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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 27, 1998
Commission File Number 0-24543
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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)
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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
nonaffiliates of the registrant at March 20, 1999 was approximately
$14,855,000.
The number of shares of the registrant's Common Stock outstanding at March
20, 1999 was 3,539,961.
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 20, 1999, 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
"--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 mid-sized warehouse club-style stores in U.S.
Territories and foreign island countries. The Company enjoys significant
benefits from the extensive experience of its management team in the warehouse
club industry. As a result of prior relationships with industry leaders such
as Costco, the Company's officers and key employees gained competencies
related to the operation methods, purchasing strategies and management
information systems employed by warehouse clubs. During the Company's early
years, its key personnel developed and implemented a business plan whereby the
Company purchased merchandise at retail from existing large-format warehouse
clubs and then resold the merchandise, at attractive margins, through stores
located in relatively remote and underserved markets. By selling only products
proven to be successful at established warehouse clubs, the Company minimized
its need for in-house buyers and was able to keep corporate costs low. The
Company utilized this strategy for several years and maintained its focus on
operations pursuant to an effective and low-cost business model. However, as
sales volume grew, the Company became able to source its merchandise directly
from manufacturers, thereby significantly reducing its cost of goods. Over
time, the Company augmented its corporate buying team as it began to
increasingly tailor its product mix to its specific markets and further
realize the benefits of direct purchasing. The Company then began to build a
functional corporate infrastructure to support anticipated growth.
Capitalizing on management's experience with the warehouse club industry,
the Company opened its first retail warehouse store in 1989. In 1992, the
Company initiated its expansion by opening stores in relatively remote island
locations. 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 while continuing to succeed against similar competitors
in its island stores, management decided in 1995 to return its focus to its
core island markets. In 1996, while further refining its island store concept,
enhancing inventory control and management information systems, adjusting its
island store product mix to include higher-margin items and local merchandise,
and developing a prototype island store design, the Company continued the
process of closing nearly all its mainland stores. The Company's founder and
current Chief Executive Officer was formerly a principal owner of a
merchandise broker and manufacturer's representative that worked exclusively
with Costco. The Company has added three other management persons and five
store managers who are former employees of Costco or the merchandise broker.
The Company believes it is now well positioned to pursue an aggressive growth
strategy focused on accelerating the roll out of its island stores that
started with the opening of two new stores in Fiji in the second half of 1998
and one new store in Curacao, Netherlands Antilles that opened March 2, 1999.
As of March 2, 1999, the Company operated eleven warehouse club-style 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 and one in
Sonora, California. In addition, management has completed a lease transaction
on a property in St. Maarten for a 36,000 square-foot store and has agreed to
terms and is awaiting business license approval in Aruba for a 27,000 square-
foot store, both in the Netherlands Antilles. Management
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is also negotiating lease transactions for stores in Barbados and Grand
Cayman, in the Caribbean; Tahiti and Papua New Guinea in the South Pacific;
and several stores in New Zealand for openings in 1999 and 2000.
The Company intends to concentrate its future expansion efforts on island
markets, which it believes offer significant opportunities for growth. To
achieve its anticipated growth, the Company plans to employ a multi-element
business strategy designed to leverage the Company's core competencies in
opening and operating stores in distant and diverse locations, while
capitalizing on the inherent features of island markets. Moreover, the Company
intends to continue utilizing a "first-mover" advantage. By opening stores in
markets that other warehouse clubs and discount retailers have not yet
entered, the Company believes that it will be better able to achieve
significant market share and develop name recognition and customer loyalty,
thus further discouraging entry by large-format discount competition.
Accordingly, the Company's future growth involves expanding into relatively
untapped markets, and the Company has identified a number of islands
throughout the Pacific and Caribbean in which larger format warehouse clubs
have not and are not expected to open stores.
