person or group commences
or publicly announces its intention to commence a tender or exchange offer
which could result in that person or group owning 15% or more of the common
stock (even if no purchases actually occur), the Rights will become
exercisable and separate certificates representing the Rights will be
distributed. The Rights would then begin to trade independently from the
Company's shares at that time. The Rights are designed to cause substantial
dilution to a person or group that attempts to acquire the Company without
approval of the Board of Directors, and thereby make a hostile takeover
attempt prohibitively expensive for the potential acquirer.
Item 2. Properties
The Company currently leases a majority of its existing store locations. The
Company has entered into an agreement to lease land in St. Maarten,
Netherlands Antilles where it will build a 36,000 square foot store. The lease
has a 25-year term with an option to extend for an additional 30 years. The
Company also leases the land for the St. Thomas store, but owns the store
facility. The stores average approximately 31,000 square feet and range in
size from approximately 22,000 square feet to approximately 40,000 square
feet. The store leases typically have a term of 10 years with options to lease
for an additional 10 years and typically are net leases. Two leases have fixed
rental rates, and the other leases have scheduled rental increases, either in
fixed increments or based on the consumer price index. With the exception of
the Sonora store which opened in an existing facility, all of the Company's
stores have been built to Company specifications.
13
Mid-Sized Format. The average size of the Company's thirteen stores is
approximately 31,000 square feet, while the traditional warehouse stores found
in the United States average approximately 115,000 square feet. The Company
has developed three store "footprints" based on a 27,000, 36,000 and 42,000-
square-foot facility, which is adaptable from anywhere between 25,000 to
45,000 square feet. The Company's prototype was developed in consultation with
architects and designers who helped design many of the warehouse stores
operating in the United States today. The prototypes were used in the
construction of the two stores in Fiji, the stores in St. Thomas and Curacao,
and the stores under development.
The Company has developed a standard lease that it uses as a starting point
for its lease negotiations with each potential landowner/developer. The
Company routinely negotiates a 10-year lease with at least two five-year
renewal options.
Approximate
Store
Square Lease Options to
Location Date Opened Footage Term Expiration Date Extend
-------- ----------- ----------- ----- --------------- ----------
Dededo, Guam............ May 1, 1992 31,200 10 years May 1, 2002 10 years
Hilo, Hawaii............ August 27, 1992 23,000 15 years August 31, 2006 10 years
Kapaa, Kauai............ March 18, 1993 22,000 10 years November 15, 2002 10 years
St. Thomas, USVI (Land
Lease)................. June 25, 1998 36,000 20 years September 30, 2017 30 years
Sonora, CA.............. January 27, 1994 23,150 10 years January 1, 2004 10 years
St. Croix, USVI......... November 3, 1994 26,210 10 years November 1, 2004 10 years
Tamuning, Guam.......... March 15, 1995 35,000 15 years March 1, 2010 10 years
Pago Pago, American
Samoa.................. March 20, 1995 32,055 10 years February 28, 2005 15 years
Nadi, Fiji.............. July 2, 1998 25,000 10 years March 1, 2008 20 years
Suva, Fiji.............. November 12, 1998 30,000 10 years November 1, 2008 10 years
Curacao, Netherlands
Antilles............... March 2, 1999 38,711 10 years February 1, 2009 10 years
Rotorua, New Zealand.... November 18, 1999 39,129 10 years November 17, 2009 10 years
Porirua, New Zealand.... December 9, 1999 40,365 10 years December 8, 2009 10 years
The Company leases approximately 6,000 square feet of office space for its
headquarters in Bellevue, Washington, which lease expires on April 30, 2000.
The Company subleases approximately 2,000 additional square feet at its
headquarters in Bellevue on a month-to-month basis. Because of additional
space requirements, the Company plans to relocate its headquarters office
around June 2000 and has entered into a letter of intent to lease
approximately 15,000 square feet of office space in Preston, Washington. The
Company relocated its Union City, California distribution facility in December
1999 to a distribution facility in San Leandro, California. The San Leandro
facility is approximately 81,000 square feet, and the lease expires on January
31, 2007. The Company also leases approximately 3200 square feet of office
space in Auckland, New Zealand. Such lease is renewed on a month-to-month
basis. The Company believes that its distribution facilities will be
sufficient to meet the Company's needs at least through the end of fiscal
2002.
Item 3. Legal Proceedings
The Company may be subject to legal proceedings or claims, either asserted
or unasserted, that arise in the ordinary course of business. While the
outcome of these claims cannot be predicted with certainty, management does
not believe that any pending legal matters will have a material adverse effect
on the Company.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of the Company's shareholders during the
fourth quarter of the fiscal year ended December 26, 1999.
14
PART II
Item 5. Market for Company's Common Stock and Related Shareholder Matters
The Company's Common Stock is traded on the Nasdaq National Market (symbol
"CULS"). The number of shareholders of record of the Company's Common Stock at
March 18, 2000, was 3,576,858.
High and low sales prices for the Company's Common Stock for the periods
indicated in 1999, are as follows. Such prices reflect inter-dealer prices,
without retail mark-up, mark-down or commission and may not necessarily
represent actual transactions.
Stock
Price
---------
Year High Low
---- ---- ----
Fiscal 1999 (ended December 26, 1999)
First Quarter.................................................. 8.13 5.50
Second Quarter................................................. 6.00 4.63
Third Quarter.................................................. 5.75 4.63
Fourth Quarter................................................. 5.38 3.88
The Company has never declared or paid any cash dividends on its Common
Stock. The Company currently anticipates that it will retain all future
earnings for use in the expansion and operations of its business and does not
anticipate paying cash dividends in the foreseeable future.
On July 23, 1998, the Commission declared effective the Company's
Registration Statement on Form S-1 (Registration No. 333-52459) as filed with
the Commission in connection with the Company's Initial Public Offering. Of
the $7,797,000 in net proceeds received by the Company upon consummation of
the Offering, approximately $4 million was used to pay off the outstanding
balance under the Company's line of credit with Seafirst Bank. The remaining
net proceeds were invested in a money market account with Bank of America.
Concurrent with the Initial Public Offering, the Company sold 160,000 shares
of Common Stock at $7.00 per share, in the Concurrent Reg. S Placement to Kula
Fund, in reliance on the exclusion from registration provided by Regulation S
under the Securities Act of 1933, as amended. As part of the Concurrent Reg. S
Placement, the Company also sold to Kula Fund, for nominal consideration, a
warrant to purchase 117,000 shares of Common Stock at an exercise price equal
to $8.40 per share (120% of the per share price in the Initial Public
Offering), which warrant contains standard net issuance provisions and is
exercisable at any time until July 23, 2002. The net proceeds of approximately
$908,000 from the Concurrent Reg. S Placement were invested in a money market
account with Bank of America.
15
Item 6. Selected Financial Data
The following selected financial data should be read in conjunction with the
consolidated financial statements and the notes thereto and the information
contained herein in "Management's Discussion and Analysis of Financial
Condition and Results of Operations." The Company's fiscal year ends on the
last Sunday in December. All years represent 52-week fiscal years except
fiscal 1995 was a 53-week fiscal year.
Selected Consolidated Financial and Operating Data
(in thousands, except per share data, average sales per square foot,
number of stores and percentage data)
Dec. 26, Dec. 27, Dec. 28, Dec. 29, Dec. 31,
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
Income Statement Data:
Net sales............... $167,079 $133,861 $124,865 $134,820 $139,652
Gross profit............ 27,395 22,324 20,468 20,996 19,477
Operating Expenses:
Store.................. 18,254 15,100 14,543 15,843 14,949
General and
administrative........ 5,654 4,139 3,225 3,039 2,728
Store opening.......... 1,217 747 327 0 600
Store closing.......... 0 238 1,346 918 400
Operating income........ 2,270 2,100 1,027 1,196 800
Interest expense, net... (403) (257) (427) (605) (555)
Other income (expense).. (57) (10) (40) 0 150
Income before income
taxes.................. 1,810 1,833 560 591 395
Income tax provision.... 656 640 197 221 145
Net income.............. $ 1,154 $ 1,193 $ 363 $ 370 $ 250
Earnings per common
share:
Basic.................. $ 0.32 $ 0.45 $ 0.18 $ 0.19 $ 0.13
Diluted................ $ 0.32 $ 0.43 $ 0.17 $ 0.17 $ 0.11
Weighted average common
shares outstanding,
diluted................ 3,618 2,759 2,124 2,147 2,198
Selected Operating Data:
Island stores:
Net sales.............. $153,164 $125,433 $111,480 $111,413 $120,010
Store contribution(2).. $ 8,013 $ 6,690 $ 5,635 $ 5,212 $ 4,958
Stores opened.......... 3 3 0 0 2
Stores closed.......... 0 1 0 0 1
Stores open at end of
period................ 12 9 7 7 7
Average net comparable
sales per square
foot(1)(3)............ $ 534 $ 596 $ 536 $ 535 $ 547
Comparable-store net
sales increase
(decrease)(1)(3)...... 6.9% 10.9 % (0.2)% (5.0)% (18.5)%
Mainland stores:
Net sales.............. $ 7,012 $ 6,782 $ 10,684 $ 23,407 $ 19,642
Store contribution(2).. $ (176) $ (94) $ (160) $ (415) $ (430)
Stores opened.......... 0 0 0 0 2
Stores closed.......... 0 0 2 1 0
Stores open at end of
period................ 1 1 1 3 4
Average net comparable
sales per square
foot(1)(3)............ $ 303 $ 293 $ 244 $ 217 $ 244
Comparable-store net
sales increase
(decrease)(1)(3)...... 3.4% (6.4)% (3.2)% (4.2)% 8.9 %
Total stores open at end
of period.............. 13 10 8 10 11
Total comparable-store
net sales increase
(decrease)(1)(3)....... 6.8% 9.9 % (0.5)% (4.9)% (15.8)%
Consolidated Balance
Sheet Data:
Working capital......... $ 5,992 $ 9,241 $ 3,814 $ 3,635 $ 3,429
Total assets............ 43,675 37,217 22,815 24,856 $ 28,525
Line of credit.......... 2,163 0 376 1,500 3,500
Long-term debt, less
current maturities..... 2,517 2,036 1,169 1,965 2,237
Total shareholders'
equity................. 20,665 19,596 9,670 9,327 8,957
- --------
(1) Fiscal 1995 was a 53-week year; all other fiscal years were 52-week years.