Industry Overview
Traditional warehouse clubs focus on both retail and small-business
customers, with store formats averaging approximately 115,000 square feet (the
Company's stores average 29,300 square feet). These retailers typically (i)
offer a range of national brand and selected private label products, 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. Prior to the inception of the membership warehouse
club concept in the mid-1970s, the dominant companies selling comparable lines
of merchandise were department stores, grocery stores and traditional
wholesalers. Warehouse clubs positioned themselves as low-price leaders in the
communities they entered and thereby quickly gained market share as their new
merchandising concepts and aggressive marketing techniques led to a more
competitive retail environment. Although the Company employs many of the
retailing methods associated with the larger companies that principally make
up the warehouse club industry, including Costco Companies, Inc. ("Costco"),
BJ's Wholesale Club, Inc. and Sam's Club, a division of Wal-Mart Stores, Inc.
("Wal-Mart"), the Company operates fewer stores, 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.
The Company believes that its target island markets are similar in many
respects to those found in the United States before the introduction of the
first warehouse club stores; however, island markets are characterized by
distinct attributes that, management believes, lead to certain competitive
advantages for the Company. Logistical challenges are presented by operating
individual store units in remote locations, whether in terms of information
flow or transportation of goods. Meeting these challenges requires specially
tailored systems and methods. Issues related to receiving local government
approvals, dealing with island real estate and site selection, and
constructing weather- resistant buildings that have been properly formatted
for efficient retailing are difficult to overcome. Retailers, and thus
consumers, in island markets generally have limited experience with modern,
more effective retailing methods and, therefore, the Company believes, an
opportunity exists to capitalize on competitive advantages inherent in
employing such techniques. In addition, 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 island
retailers. As a result, an unusually strong yet largely unsatisfied demand for
certain products may exist. Moreover, each island or region demonstrates
unique consumer preferences and thus may require effective retailers to
conduct regional research and to incorporate flexible localized merchandise
purchasing policies in order to offer a diverse selection of local products,
as well as popular U.S. brand-name products. Based on the increasing
acceptance of the traditional warehouse-club concept in mainland markets, the
Company's experience and operating results in current island locations, as
well as its market research of potential markets, the Company believes that
significant opportunities exist in island markets for expansion of its
warehouse club-style store concept.
The Company has identified its prototypical target market as an island with
a minimum population of 40,000 and a Gross Domestic Product of at least $125
million. The Company estimates that at least 30 Pacific and
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Caribbean islands meet or exceed these criteria. Based on its estimates, the
Company believes these islands currently represent as many as 90 potential
locations for its island concept stores.
Business Strategy
The Company's goal is to expand its operations significantly in island
markets by leveraging its island-operations expertise, utilizing modern
systems and merchandising techniques, offering competitive prices while
maintaining attractive margins, providing a localized product mix and
benefiting from low overhead costs. The Company has identified a goal of
opening an additional three stores in 1999 and six stores per year thereafter.
Concentrate Expansion Efforts in Island Markets. The Company's expansion
strategy focuses on opening mid-sized warehouse club-style stores in island
markets throughout the Pacific and Caribbean. The Company believes these
markets offer significant opportunities for growth. Specifically, island
markets are often characterized by (i) significant geographic and logistical
challenges, (ii) local competition with minimal experience in modern retailing
methods, and (iii) a demand for U.S. brand-name products that have limited
availability. In addition, the Company believes that traditional large-format
warehouse club and discount retailers are generally unwilling to adapt their
multi-unit, continent-based operations to meet the unique characteristics and
small populations of island markets.
Leverage Island-Operations Expertise. Capitalizing on its experience in
opening and operating retail warehouse club-style stores in remote U.S.
Territories and the Hawaiian Islands, the Company has developed core
competencies in overcoming the inherent challenges of island market
operations. The Company has refined a mid-sized building prototype designed to
endure severe island weather conditions. This prototype also incorporates low
construction costs, specifications that can be easily and quickly replicated,
and standardized equipment designed either to be readily repaired by island
employees or efficiently monitored off-site by equipment vendors. Moreover,
the Company has made a significant investment 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. In addition, through its long-standing
relationships with steamship lines, and with its present volume of deliverable
goods, the Company negotiates what it believes to be competitive
transportation rates while selecting efficient shipping routes and cost-
effective freight techniques, including the use of both a Company-operated
cross-dock depots and independently operated distribution facilities.