Comparable store net sales and average sales per square foot for fiscal
1995 have been adjusted to reflect a 52-week year. The Company's fiscal
quarters are 13 weeks.
(2) Store contribution is determined by deducting store expenses from store
gross profit.
(3) A new store becomes comparable after it has been open for a full 13
months.
16
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This Annual Report on Form 10-K includes forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995. This Act
provides a "safe harbor" for forward-looking statements to encourage companies
to provide prospective information about themselves as long as they identify
these statements as forward-looking and provide meaningful cautionary
statements identifying important factors that could cause actual results to
differ from the projected results. All statements other than statements of
historical fact made in this Annual Report on Form 10-K are forward-looking.
In particular, statements herein regarding future results of operations and
financial position, the Company's ability to develop new markets, manage rapid
growth, and any other guidance on future periods are forward-looking
statements. Forward-looking statements reflect management's expectations. The
following discussions and the section entitled "Business--Important Factors
Regarding Forward-Looking Statements" describe some, but not all, of the
factors that could cause these differences.
Overview
Background
Cost-U-Less began operations in 1989 by opening a mid-sized warehouse club-
style store in Maui, Hawaii. The Company's store concept proved successful in
the more remote, and in many ways more challenging, island markets. The
Company began experimenting in late 1992 with similar stores in various
mainland markets. Over the course of a three-year period, the Company opened
six mainland stores and seven island stores, but, over time, found that most
of the mainland stores did not meet the Company's performance expectations.
The Company therefore focused on its core competencies in operating island
stores and began closing its mainland stores. Currently only one mainland
store remains open and serves as an efficient testing ground for new operating
and merchandising methods. The Company intends to retain this store while
targeting its future growth on island markets.
1999 Review
In 1999, three new stores were opened; Curacao, Netherlands Antilles (in
March), Rotorua, New Zealand (in November), and Porirua, New Zealand (in
December). Additionally, the Company opened buying offices in Auckland, New
Zealand and Sydney, Australia, to support the operations in New Zealand and
Fiji. The Fijian stores were opened in 1998, and represented the Company's
first foreign island country stores. Historically, the Company's island stores
achieved profitability within the first year of operation. The Curacao store
is operating within Company expectations. The stores in Fiji and New Zealand
have performed below Company expectations. The two Fijian stores have shown
improved performance, but continue to perform below Company expectations.
Compared to other island markets in which the Company operates, New Zealand
has significantly more competitive market challenges. Additionally, New
Zealand has established and accepted regional brands and goods that compete
with the U.S. brands offered by the Company. The Company is taking several
actions in an effort to improve New Zealand performance. See "2000 Strategy"
on the succeeding page.
The Company began implementing a strategy to increase its business to
business sales. Business to business sales ("business sales") occur through
our retail stores and distribution facilities. Business sales through the
Company's distribution facilities represent 4.1%, 1.2%, and 2.2% of the
Company's total sales in fiscal 1999, 1998, and 1997, respectively. The gross
margin on these sales are lower than retail gross margins. However, because
there are generally lower handling costs associated with these sales, these
sales are generally profitable and complement the retail business. The gross
margin on business sales through the distribution facilities were 7.5% in
1999, compared to 10.9% in 1998 and 1997. We anticipate increased business
sales in fiscal 2000.
The Company benefits from attractive store-level economics and favorable
returns on investment at its island stores. The Company's nine island stores
opened for all of fiscal 1999 generated average per store net sales of $15.5
million, average net sales per square foot of $534, average annual per store
contribution (store
17
gross profit less direct store expenses) of approximately $860,000, and
average annual contribution before depreciation of $968,000. The Company uses
the entire interior space of its store, including receiving and office space,
in calculating average net sales per square foot.
The Company receives, consolidates and loads merchandise at its distribution
facilities, then ships merchandise to its island stores in fully loaded
containers. The Company also receives local goods delivered directly to the
stores. In-store inventory is managed primarily by electronically monitoring
sell-through of merchandise and maintaining efficient distribution facilities.
Inventory turns in 1999 decreased to 7.1 compared to 7.5 in 1998 and 1997. The
reduction was primarily due to the impact of under-performing stores in Fiji,
and to a lesser extent, New Zealand.
2000 Strategy
The Company plans to take several actions to improve performance in New
Zealand and Fiji. The Company believes it is the first warehouse club concept
in the New Zealand market, and that through improved merchandising,
promotional activity, implementing a business sales strategy, and more
experienced store management, the New Zealand market will become more
accustomed to the warehouse club concept, and that store performance can be
improved. Furthermore, the Auckland, New Zealand buying office will be
downsized, which the Company believes will reduce costs. Buying responsibility
will be realigned, with the Corporate buying office coordinating overall
buying activities. In Fiji, performance has been improving, and the Company
plans to improve the merchandising, and increase the business sales. While
management believes the actions described above can significantly improve
profitability in these stores, there can be no assurance that the actions
described above will be successful. With a relatively small base of 13 stores,
under-performing stores can have a materially adverse impact on Company
performance.
The Company is developing a business plan that will define how and where the
Company will achieve growth beginning in 2001. The plan will look to markets
in the Pacific and Caribbean with the attributes that typify the Company's
most successful stores. The plan will return the Company to its primary
strategy of entering island markets ahead of larger warehouse club
competitors, entering markets that have acceptance and demand for U.S. goods
where supply is minimal, and leveraging the Company island-operations
expertise, systems, and merchandising methods. To prepare for growth beginning
2001, the Company is improving merchandising methods, systems, and
information, and reviewing the key attributes associated with successful
stores.
Business sales through Company stores and distribution facilities are
expected to increase in fiscal year 2000. The additional sales, although at
lower margins than retail margins, are profitable and more fully utilize the
Company's logistic capabilities and facilities.
Recently, a membership warehouse club announced their intent to enter the
St. Thomas market, where the Company has an established and successful store.
The Company will be developing and implementing marketing and other strategies
to prepare for this new competition. However, the Company's gross margins are
generally lower for those stores in markets where traditional warehouse clubs
and discount retailers operate.
18
Results of Operations
The following table sets forth, for the periods indicated, the percentage of
the Company's net sales represented by certain consolidated income statement
data.
Fiscal Year Ended
--------------------------------------
December 26, December 27, December 28,
1999 1998 1997
------------ ------------ ------------
Net sales............................. 100.0 % 100.0 % 100.0 %
Gross margin.......................... 16.4 16.7 16.4
Operating Expenses:
Store............................... 10.9 11.3 11.6
General and administrative.......... 3.4 3.1 2.6
Store opening....................... .7 0.5 0.3
Store closing....................... -- 0.2 1.1
Operating income...................... 1.4 1.6 0.8
Interest expense...................... (0.2) (0.2) (0.3)
Income before income taxes............ 1.1 1.4 0.5
Income tax provision.................. 0.4 0.5 0.2
Net income............................ 0.7 % 0.9 % 0.3 %
Fiscal 1999 Compared to Fiscal 1998
Net Sales. Net sales in fiscal 1999 increased 24.8% to $167.1 million from
$133.9 million in 1998. The increase was primarily due to a full year of sales
from the two additional stores opened in fiscal 1998, and the Curacao store
that opened in March 1999. Comparable sales (stores open at least 13 months)
increased 6.8% during fiscal 1999, compared to 9.9% in 1998. With one new
store planned in fiscal 2000, sales growth is expected to slow from the 1999
sales growth of 24.8% in fiscal 2000.
Gross Margin. Gross margin decreased to 16.4% in fiscal 1999 from 16.7% in
fiscal 1998. The decrease was primarily due to increased business sales which
carry lower margins, but are executed at minimal direct expense. Excluding
business sales, gross margin rate was approximately the same as 1998. Gross
profit increased 22.7% to $27.4 million in 1999 from 1998 gross margin dollars
of $22.3 million, primarily as a result of increased sales.
Store Expenses. Store expenses increased $3.2 million in 1999 to $18.3
million from $15.1 million in 1998. As a percent of sales, store expenses
decreased to 10.9% in 1999 from 11.3% in 1998. The increase in store expenses
was primarily due to a full year of expenses being required in 1999 for two
additional stores opened in 1998, and the new stores opened in 1999. The
decrease in store expenses as a percent of sales was primarily due to higher
sales volume in 1999 compared to 1998, while variable expenses increased only
6.8%.
General and Administrative Expense. General and administrative expenses
increased $1.5 million in 1999 to $5.6 million compared to $4.1 million in
1998. The increase was due to establishing the New Zealand and Australia
buying offices, and personnel additions at the corporate office, primarily in
information technology, to support system enhancements and improved store
communications. It is expected that the rate of increase will slow in 2000 as
the Company is better positioned to support 2000 growth.
Store Opening Expense. Store opening expenses increased $.5 million to $1.2
million in 1999, compared to $.7 million in 1998. The increase was primarily
due to the costs to open Curacao in the first quarter 1999 and the two New
Zealand stores in the fourth quarter of 1999. In 1998, the Company re-located
the St. Thomas store, and opened two Fijian stores. In addition, 1999 store
opening expense included costs to open the St. Maarten store. The St. Maarten
store is planned in open in 2000. We expect store opening costs to decline in
2000, due to one planned new store in 2000.
19
Net Interest Expense. Net interest expense increased $146,000 to $403,000 in
1999 due primarily to additional borrowings incurred during 1999 to fund the
construction and opening of new and future stores.
Fiscal 1998 Compared to Fiscal 1997
Net Sales. Net sales in fiscal 1998 increased 7.2%, to $133.9 million from
$124.9 million in 1997. The increase was primarily due to a same store sales
increase of 9.9%, which was offset by the loss of sales from two closed stores
in late 1997. The sales from two additional stores in 1998 were further offset
by a decrease in business sales of $1.1 million in 1998.
Gross Margin. Gross margin increased to 16.7% in fiscal 1998 from 16.4% in
fiscal 1997. The increase in gross margin was due to the closure of two low-
margin mainland stores in 1997, and increased sales in higher-margin
departments such as the fresh meat and perishable departments, and decreased
distribution costs resulting from higher volumes. Gross profit increased 8.8%
to $22.3 million in 1998 from $20.5 million in 1997, which resulted from
increased sales and gross margin.
Store Expenses. Store expenses increased $557,000 in 1998 to $15.1 million
from $14.5 million in 1997. The increase resulted from increased sales. As a
percentage of net sales, store expenses decreased to 11.3% in 1998 from 11.6%
in 1997.
General and Administrative Expenses. General and administrative expenses
increased $914,000 in 1998, or 28.3%, to $4.1 million from $3.2 million in
1997. The increase was primarily due to an increase in corporate employees
resulting from the increased complexities from foreign operations, and in
costs directly associated with being a public company, including, but not
limited to, professional fees, travel, increased insurance, and investor
relations costs.
Store Closing Expenses. Store closing expenses decreased to $238,000 in 1998
from $1.3 million in 1997. The decrease resulted from one store being closed
in June 1998 in connection with the completion of a new store in St. Thomas.
In 1997, the Company closed two domestic stores. The store closure in 1998 was
attributable to the Company's only island store not built to company
specifications. Damage from a hurricane in 1995 was not satisfactorily
repaired and, as a result, the Company reached an agreement for an early
termination of the lease.
Interest Expense. Interest expense declined $170,000 in 1998 to $257,000,
from $427,000 in 1997. The decrease was due primarily to an increase in
interest income of $96,000 from interest bearing deposits on the net proceeds
from the initial public offering and a reduction in average outstanding
borrowings.
Liquidity and Capital Resources
The Company has financed its operations with proceeds from its initial
public offering, various credit facilities, and internally generated funds. In
July 1998, the Company raised $8.7 million in net proceeds from its initial
public offering and concurrent private placement. See "Market for Company's
Common Stock and Related Shareholder Matters."
Net cash provided by operations was $101,000, $245,000, and $4.6 million for
fiscal years 1999, 1998 and 1997, respectively. The decrease in net cash
provided by operations in 1999 compared to 1998, and 1998 compared to 1997,
was primarily due to an increase in inventory for three additional stores in
1999, and two additional stores in 1998. Net cash provided by operations in
1999 and 1998 decreased significantly from 1997, when the Company closed four
stores.
Net cash used in investing activities was $5.5 million, $7.2 million, and
$.9 million for fiscal years 1999, 1998 and 1997, respectively. The cash used
in investing activities in 1999 and 1998 was primarily due to additional store
openings in 1999 and 1998, including the construction of the re-located St.
Thomas store, and new corporate computer hardware in 1998. Cash used in 1997
was primarily related to equipment for the Corporate office and stores.
20
Net cash provided by financing activities was $2.1 million in 1999, and was
used primarily to fund the Company's three new stores in 1999. In 1998, net
cash provided by financing activities of $10.2 million was primarily due to
the Company's July 1998 initial public offering and concurrent Reg. S
placement that provided net proceeds of $8.7 million, and $3.0 million in long
term debt financing related to the construction of the re-located St. Thomas
store. Net cash used in financing activities in 1997 was due to cash supplied
by the closure of four stores that was used to pay down debt.
On May 1, 1999, the Company renewed and increased its line of credit with a
financial institution to the amount of $8.0 million. The line of credit
expires May 1, 2000. Since the line of credit matures annually, the Company is
currently in the process of renewing the line of credit for another year,
which it expects to complete before May 1, 2000. Borrowings under the line of
credit bear interest at the Company's option of the financial institution's
prime rate or at LIBOR plus 1.5% (8.5% at December 26, 1999). The collateral
for the line of credit consists of inventories, equipment and trade accounts
receivable. The line of credit contains certain covenants, including requiring
the Company to maintain minimum tangible net worth and minimum ratios of
current assets to current liabilities, debt to tangible net worth and
quarterly cash flow and must obtain the consent of the lender to (i) pay
dividends, (ii) purchase or sell assets or incur indebtedness, other than in
the ordinary course of business, (iii) make loans to, or investments in, any
other person, (iv) enter into a merger or other business combination, or (v)
make capital expenditures in excess of a specified limit as of and for the
year ended December 26, 1999. The Company was in compliance with all such
covenants. Borrowings under the line of credit as of December 26, 1999
amounted to $2.2 million. Amounts available under the line of credit are
reduced by outstanding letters of credit of $1.1 million. The Company expects
to continue to utilize the line of credit facility this year to finance the
inventory for the new St. Maarten store.
In November 1999, the Company entered into a $2.0 million note payable for
the construction of its new store in St. Maarten. The note payable carries
interest at the prime rate plus 1% (9.50% at December 26, 1999), and is
secured by a first security interest on the St. Maarten leasehold interest and
personal property. The Company expects to finance a substantial portion of its
merchandise inventory cost through a combination of vendor and bank financing.
The Company estimates that the St. Maarten store will require approximately
$1.8 million of inventory, approximately half of which will be funded by
vendors.
The Company believes that amounts available under its various credit
facilities, existing cash available for working capital purposes, and cash
flow from operations will be sufficient to open the St. Maarten store and fund
Company operations through fiscal 2000.
Year 2000 Compliance
In prior years, the Company discussed the nature and progress of its plans
to become Year 2000 ready. In late 1999, the Company completed its remediation
and testing of systems. As a result of those planning and implementation
efforts, the Company experienced no significant disruptions in critical
information technology and noninformation technology systems and believes
those systems successfully responded to the Year 2000 date change. The Company
is not aware of any material problems resulting from Year 2000 issues, either
with its products, its internal systems, or the products and services of third
parties. The Company will continue to monitor its critical computer
applications and those of its suppliers and vendors throughout the Year 2000
to ensure that any latent Year 2000 matters that may arise are addressed
promptly. The Company did not incur significant costs related to the Year 2000
issue.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company operates stores in foreign countries and has market risks
associated with foreign currencies. However, sales are primarily made in U.S.
cash or foreign currencies with minimal trade credit extended and no
borrowings exist in foreign currencies. Cash deposited from sales are remitted
back to the U.S. bank account, routinely. Because of the minimal trade credit,
the Company's exposure to foreign currency market risk is not considered
significant and is not concentrated in any single currency. Management does
not believe that it experiences any significant market risk from foreign
currencies.