Utilize Modern Systems and Merchandising Methods to Successfully Enter
Target Markets. The Company believes that merchants in target markets often
have not adopted modern retail operating efficiencies, including computerized
cash registers and inventory-tracking devices, state-of-the-art refrigeration
and air-conditioning equipment, efficient shelving and display racks, improved
forklifts and sophisticated security systems. Moreover, the Company believes
that many locally operated stores do not have access to the vendor network and
distribution channels developed by the Company. As a result, the Company
believes that it will be able to successfully enter remote island markets by
using its advanced systems to provide a superior shopping environment for its
customers by (i) monitoring sales and inventory levels and using this
information to respond rapidly to changing consumer preferences and (ii)
offering a level of product selection and customer service often not found in
most of its local competitors' island stores.
Emphasize Strong Margins While Maintaining Everyday Low Prices. In addition
to providing a pleasant shopping atmosphere, the Company is able 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 and access
to volume-purchasing discounts, the Company believes it is able to acquire
some products at a significantly lower cost than that paid by other island
retailers. The Company passes along much of these savings to its customers
through "low price leader," "everyday low prices" and "dare to compare"
pricing policies. In addition, unlike most warehouse clubs, the Company does
not charge a club membership fee, further providing cost-effective shopping to
its customers. However, due to the demand in island markets for the Company's
goods, the lack of meaningful price competition and the generally high price
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levels found in such markets, the Company believes its prices are often higher
than those charged on the mainland by warehouse clubs and discount retailers,
enabling the Company historically to achieve higher margins (16.7% for fiscal
year 1998) than those achieved by mainland warehouse clubs and discount
retailers (typically 10-12%).
Use Localized Product Sourcing Yet Derive Benefits of Centralized
Purchasing. An important element of the Company's marketing strategy is to
specifically cater its product selection to each distinct island market. To
this end, the Company conducts market research through its vendors, store
managers and resident employees to ascertain the preferences of each
particular locale, including determining which national brands are favored and
which regional and ethnic items are desired. The Company's buyers then procure
a majority of these products through the Company's 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.
Capitalize on Efficient Facilities, Controlled Operating Expenditures and
Cost-Effective Labor. The Company seeks to minimize costs throughout its
operations in an effort to decrease overhead and increase margins. These
savings are achieved through the use of efficient facilities, including stores
that (i) do not incorporate expensive fixtures such as floor tiles and false
ceilings, (ii) are energy efficient as a result of modern refrigeration and
air-conditioning equipment, (iii) encourage self-service and feature
sophisticated scanning systems, thereby reducing labor and shrink expense, and
(iv) maximize selling-floor space, thus reducing overall space requirements
and rental expense. In addition, the Company has been able to limit
advertising expense by relying primarily on "word-of-mouth" publicity in
island markets because of its significant market presence in relation to most
of its competitors. Further, the Company's efforts at controlling inventory
shrink expense have contributed to increased margins. Finally, 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 decreased labor costs.
Maintain Relationship With CDC. The Company has developed a relationship
with Commonwealth Development Corporation ("CDC"), a development finance
institution of the U.K. government. Organized in 1948, CDC is engaged in
economic development activities in overseas countries, including venture
capital and other investments, and has significant interests in the Pacific
Islands and Caribbean regions. Kula Fund, a private equity fund established in
1997 for 12 Pacific Island countries and managed by a CDC affiliate, is
financed by CDC, Asian Development Bank, European Investment Bank,
International Finance Corporation, Societe de Promotion et de Participation
pour la Cooperation Economique/Proparco and Fiji National Provident Fund. The
Company sold 160,000 shares of Common Stock to Kula Fund, an affiliate of CDC,
in a private placement (the "Concurrent Reg. S. Placement") at $7.00 per
share, and also sold to Kula Fund, for nominal consideration, a warrant to
purchase 117,000 shares of Common Stock at an exercise price of $8.40 per
share (120% of the public offering price), containing standard net issuance
provisions, exercisable at any time for a period of four years. In addition,
the Company elected Ashley Emberson-Bain to its Board of Directors. Mr.
Emberson-Bain has been employed by CDC since 1986 in a variety of management,
investment and staff positions. Since 1995, he has been principally
responsible for overseeing CDC investments in the Pacific Islands. The Company
believes that CDC's strong ties to, and knowledge of, the Pacific Islands and
Caribbean regions, and its presence in most areas where the Company either
operates or plans to operate, will strengthen the Company's business and
business strategy. See "Market for Registrant's Common Stock and Related
Shareholder Matters."
Expansion Plans
General. The Company's expansion plans focus on opening new stores in
foreign island markets. The Company believes such island markets offer
significant opportunities for growth because they are often characterized by
(i) significant geographic and logistical barriers to entry, (ii) existing
higher-priced local competitors with minimal experience with modern operating
processes in purchasing, distribution, merchandising and information
technologies, and (iii) a demand for U.S. brand-name products that have
limited availability.
5
The Company resumed expansion efforts in fiscal 1998 after concentrating its
efforts in fiscal 1996 and 1997 on (i) improving internal operating
efficiencies, (ii) standardizing its island business model and related
strategies, and (iii) closing nearly all of its U.S. mainland stores. The
Company opened three stores in fiscal 1998 (one in June in St. Thomas and two
in Fiji, in July and November), and plans to open four stores in fiscal 1999
(including one store in Curacao, Netherlands Antilles, which opened March 2,
1999). Overall, the Company anticipates opening 26 new stores during the five-
year period ending fiscal 2002 throughout the Caribbean and Pacific. The
Company expects to finance new stores initially with the net proceeds of its
initial public offering in July 1998 (the "Initial Public Offering") and later
with a combination of borrowed funds under a line of credit with Seafirst Bank
and cash flow from operations. If the Company is unable to obtain adequate
funds from debt financing or internally from operations, the expansion program
could be curtailed or otherwise adversely affected. Furthermore, due to
difficulties in certain economies in the South Pacific arising from the "Asian
Crisis" and in reaching acceptable lease terms for new stores, the Company
reduced expected store openings in 1999 from six to four. See "Important
Factors Regarding Forward-Looking Statements--Ability to Manage Growth and
Uncertainties Associated With Expansion Outside U.S. Territories."
The Company has identified approximately 23 target markets in the Pacific
Islands and the Caribbean (for approximately [26] stores) as a result of its
in-house analysis of demographic and income factors. Company personnel have
visited eight of these markets for purposes of site selection and review of
governmental requirements. In addition, management has completed a lease
transaction on a property in St. Maarten for a 36,000 square-foot store and
has agreed to terms and is awaiting business license approval in Aruba for a
27,000 square-foot store, both in the Netherlands Antilles. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Overview--Store Openings."
Mid-Sized Format. The average size of the Company's eleven stores is
approximately 29,300 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 store in St. Thomas and Curacao,
and the stores under development.
Site Selection. The Company believes that the reduced size of its stores, as
compared to typical large-format discount retailers, will enable it to operate
profitably in markets far less populated than typical warehouse clubs. The
Company chooses potential store sites by comparing the demographics of its
current store base to the demographics of the target market.
Because of the unavailability of detailed demographic studies by third-party
consultants, the Company's market analysis is performed in-house. The Company
compares the results of its analysis with the demographic statistics of its
successful island stores. If the demographics for a targeted location compare
favorably with those of its current island operations, the Company includes
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 of at least 40,000,
sufficient space for the Company's facility, including parking and loading
docks, access to utilities and acceptable geological conditions for successful
construction.