21
Item 8. Financial Statements and Supplementary Data
The following consolidated financial statements and supplementary data are
included beginning on page 23 of this Report:
Page
----
Report of Ernst & Young LLP, Independent Auditors....................... 23
Consolidated Financial Statements:
Consolidated Balance Sheets........................................... 24
Consolidated Statements of Income..................................... 25
Consolidated Statements of Shareholders' Equity....................... 26
Consolidated Statements of Cash Flows................................. 27
Notes to Consolidated Financial Statements............................ 28
22
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors
Cost-U-Less, Inc.
We have audited the accompanying consolidated balance sheets of Cost-U-Less,
Inc. as of December 26, 1999 and December 27, 1998 and the related
consolidated statements of income, shareholders' equity, and cash flows for
each of the years in the three year period ended December 26, 1999. Our audits
also included the financial statement schedule listed in the Index at Item
14(a). These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Cost-U-Less, Inc. at December 26, 1999 and December 27, 1998 and the
consolidated results of its operations and its cash flows for each of the
years in the three year period ended December 26, 1999, in conformity with
accounting principles generally accepted in the United States. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.
ERNST & YOUNG LLP
Seattle, Washington
February 21, 2000
23
COST-U-LESS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
December 26, December 27,
1999 1998
------------ ------------
ASSETS
------
Current assets:
Cash and cash equivalents.......................... $ 792 $ 4,289
Receivables (net of allowance of $150 and $143 in
1999 and 1998, respectively)...................... 2,122 1,696
Income tax receivable.............................. 518 157
Inventories........................................ 21,605 16,685
Prepaid expenses................................... 265 210
Deferred taxes..................................... 769 511
------- -------
Total current assets............................. 26,071 23,548
Buildings and equipment, net......................... 16,563 12,712
Deposits and other assets............................ 974 816
Deferred taxes, net.................................. 67 141
------- -------
Total assets..................................... $43,675 $37,217
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Line of credit..................................... $ 2,163 $ --
Accounts payable................................... 14,387 11,443
Accrued expenses................................... 2,382 1,809
Current portion of long-term debt.................. 422 633
Current portion of capital lease obligations....... 725 422
------- -------
Total current liabilities........................ 20,079 14,307
Deferred rent........................................ 414 524
Long-term debt, less current portion................. 2,517 2,036
Capital lease obligations, less current portion...... 0 754
------- -------
Total liabilities................................ 23,010 17,621
Commitments
Shareholders' equity:
Preferred stock--$0.001 par value; Authorized
shares--2,000,000; Issued and outstanding shares,
respectively--none.................................. -- --
Common stock--$0.001 par value; Authorized shares--
25,000,000; Issued and outstanding shares,
respectively--3,576,858 and 3,539,961............... 12,422 12,305
Retained earnings.................................... 8,512 7,358
Accumulated other comprehensive loss................. (269) (67)
------- -------
Total shareholders' equity....................... 20,665 19,596
------- -------
Total liabilities and shareholders' equity....... $43,675 $37,217
======= =======
See accompanying notes.
24
COST-U-LESS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except share data)
Fiscal Year Ended
--------------------------------------
December 26, December 27, December 28,
1999 1998 1997
------------ ------------ ------------
Net sales ............................. $ 167,079 $ 133,861 $ 124,865
Merchandise costs...................... 139,684 111,537 104,397
--------- --------- ---------
Gross profit........................... 27,395 22,324 20,468
Operating expenses:
Store................................ 18,254 15,100 14,543
General and administrative........... 5,654 4,139 3,225
Store openings....................... 1,217 747 327
Store closings....................... 0 238 1,346
--------- --------- ---------
Total operating expenses............... 25,125 20,224 19,441
--------- --------- ---------
Operating income....................... 2,270 2,100 1,027
Other income (expense):
Interest expense, net................ (403) (257) (427)
Other................................ (57) (10) (40)
--------- --------- ---------
Income before income taxes............. 1,810 1,833 560
Income tax provision................... 656 640 197
--------- --------- ---------
Net income............................. $ 1,154 $ 1,193 $ 363
========= ========= =========
Earnings per common share:
Basic................................ $ 0.32 $ 0.45 $ 0.18
========= ========= =========
Diluted ............................. $ 0.32 $ 0.43 $ 0.17
========= ========= =========
Weighted average common shares
outstanding .......................... 3,557,789 2,664,192 1,999,961
========= ========= =========
Weighted average common shares
outstanding, diluted ................. 3,618,193 2,758,939 2,123,784
========= ========= =========
See accompanying notes.
25
COST-U-LESS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands, except share data)
Accumulated
Common Common Other
Stock-- Stock-- Retained Comprehensive
Shares Amount Earnings Income (Loss) Total
--------- ------- -------- ------------- -------
Balance at December 29,
1996........................ 1,999,961 $ 3,525 $5,802 $ 0 $ 9,327
Net income................. -- -- 363 -- 363
Foreign currency
translation adjustments... -- -- -- (20) (20)
-------
Comprehensive income....... 343
--------- ------- ------ ----- -------
Balance at December 28,
1997........................ 1,999,961 3,525 6,165 (20) 9,670
Initial public offering:
Sale of common stock, net
of $2,075 of offering
costs..................... 1,540,000 8,705 -- -- 8,705
Compensation related to
stock options............. -- 75 -- -- 75
Net income................. -- -- 1,193 -- 1,193
Foreign currency
translation adjustments... -- -- -- (47) (47)
-------
Comprehensive income....... 1,146
--------- ------- ------ ----- -------
Balance at December 27,
1998........................ 3,539,961 12,305 7,358 (67) 19,596
Exercise of common stock
options................... 36,897 117 117
Net income................. -- 1,154 -- 1,154
Foreign currency
translation adjustments... -- -- -- (202) (202)
-------
Comprehensive income....... 952
--------- ------- ------ ----- -------
Balance at December 26,
1999........................ 3,576,858 $12,422 $8,512 $(269) $20,665
========= ======= ====== ===== =======
See accompanying notes.
26
COST-U-LESS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
December 27, December 27, December 28,
1999 1998 1997
------------ ------------ ------------
OPERATING ACTIVITIES:
Net income............................ $ 1,154 $ 1,193 $ 363
Adjustments to reconcile net income to
net cash provided by operating
activities:
Depreciation and amortization....... 1,598 1,092 917
Writedown of property and
equipment.......................... 46 195 637
Deferred tax (benefit) provision.... (184) 42 (253)
Compensation related to stock
options............................ -- 75 --
Reserve for bad debts............... 7 118 --
Cash provided by (used in) changes
in operating assets and
liabilities:
Receivables....................... (434) (791) (308)
Income tax receivable............. (361) 22 208
Inventories....................... (4,920) (4,414) 2,667
Prepaid expenses.................. (54) (73) 179
Deposits and other assets......... (158) (180) (193)
Accounts payable.................. 2,944 2,467 352
Accrued expenses.................. 573 456 (142)
Deferred rent..................... (110) 43 151
------- ------- -------
Net cash provided by operating
activities..................... 101 245 4,578
INVESTING ACTIVITY:
Cash used to purchase buildings and
equipment............................ (5,495) (7,152) (899)
FINANCING ACTIVITIES:
Proceeds from sale of common stock.... 117 8,705 --
Proceeds (payments) from (on) line of
credit, net.......................... 2,163 (376) (1,125)
Proceeds from long-term debt.......... 907 3,000 --
Payments on long-term debt............ (637) (715) (1,246)
Payments on capital lease
obligations.......................... (451) (399) (375)
------- ------- -------
Net cash provided by (used in)
financing activities........... 2,099 10,215 (2,746)
Foreign currency translation
adjustments.......................... (202) (47) --
------- ------- -------
Net increase (decrease) in cash and cash
equivalents............................ (3,497) 3,261 933
Cash and cash equivalents:
Beginning of period................... 4,289 1,028 95
------- ------- -------
End of period......................... $ 792 $ 4,289 $ 1,028
======= ======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid during the period for:
Interest............................ $ 478 $ 409 $ 442
Income taxes........................ $ 1,187 $ 577 $ 102
See accompanying notes.
27
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Nature of Business
Cost-U-Less, Inc. (the "Company") operates mid-sized warehouse club-style
stores in the United States (U.S.), U.S. territories, and foreign island
countries throughout the Pacific and the Caribbean. At December 26, 1999, the
Company operated thirteen stores located in Hawaii, California, the U.S.
Virgin Islands, Netherlands Antilles, Guam, American Samoa, Republic of Fiji
(Fiji), and New Zealand.
Fiscal Year
The Company's fiscal year ends on the last Sunday in December. The years
ended December 26, 1999, December 27, 1998, and December 28, 1997 represent
52-week fiscal years.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries in the U.S. Virgin Islands, Netherlands
Antilles, Guam, American Samoa, Nevada, Fiji, New Zealand and St. Maarten. All
significant inter-company accounts and transactions have been eliminated in
consolidation.