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Store Openings. The Company prefers to lease its facilities, which are
generally built to Company specifications. To this end, 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. The
Company typically does not incur construction expenses for the building
itself, however, the Company provides each developer with construction
specifications and a project timeline. The Company plans to source
construction materials for its buildings to help control lease costs and
ensure building quality. The Company estimates that it takes approximately
eight months from execution of the lease to store opening. The use of the
Company's prototype plans helps ensure that the building will be properly
configured for installation of the Company's fixtures. The refrigeration
equipment will be installed under the supervision of the equipment vendor,
with the Company's crew installing other equipment. The Company anticipates
that in fiscal 1999 its required investment to open a new store will be
approximately $1.8 million, including approximately $250,000 for opening
expenses, $800,000 for store fixtures and equipment and $750,000 for
inventory. The Company expects to carry approximately $1.5 million of
inventory, including $300,000 of inventory in transit. Typically, 50% of the
Company's inventory is vendor-financed, resulting in a $750,000 average per-
store inventory investment by the Company.
The new St. Thomas store, which opened in June 1998, has been constructed at
a total estimated cost of $2.9 million, including $600,000 for furniture,
fixtures and equipment. The former St. Thomas store has been closed and the
equipment and inventories will be relocated to the St. Maarten and Aruba
stores under development. In addition to the new St. Thomas store, which was
built and is owned by the Company, the St. Maarten store will also be built
and owned by the Company. To finance the construction of the St. Maarten
store, which is estimated to cost $3.0 million, a construction loan of $2.0
million is currently being negotiated. 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 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 its island stores, which it believes will help drive
and support its planned expansion. The Company's seven island stores open
during all of fiscal 1998 generated annual average net sales of approximately
$17.6 million, average net sales per square foot of $596, average annual per
store contribution of approximately $993,000 and average annual per store
contribution before depreciation of approximately $1.1 million. The average
investment in buildings, equipment and leasehold improvements as of December
27, 1998 in the seven island stores was approximately $1.4 million. The
average investment in inventory, net of accounts payable of approximately 50%,
was $750,000 at December 27, 1998. The store contribution return on average
island investment for fiscal 1998 was 46%.
Merchandising
Store Layout. The Company has incorporated into its prototype store many
standard features found in domestic warehouse clubs that had been previously
unused in most 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 its
island competitors. Additionally, because of the damage often caused by severe
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weather in its island markets, 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. Customers
enter through large roll-up metal doors and utilize a large shopping cart or,
in some instances, a rolling flat-bed cart for purchases in larger sizes or
quantities. All items are within easy reach on the floor or, because of the
Company's reduced store size, on a shelf above the sales floor. 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 $50. 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.
Product Categories. 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 28% 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-Nonperishables. Dry grocery goods, including soda, wine, beer,
liquor, candy and snacks, represent approximately 42% 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 30% 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. 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, which allows the Company to quickly spot product
trends and discontinue slow-moving products. Moreover, 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." This strategy differs from traditional
warehouse clubs, which typically stock only products in bulk quantities to
satisfy their wholesale client base. The Company purchases merchandise from
manufacturers and suppliers on a purchase order basis exclusively.
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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, which
allows 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, that operate in some of the
Company's island markets. In order to ensure that the Company has 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.
Operations
Distribution and Inventory Management. The Company typically buys directly
from manufacturers in large quantities (full truck loads whenever possible).
The Company currently uses three distribution facilities: a Company-operated
facility in Union City, California and independently operated facilities in
Port Everglades, Florida and Auckland, New Zealand. The Company has no written
agreements with these distribution facilities, but instead has month-to-month
service relationships. Prices are on a per-pallet basis and are based on
volume. At each distribution facility, merchandise is received, consolidated
and crossdocked, 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 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.
Operating Systems. The Company believes that its operating systems provide a
competitive advantage over local retailers. 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. The Company has designated the
Sonora, California store as a testing facility to test various store layouts
and display patterns, which enables management to review and monitor various
store designs and innovations before they are implemented in island locations.
In its new stores, the Company will utilize a specialized refrigeration system
comprised of several, smaller compressor rather than one large one. Because
the system uses many different compressors, the loss of one compressor does
not shut down the entire refrigeration system. At the first indication of
system failure, the refrigeration supplier notifies a local service provider,
who visits the Company's facility and replaces the faulty component. This
system also helps minimize the loss of product associated with damaged
refrigeration units.