Foreign Currency Translations
The U.S. dollar is the functional currency for all locations, except for
Fiji, New Zealand, and Netherlands Antilles, where the local currency is the
functional currency. Assets and liabilities denominated in foreign currencies
are translated at the applicable exchange rate on the balance sheet date. Net
sales costs and expenses are translated at the average rates of exchange
prevailing during the period. Adjustments resulting from this process are
charged or credited to shareholders' equity, net of taxes and are included in
determining comprehensive income. Realized and unrealized gains on foreign
currency transactions are included in other income (expense).
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the U.S. requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
Cash Equivalents
The company considers all highly liquid investments with an initial maturity
three months or less to be cash equivalents.
Financial Instruments
The carrying value of financial instruments, including cash, receivables,
payables, and long-term debt, approximates market value at December 26, 1999
and December 27, 1998.
Inventories
Inventories are carried at the lower of average cost or market.
28
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Buildings and Equipment
Buildings and equipment are stated at cost, less accumulated depreciation
and amortization. Depreciation and amortization are computed using the
straight-line method over the estimated useful lives of the assets, ranging
from 5 to 20 years. Equipment acquired under capitalized leases is depreciated
over the shorter of the asset's estimated useful life or the life of the
related lease. Leasehold improvements are amortized over the lesser of the
term of the lease or the assets' estimated useful lives.
Revenue Recognition
The Company recognizes revenue from product sales when the products are
purchased by the customer.
Long Lived Assets
The Company periodically evaluates the recoverability and possible
impairment of its long-lived assets. Management's analysis is based on several
factors, including, but not limited to, management's plans for future
operations, recent operating results, and projected cash flows.
Letter of Credit
As of December 26, 1999, the Company has $1.1 million outstanding in standby
letters of credit.
Advertising Costs
The cost of advertising is expensed as incurred. Advertising expenses
incurred during fiscal years 1999, 1998, and 1997 were not material to the
Company's operating results.
Store Opening Costs
Pre-opening costs incurred in connection with the startup and promotion of
new stores are expensed as incurred.
Stock-Based Compensation
The Company has elected to apply the disclosure-only provisions of Financial
Accounting Standards Board Statement No. 123, Accounting for Stock-Based
Compensation. Accordingly, the Company accounts for stock-based compensation
using the intrinsic value method prescribed by Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations under APB No. 25, whereby compensation cost for stock options
is measured as the excess, if any, of the fair value of the Company's common
stock at the date of grant over the stock option exercise price.
Income Taxes
Income tax expense includes U.S. and foreign income taxes. The Company
accounts for income taxes under the liability method. Under the liability
method, deferred tax and liabilities are determined based on differences
between financial reporting and tax bases of assets and liabilities, and are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse. Valuation allowances are established when
necessary to reduce deferred tax assets to the amounts expected to be
realized.
29
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Earnings Per Share
Basic earnings per share is computed using the weighted average number of
common shares outstanding during the period and excludes any dilutive effects
of stock options and warrants. Diluted earnings per share are computed using
the weighted average number of common shares and common stock equivalent
shares outstanding during the period. Common stock equivalent shares are
excluded from the computation if their effect is anti-dilutive.
Comprehensive Income
Comprehensive income is reported in the consolidated statement of
shareholders' equity. The Company's comprehensive income includes its net
income and the effect of foreign currency translation adjustments.
Segment Reporting
Effective January 1, 1997, the Company adopted the Statement No. 131,
"Disclosures about Segments of an Enterprise and Related Information", which
establishes standards for reporting information about operating segments in
annual financial statements. It also establishes standards for related
disclosures about products and services, geographic areas, and major
customers. The adoption of this Statement did not affect results of operations
or financial position. The Company operates two segments, island and mainland
stores.
New Accounting Pronouncement
In June 1998 , the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" which
establishes standards for recognition, measurement, and reporting of
derivatives and hedging activities and is effective for the Company's year
ending December 31, 2000. The Company anticipates that the adoption of this
new accounting standard will not have a material impact on the Company's
financial statements.
2. Buildings and Equipment
Buildings and equipment consist of the following (in thousands) at:
December 26, December 27,
1999 1998
------------ ------------
Buildings........................................ $ 2,874 $ 2,874
Equipment........................................ 16,263 11,898
Leasehold improvements........................... 1,386 1,171
------- -------
Buildings, equipment and leasehold
improvements.................................. 20,523 15,943
Less accumulated depreciation and amortization... 5,202 3,823
------- -------
Net book value of depreciable assets........... 15,321 12,120
Computer system and software development in
progress........................................ 0 592
Construction in progress......................... 1,242 0
------- -------
Total assets..................................... $16,563 $12,712
======= =======
3. Line of Credit
The Company maintains an $8,000,000 line of credit with a commercial bank
that expires May 1, 2000. Borrowings bear interest at the Company's option of
the prime rate or LIBOR plus 1.5% (8.5% at December 26, 1999). Borrowings are
secured by various Company assets. As of December 26, 1999, borrowings
outstanding
30
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
under the line of credit amounted to $2,163,000. Amounts available under the
line of credit are reduced by outstanding letters of credit of $1.1 million.
In accordance with the terms of this line of credit, the Company is required
to maintain certain financial covenants. As of and during the year ended
December 26, 1999, the Company was in compliance with all such covenants.
4. Long-Term Debt
In 1997 the Company entered into a $1,000,000 note payable to a bank to fund
construction of the St. Thomas store. The note bears interest at the fixed
rate index plus 1.75% (7.77% at December 26, 1999), and matures April 2000. As
of December 26, 1999, there was a balance owed of $221,000, and is secured by
various Company assets.
Also, in conjunction with the construction of the St. Thomas store, the
Company entered into a $2,000,000 note payable to a bank with interest at the
prime rate plus 1% (9.5% at December 26, 1999), maturing June 2013. As of
December 26, 1999, there was a balance owed of $1,811,000, and is secured by a
first leasehold priority mortgage on the St. Thomas building. The Company
makes principal payments of approximately $11,000 per month.
In November 1999, the Company entered into a $2,000,000 credit facility with
a financial institution to fund the construction of the St. Maarten store. At
December 26, 1999, the Company had borrowed $907,000 against this credit
facility to fund construction in progress related to the St. Maarten store.
The credit facility bears interest at the prime rate plus 1% (9.50% at
December 26, 1999). The note is secured by a first leasehold security interest
on the St. Maarten leasehold interest and personal property. The Company will
make principal payments of approximately $11,000 per month, upon completion of
the store, which is expected to be third quarter of 2000.
Maturities of long-term debt during the next five fiscal years and
thereafter are as follows (in thousands):
2000......................... $ 422
2001......................... 267
2002......................... 267
2003......................... 267
2004......................... 267
Thereafter................... 1,449
------
Total...................... $2,939
======
5. Income Taxes
Income (loss) before income taxes by jurisdiction is as follows:
1999 1998 1997
------- ------ ------
United States...................................... $ 3,070 $1,279 $ (795)
U.S. Territories................................... 1,812 1,375 1,520
Foreign............................................ (3,072) (821) (165)
------- ------ ------
Income before income taxes....................... $ 1,810 $1,833 $ 560
======= ====== ======
31
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The provision for income taxes is as follows:
1999 1998 1997
----- ----- -----
Current Income Taxes:
United States........................................ $ 217 $ 112 $ 0
U.S. Territories..................................... 653 483 463
Other................................................ (30) 3 (13)
----- ----- -----
Current Income Taxes............................... 840 598 450
Deferred Income Taxes
United States........................................ $ 346 $ 273 $(268)
U.S. Territories..................................... 132 0 0
Foreign.............................................. (662) (231) 0
Other................................................ 0 0 15
----- ----- -----
Deferred income taxes.............................. (184) 42 (253)
----- ----- -----
Provision for Income Taxes............................. $ 656 $ 640 $ 197
===== ===== =====
A reconciliation of the Company's effective tax rate with the federal
statutory rate of 34% for the years ended December 26, 1999, December 27,
1998, and December 28, 1997, is as follows:
1999 1998 1997
---- ---- ----
Tax at U.S. Statutory Rate............ $615 34.0 % $623 34.0 % $190 34.0 %
Non-Deductible Permanent Differences.. 3 0.2 % 10 0.5 % 1 0.2 %
Change in Valuation Allowance......... 0 0.0 % 32 1.7 % (22) (3.9)%
Statutory Rate Difference as Compared
to U.S. Statutory Rate: U.S.
Territories.......................... 45 2.5 % 46 2.5 % 14 2.5 %
Other................................. (7) (0.4)% (71) (12.7)% 14 2.5 %
---- ---- ----
Effective Income Tax Rate........... $656 36.2 % $640 34.9 % $197 35.2 %
==== ==== ====
The Company's ability to utilize various tax benefits is dependent on
generating taxable income in the future. At December 26, 1999, the company had
recognized certain net tax benefits of foreign net operating loss carry-
forwards that are dependent on future earnings of the Company's U.S. and
foreign operations. The Company has implemented a tax strategy which will
allow the Company to utilize these tax benefits.
Effective December 26, 1999, the Company elected to treat its wholly-owned
subsidiary in New Zealand as a branch for U.S. tax purposes. The effect of
such election resulted in a U.S. tax benefit of approximately $396,000 in
1999. In addition, the Company utilized $321,000 of foreign tax credits in the
year ended December 26, 1999.
32
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Significant components of the Company's deferred tax assets and liabilities
are as follows:
1999 1998
------ ------
Deferred Tax Assets
Inventory Adjustments...................................... $ 152 $ 157
Vacation Accrual........................................... 100 80
Bad Debt Expense........................................... 51 21
Net Operating Loss Carryforward--U.S. ..................... 0 80
Net Operating Loss Carryforward--Foreign................... 1,103 441
Deferred Rent.............................................. 144 178
Foreign tax credits........................................ 0 321
Other...................................................... 24 14
------ ------
Total Deferred Tax Assets.................................. 1,574 1,292
Valuation Allowance...................................... (199) (199)
------ ------
1,375 1,093
Deferred Tax Liabilities
Cash Discounts............................................. (13) (65)
Fixed Asset Basis Difference............................... (526) (376)
------ ------
Total Deferred Tax Liabilities............................. (539) (441)
------ ------
Net Deferred Tax Assets...................................... $ 836 $ 652
====== ======
The net deferred tax assets are classified on the balance sheet as follows:
Current Assets............................................... $ 769 $ 511
Long-Term Assets, net........................................ 67 141
------ ------
Net Deferred Tax Assets...................................... $ 836 $ 652
====== ======
As of December 26, 1999, the Company's Fiji subsidiary has net operating
losses (NOL's) of $2.5 million, which will begin to expire in the year 2006.
Other NOL's in Australia, Netherlands Antilles, and St. Maarten of
approximately $.6 million are not subject to expiration time limits.
6. Shareholders' Equity
Common Stock
On May 13, 1998, the Company effected a 1-for-3.38773 reverse split of its
common stock. All outstanding common and common equivalent shares and per-
share amounts in the accompanying financial statement and related notes have
been retroactively adjusted to give effect to the stock split.
On July 23, 1998, the Company sold 1,380,000 shares of common stock at $7.00
per share in an Initial Public Offering. Concurrent with the Initial Public
Offering on July 23, 1998, the Company issued 277,000 warrants to certain
shareholders at grant prices ranging from $8.40 to $10.15. At December 26,
1999, these warrants are fully vested and exercisable.
Stock Options
The Company maintains an Amended and Restated 1989 Stock Option Plan (the
"1989 Plan") which provides for the granting of incentive and nonqualified
stock options to employees, directors, and consultants of
33
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
the Company. An aggregate of 398,496 shares of common stock has been
authorized for issuance under the 1989 Plan. Options issued under the 1989
Plan vest ratably over five years and expire ten years from the date of grant
and are generally granted at prices equal to the fair value on the date of
grant. There were 175,936 options available for future grant under the 1989
Plan at December 26, 1999. No additional options will be granted under the
1989 Plan.
In 1998, the Company adopted, and shareholders approved, issuance of the
1998 Stock Incentive Compensation Plan (the "1998 Plan"). The 1998 Plan
provides for the granting of various stock awards, including stock options and
issuance of restricted stock, with a maximum of 500,000 shares of common stock
available for issuance. Options issued under the 1998 Plan vest at various
terms ranging from immediately to five years and expire ten years from the
date of grant and are generally granted at prices equal to the fair value on
the date of grant. There were 123,201 options available for future grant under
the 1998 Plan at December 26, 1999.
A summary of the status of stock option plans as of December 26, 1999,
December 27, 1998, and December 28, 1997, and changes during the years then
ended are presented below:
1999 1998 1997
----------------- ------------------ -----------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
------- -------- -------- -------- ------- --------
Outstanding, beginning
of year................ 452,150 $5.35 291,009 $5.49 270,320 $4.98
Granted at fair
value................ 114,288 5.03 442,546 6.96 45,744 9.82
Forfeited............. (13,275) 5.77 (281,405) 9.08 (25,055) 9.45
Exercised............. (36,897) 3.18 -- -- -- --
------- -------- -------
Outstanding, end of
year................... 516,266 5.40 452,150 5.35 291,009 5.49
======= ======== =======
The weighted average fair values of options granted in 1999, 1998, and 1997
were $2.63, $5.18, and $0.09, respectively.
The following summarizes information related to options outstanding and
exercisable at December 26, 1999:
Outstanding Exercisable
----------------------------------------------------- ----------------------
Weighted Weighted Weighted
Range of Average Average Average
Exercise Exercise Contractual Exercise
Prices Options Price Life Options Price
------------ ------- -------- ----------- ------- --------
$0.79 - 3.38 69,366 $1.85 1.38 years 69,366 $1.85
3.72 - 6.00 188,815 4.51 8.50 years 95,192 4.02
7.00 258,085 7.00 8.87 years 201,451 7.00
------- -------
516,266 5.40 366,009 5.25
======= =======
In October 1998, the Company offered employees and directors with options
granted with exercise prices greater than $7.00 per share the opportunity to
surrender those options and receive new options with an exercise price of
$7.00 per share. With the exception of the exercise price, the terms of the
new options, including the vesting schedule, are identical to the terms of the
old options except for officers and directors who accepted a delay in vesting
of six months. The holders of 267,385 options elected to exchange their
options under this
34
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
repricing offer, including directors of the Company holding 168,246 options.
All options surrendered were reissued under the 1998 Plan.
In January 1998, the Company granted 88,554 options with immediate vesting
to a director of the Company. The options were granted with an exercise price
of $7.62, with a deemed fair value of $8.47. Accordingly, for financial
statement presentation purposes, compensation expense of $75,000 was
recognized in 1998.
Pro-Forma Disclosure
The Company applies APB No. 25 and related interpretations in accounting for
options under the 1989 and 1998 Plans. Accordingly, stock compensation has
been recognized for the amortized intrinsic value of stock option grants. Had
the stock option compensation expense for the Company's stock option plans
been determined based on the fair value at the grant dates for options granted
in 1999, 1998, and 1997, consistent with the fair value methods of SFAS No.
123, the Company's net income and earnings per share amounts would have been
reduced to these pro-forma amounts.
1999 1998 1997
------ ------ -----
(Net income in
thousands)
Net income as reported.................................. $1,154 $1,193 $ 363
Net income pro forma.................................... $ 911 $1,068 $ 357
Earnings per common share, basic as reported............ $ 0.32 $ 0.45 $0.18
Earnings per common share, basic pro forma.............. $ 0.26 $ 0.40 $0.18
Earnings per common share, diluted as reported.......... $ 0.32 $ 0.43 $0.17
Earnings per common share, diluted pro forma............ $ 0.25 $ 0.39 $0.17
The fair value of each option is estimated on the date of grant under the
Black-Scholes option-pricing model using the following assumptions:
1999 1998 1997
------- ------- -------
Risk-free interest rate........................... 6.00% 5.50% 6.20%
Expected life..................................... 5 years 5 years 5 years
Expected dividend yield........................... 0% 0% 0%
Volatility........................................ 84% 126% 0%
Warrants
In 1991, the Company issued 29,518 warrants to an officer. The warrants
grant the holder the right to purchase 29,518 shares of the Company's common
stock at a per-share price of $2.37. The warrants are currently exercisable
and expire in 2001.
Common Stock Reserved
Common stock reserved for future issuance at December 26, 1999 is as
follows:
Stock options...................................................... 815,403
Warrants........................................................... 306,518
---------
1,121,921
=========
On February 23, 1999, the Company's Board of Directors declared a dividend
distribution of preferred share purchase rights (the "Rights") pursuant to a
Shareholder Rights Plan. The Rights initially trade with shares of
35
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
the Company's common stock and have no impact upon the way in which
shareholders can trade the Company's common stock. However, ten days after a
person or group acquires 15% or more of the Company's common stock, or such
date, if any, as the Board of Directors may designate after a person or group
commences or publicly announces its intention to commence a tender or exchange
offer which could result in that person or group owning 15% or more of the
Company's common stock (even if no purchases actually occur), the Rights will
become exercisable and separate certificates representing the Rights will be
distributed. The Rights would then begin to trade independently from the
Company's shares at that time. As of December 26, 1999, no rights have become
exercisable.
The following table sets forth the computation of basic and diluted earnings
per common share:
Fiscal Year Ended
--------------------------------------
December 26, December 27, December 28,
1999 1998 1997
------------ ------------ ------------
Numerator:
Net income......................... $ 1,154 $ 1,193 $ 363
Denominator:
Denominator for basic earnings per
share--weighted average shares.... 3,557,789 2,664,192 1,999,961
Effect of dilutive common equivalent
shares:
Stock options and warrants......... 60,404 94,747 123,823
Denominator for diluted earnings
per share--adjusted weighted
average shares and assumed
conversion of stock options and
warrants.......................... 3,618,193 2,758,939 2,123,784
Basic earnings per common share...... $ 0.32 $ 0.45 $ 0.18
Diluted earnings per common share.... $ 0.32 $ 0.43 $ 0.17
7. Segment Information
The Company reports operating results in two segments due to distinct
geographical and operational differences. These two segments include the
Company's discount retail stores located in its island markets and those
located on the U.S. mainland. Other business activities include sales directly
from the Company's distribution facilities. These sales are not significant to
include as a separate segment and are aggregated with other operations that
are not directly related to the operations of the stores in the particular
segments. Segment contribution is segment revenue less direct segment
operating expenses.
36
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Island Mainland
Stores Stores Other Totals
-------- -------- ------ --------
(in thousands)
Year Ended December 26, 1999
Net sales................................... $153,164 $ 7,012 6,903 167,079
Contribution................................ 8,013 (176) 1,304 9,141
Depreciation................................ 1,076 67 0 1,143
Store opening expense....................... 1,217 0 0 1,217
Operating profit (loss)..................... 6,796 (176) 1,304 7,924
Segment inventories......................... 17,262 799 0 18,061
Segment total assets........................ 38,084 1,277 0 39,361
Year Ended December 27, 1998
Net sales................................... $125,433 $ 6,782 $1,646 $133,861
Contribution................................ 6,690 (94) 628 7,224
Depreciation................................ 727 69 -- 796
Store opening expense....................... 747 -- -- 747
Store closing expense....................... 238 -- -- 238
Operating profit (loss)..................... 5,705 (94) 628 6,239
Segment inventories......................... 12,387 806 -- 13,193
Segment total assets........................ 26,363 1,328 -- 27,691
Year Ended December 28, 1997
Net sales................................... $111,480 $10,684 $2,701 $124,865
Contribution................................ 5,635 (160) 450 5,925
Depreciation................................ 579 110 -- 689
Store opening expense....................... 327 -- -- 327
Store closing expense....................... -- 1,346 -- 1,346
Operating profit (loss)..................... 5,308 (1,506) 450 4,252
Segment inventories......................... 8,655 764 -- 9,419
Segment total assets........................ 16,240 1,350 -- 17,590
Reconciliation of Contribution to Consolidated Income before Income Taxes
Fiscal Year Ended
--------------------------------------
December 26, December 27, December 28,
1999 1998 1997
------------ ------------ ------------
Total contribution for reportable
segments.............................. $ 7,837 $ 6,596 $ 5,475
Other contribution..................... 1,304 628 450
Administrative expense not allocated to
segments.............................. (5,654) (4,139) (3,225)
Store opening/closing expenses......... (1,217) (985) (1,673)
Other (expense)........................ (57) (10) (40)
Interest expense....................... (403) (257) (427)
------- ------- -------
Consolidated income before income
taxes................................. 1,810 $ 1,833 $ 560
======= ======= =======
37
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Reconciliation of Significant Items
Segment Consolidated
Totals Corporate Totals
------- --------- ------------
(in thousands)
December 26, 1999
Other significant items
Depreciation..................................... $ 1,143 $ 455 $ 1,598
Inventories...................................... 18,061 3,544 21,605
Total assets..................................... 39,361 4,314 43,675
December 27, 1998
Other significant items
Depreciation..................................... $ 796 $ 296 $ 1,092
Inventories...................................... 13,193 3,492 16,685
Total assets..................................... 27,691 9,526 37,217
December 28, 1997
Other significant items
Depreciation..................................... $ 689 $ 228 $ 917
Inventories...................................... 9,419 2,852 12,271
Total assets..................................... 17,590 5,225 22,815
Geographic Information
Long-lived
Sales Assets
-------- ----------
(in thousands)
1999
United States............................................. $ 38,872 $ 3,817
Other foreign countries*.................................. 128,207 13,787
-------- -------
$167,079 $17,604
1998
United States............................................. $ 30,798 $ 3,857
Other foreign countries*.................................. 103,063 9,671
-------- -------
$133,861 $13,528
======== =======
1997
United States............................................. $ 34,801 $ 3,451
Other foreign countries*.................................. 90,064 3,914
-------- -------
$124,865 $ 7,365
======== =======
- --------
*Including U.S. territories.
38
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
8. Store Closures
In 1997, the Company closed the Davis, California and Walla Walla,
Washington stores. In 1998, the existing St. Thomas store was closed upon
completion of the newly constructed St. Thomas store. There were no store
closures during 1999. The following represents the costs charged to expense
related to the store closures for the indicated fiscal years:
December 27, December 28,
1998 1997(1)
------------ ------------
Lease buyout....................................... $-- $ 421
Leasehold improvement writeoff..................... 210 635
Other closure costs................................ 28 290
---- ------
$238 $1,346
==== ======
- --------
(1) The 1997 charge of $1,346,000 includes $256,000 of additional closure
costs related to stores closed in prior years.
December 27, December 28,
1998 1997
------------ ------------
Accrued store closure expense at beginning of
year........................................... $ 15 $ 320
Store closure expense paid during year.......... 253 1,651
Accruals for store closures during year......... 238 1,346
---- ------
Accrued store closure expense at end of year.... $ 0 $ 15
==== ======
Total revenues and net operating losses contributed by the stores closed
were as follows:
1997
--------------
(in thousands)
Total revenues .............................................. $3,433
------
Store operating losses....................................... $ 243
======
The store closure in 1998 was due to a new store replacing the closed store
and is therefore not included. There were no store closures in 1999.
9. Lease Commitments
The Company has entered into operating leases for its retail and
administrative office locations. The leases range from 5 to 15 years and
include renewal options. The Company is required to pay a base rent, plus
insurance, taxes, and maintenance. The Company also leases equipment that may
be purchased for a nominal amount on expiration of the lease.
39
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A summary of the Company's future minimum lease obligations under leases
with initial or remaining terms of one year or more is as follows:
Capital Lease Operating Lease
------------- ---------------
(in thousands)
2000......................................... $761 $ 5,279
2001......................................... -- 5,270
2002......................................... -- 5,071
2003......................................... -- 4,629
2004......................................... -- 4,306
Thereafter................................... -- 19,399
---- -------
761 $43,954
---- =======
Less amounts representing interest(1)........ (36)
----
Present value of net minimum capital lease
obligations................................. $725
====
- --------
(1) Amounts representing interest are at rates ranging from 7.450% to 13.466%.
Rent expense under operating leases for the fiscal years ended December 26,
1999, December 27, 1998, and December 28, 1997 totaled $4,342,000, $3,702,000,
and $3,817,000, respectively.
Equipment under capitalized leases had a cost of $1,669,000 and $1,669,000
and accumulated depreciation of $568,000 and $476,000 at December 26, 1999 and
December 27, 1998, respectively. Total minimum capital lease payments include
$431,000 of residual value payments to be paid in fiscal year 2000.
10. Employee Benefit Plans
The Company maintains a 40l(k) profit-sharing plan covering all eligible
employees over the age of 18 with at least six months of service.
Participating employees may elect to defer and contribute up to 15% of their
compensation to the plan, subject to annual limitations under the Internal
Revenue Code. The Company matches employee contributions at a rate of 25%. The
Company's matching contributions to the plan approximated $90,000, $87,000,
and $75,000, in fiscal 1999, 1998, and 1997, respectively.
The Company also has a Manager Bonus Program, under which managers are paid
an annual bonus based on the net income of the Company. All amounts payable
under the program are accrued in the year earned. Accordingly, bonuses accrued
under the program totalled $284,000, $257,000, and $213,000, for fiscal 1999,
1998, and 1997, respectively.
40
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
11. Quarterly Financial Data (Unaudited)
The following is a summary of the Company's unaudited quarterly results of
operations:
Earnings
(Loss) Per
Store Net Common Share
Weeks Net Gross Income -------------
in Period Sales Profit (Loss) Basic Diluted
--------- ------- ------ ------ ----- -------
(in thousands, except store weeks and per-
share data)
Fiscal 1999
First quarter..................... 134 $37,987 $6,387 $276 $0.08 $0.08
Second quarter.................... 143 41,227 6,868 477 0.13 0.13
Third quarter..................... 143 41,221 6,783 319 0.09 0.09
Fourth quarter.................... 151 46,644 7,357 82 0.02 0.02
Fiscal 1998
First quarter..................... 104 $31,753 $5,202 $325 $0.16 $0.15
Second quarter(1)................. 104 31,452 5,293 62 0.03 0.03
Third quarter..................... 114 32,958 5,457 288 0.09 0.09
Fourth quarter.................... 123 37,698 6,372 518 0.15 0.14
- --------
(1) Includes store closure costs of $238,000.
The decrease in net income from third quarter 1999 to fourth quarter 1999 was
primarily due to lower gross margins, and higher than expected costs to open
and develop the New Zealand and Fiji markets.
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
None.
41
PART III
Item 10. Executive Officers and Directors of the Registrant
Information called for by Part III, Item 10, is included in the Company's
Proxy Statement relating to the Company's annual meeting of shareholders to be
held on May 18, 2000, and is incorporated herein by reference. Such Proxy
Statement will be filed within 120 days of December 26, 1999, the Company's
fiscal year end.
Item 11. Executive Compensation
Information called for by Part III, Item 11, is included in the Company's
Proxy Statement relating to the Company's annual meeting of shareholders to be
held on May 18, 2000 and is incorporated herein by reference. Such Proxy
Statement will be filed within 120 days of December 26, 1999, the Company's
fiscal year end.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information called for by Part III, Item 12, is included in the Company's
Proxy Statement relating to the Company's annual meeting of shareholders to be
held on May 18, 2000 and is incorporated herein by reference. Such Proxy
Statement will be filed within 120 days of December 26, 1999, the Company's
fiscal year end.
Item 13. Certain Relationships and Related Transactions
Information called for by Part III, Item 13, is included in the Company's
Proxy Statement relating to the Company's annual meeting of shareholders to be
held on May 18, 2000 and is incorporated herein by reference. Such Proxy
Statement will be filed within 120 days of December 26, 1999, the Company's
fiscal year end.
42
PART IV
Item 14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K
(a) Documents filed as part of this Report:
(1) Financial Statements--all consolidated financial statements of the
Company as set forth under Item 8, beginning on p. 22 of this Report.
(2) Financial Statement Schedules--Schedule II Valuation and Qualifying
Accounts.
The independent auditors' report with respect to the financial statement
schedules appears on page 23 of this Report. All other financial statements
and schedules not listed are omitted because either they are not applicable or
not required, or the required information is included in the consolidated
financial statements.
(3) Exhibits
Exhibit
No. Description
------- -----------
3.1* Restated Articles of Incorporation of Cost-U-Less, Inc.
3.2* Amended and Restated Bylaws of Cost-U-Less, Inc.
10.1* 1998 Stock Incentive Compensation Plan
10.2* Amended and Restated 1989 Stock Option Plan
10.3* Form of Director Stock Option Agreement (Vesting)
10.4* Form of Director Stock Option Agreement (Nonvesting)
10.5* Manager Bonus Program
10.6* Common Stock Purchase Warrant between the Company and Michael J.
Rose
10.7* Business Loan Agreement between Bank of America NT & SA dba Seafirst
Bank and the Company, dated April 28, 1998
10.8* Promissory Note between Bank of America NT & SA dba Seafirst Bank
and the Company, dated December 31, 1997 [update]
10.9* Construction/Permanent Loan Agreement by and among CULUSVI, Inc.,
the Company and Banco Popular de Puerto Rico, dated November 6, 1997
10.10* Lease Agreement between Westmall Limited and the Company, effective
March 1, 1998
10.11** Lease Agreement between Fiji Public Service Association and the
Company, dated June 4, 1998
10.12* Lease Agreement between Baroud Real Estate Development N.V. and the
Company, dated April 3, 1998
10.13* Ground Lease between Market Square East, Inc. and the Company, dated
October 20, 1997
10.14* Month-to-Month Rental Agreement (Gross) between Whipple Road
Associates and the Company, dated January 6, 1995
10.15* Sublease Agreement between Tamuning Capital Investment, Inc. and the
Company dated July 15, 1994
10.16* Lease Agreement between Ottoville Development Company and the
Company, dated March 9, 1994
10.17* Lease Agreement between Inmostrat Corporation and the Company, dated
August 1993
10.18* Lease Agreement between Hassan Rahman and the Company, dated July
30, 1993
10.19* Industrial Real Estate Lease (Single-Tenant Facility) between Hilo
Partners and the Company, dated September 1, 1991
10.20* Indenture of Lease between Kai Pacific Limited and the Company,
dated August 30, 1991
10.21* Lease Agreement between Tonko Reyes, Inc. and the Company, dated
July 1991
10.22* Letter Agreement between Streamline Capital Corporation and the
Company, dated December 5, 1997, as amended March 12, 1998
10.23**** Purchase Agreement between Kula Fund and the Company, dated July 28,
1998
10.24**** Common Stock Purchase Warrant between Kula Fund and the Company,
dated July 28, 1998
43
Exhibit
No. Description
------- -----------
10.25*** Rights Agreement dated March 15, 1999 between the Company and
ChaseMellon Shareholder Services, L.L.C., as rights agent
10.26**** Lease Agreement between Caribe Lumber & Trading N.V. (St. Maarten)
and the Company, dated February 19, 1999
10.27 Sublease Agreement between New Breed Distribution Corp. of
California, Inc. and the Company dated November 1, 1999. In
accordance with Rule 201 of Regulation S-T, Exhibit 10.27 is being
filed in paper pursuant to a temporary hardship exemption.
10.28 Lease Agreement between AMB Property, L.P., and the Company dated
December 2, 1999. In accordance with Rule 201 of Regulation S-T,
Exhibit 10.28 is being filed in paper pursuant to a temporary
hardship exemption.
10.29 Lease Agreement between Pukeroa Oruawhata Holdings Limited and the
Company dated February 17, 2000 . In accordance with Rule 201 of
Regulation S-T, Exhibit 10.29 is being filed in paper pursuant to a
temporary hardship exemption.
10.30 Lease Agreement between North Gate Park Limited and the Company
dated December 9, 1999. In accordance with Rule 201 of Regulation S-
T, Exhibit 10.30 is being filed in paper pursuant to a temporary
hardship exemption.
21.1**** Subsidiaries of the Company
23.1 Consent of Ernst & Young LLP, Independent Auditors
24.1 Power of Attorney (see page 45).
27.1 Financial Data Schedule
- --------
* Incorporated by reference to the Company's Registration Statement on Form
S-1 (Registration No. 333-52459).
** Incorporated by reference to the Company's Quarterly Report on Form 10-Q
dated September 2, 1998.
*** Incorporated by reference to the Company's Registration Statement on Form
8-A dated March 15, 1999.
**** Incorporated by reference to the Company's Annual Report on Form 10-K dated
March 26, 1999.
(b) Reports on Form 8-K:
None.
44
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
COST-U-LESS, INC.
Date: March 27, 2000 /s/ J. Jeffrey Meder
By: _________________________________
J. Jeffrey Meder
President and
Chief Executive Officer
Each person whose individual signature appears below hereby authorizes and
appoints J. Jeffrey Meder and Roy W. Sorensen, and each of them, with full
power of substitution and resubstitution and full power to act without the
other, as his or her true and lawful attorney-in-fact and agent to act in his
or her name, place and stead and to execute in the name and on behalf of each
person, individually and in each capacity stated below, and to file, any and
all amendments to this Report, and to file the same, with all exhibits
thereto, and other documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorneys-in-fact and agents, and each
of them, full power and authority to do and perform each and every act and
thing, ratifying and confirming all that said attorneys-in-fact and agents or
any of them or their or his or her substitute or substitutes may lawfully do
or cause to be done by virtue thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the Company
and in the capacities indicated below on the 27th day of March, 2000.
Signature Title
--------- -----
/s/ Michael J. Rose Chairman of the Board
____________________________________
Michael J. Rose
/s/ J. Jeffrey Meder President and Chief Executive Officer
____________________________________ (Principal Executive Officer)
J. Jeffrey Meder
/s/ Roy W. Sorensen Vice President, Chief Financial Officer,
____________________________________ Secretary and Treasurer (Principal
Roy W. Sorensen Financial and Accounting Officer)
/s/ David A. Enger Director
____________________________________
David A. Enger
/s/ Wayne V. Keener Director
____________________________________
Wayne V. Keener
/s/ Gary W. Nettles Director
____________________________________
Gary W. Nettles
/s/ George C. Textor Director
____________________________________
George C. Textor
45
SCHEDULE II
COST-U-LESS, INC.
VALUATION AND QUALIFYING ACCOUNTS
Balance Balance
at at End
Beginning (1) of
Description of Period Additions Deductions Period
----------- --------- --------- ---------- --------
Year Ended December 26, 1999
Reserves and allowances deducted from
asset accounts:
Allowance for doubtful accounts....... $143,000 $ 93,000 $86,000 $150,000
Year Ended December 27, 1998:
Reserves and allowances deducted from
asset accounts:
Allowance for doubtful accounts....... $ 25,000 $127,000 $ 9,000 $143,000
Year Ended December 28, 1997:
Reserves and allowances deducted from
asset accounts:
Allowance for doubtful accounts....... $ 25,000 $ 38,000 $38,000 $ 25,000
- --------
(1) Uncollectible accounts written off, net of recoveries.
46