9
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, and in the depot located in Union City, California. All data
from each location is sent via modems, or the Internet, to the computer system
located at the Company's corporate headquarters in Bellevue, Washington. The
Company implemented a new corporate computer system on January 31, 1999, which
has enhanced, extended and improved the data capabilities of its systems. The
Company is developing the specifications for integrated systems to support
automatic replenishment of inventory and supplies, and to further improve
profiling sales and purchasing trends. The Company implemented changes in 1998
to its software to handle multi-currency and multi-measurement inventory and
purchase order functions. The Company believes that its current computer
systems will support anticipated growth at least through fiscal 2002. In order
to maintain its competitive advantage in its chosen markets, the Company uses
a corporate-wide intranet and the Internet, which allows 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. The Company's
expansion plans anticipate continued use of the intranet and the Internet to
connect its stores, thereby decreasing communication costs. The Company plans
to integrate new applications aimed at providing enhanced services, data
analysis and improved customer service, thus raising office and store
productivity. While the Company has taken a number of precautions against
certain events that could disrupt the operation of its management information
systems, there can be no assurance that the Company will not experience
systems failure or interruptions, which could have a material adverse effect
on the Company's business, financial condition and operating results. See
"Important Factors Regarding Forward-Looking Statements--Dependence on
Systems; Year 2000 Compliance."
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.
In order to meet its expansion goals, the Company believes it will need to
hire approximately 45 employees for each new store. 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 the Company's store in Tamuning,
Guam, which is used as a training facility for potential managers. 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 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.
Local service providers are also trained in the maintenance and repair of
the Company's refrigeration and air-conditioning systems. The Company and its
refrigeration supplier send crews to facilities during the construction phase
to install these systems. These crews work with local electricians, training
them in the operation and installation of the Company's systems. Thus, when
repairs are necessary, the Company may opt to
10
use a local vendor rather than incur the expense and time involved in using a
service person from either the U.S. mainland or New Zealand.
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 currently spends less than 0.2% of net sales on advertising, and
in the past has utilized coupon books, direct mail advertising and newspaper
advertisements.
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 Corporation ("Kmart") and
Costco in Hawaii and 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 is targeting expansion in additional
island markets that it believes are underserved by existing 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 deter entry by most 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. 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. 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
"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,
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
11
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 "Risk Factors--Risks Associated With Island and
International Operations."
Employees
As of March 20, 1999, the Company had 36 full-time employees at its
corporate headquarters in Bellevue, Washington, and 11 employees at its main
distribution facility in Union City, California. In total, the Company employs
approximately 450 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 94%
of the Company's total net sales for fiscal 1998. 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.
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--Operations."
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, ten of the Company's
eleven 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 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--Operations."
12
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; any failure to do
so would have a material adverse effect on the Company's business, financial
condition and operating results. See "--Business--Expansion Plans."
Uncertainties Associated With Expansion Outside U.S. Territories. As of
March 2, 1999, eight 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 Company's future expansion plans 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 believes that
because its future expansion includes numerous countries and currencies, its
exposure from any one currency devaluation would not significantly affect
operating results. 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--Expansion Plans."
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."
Ability to Manage Growth
The Company intends to pursue an aggressive 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, and (iii) maintain positive comparable store net
sales. The Company currently operates eleven stores and plans to open an
additional 23 new stores by the end of the year 2002, which represents a
significant increase in the number of stores opened and operated by the
Company. Although in prior years the Company opened new stores on a fairly
rapid schedule, it has not done so in foreign island markets at such a rapid
pace. Moreover, to date, the Company has never opened more than four stores in
any given fiscal year and has no operating experience in most of the markets
in which it expects to open new stores. These new markets may present
operational, competitive, regulatory and merchandising challenges that are
different from
13
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.
The Company's ability to open new stores on a timely basis will also depend
on a number of factors, some of which may be beyond the Company's control,
including the ability to (i) properly identify and enter new markets, (ii)
locate suitable store sites, (iii) negotiate acceptable lease terms, (iv)
construct or refurbish sites, and (v) obtain necessary funds on satisfactory
terms. 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 Company intends to locate its stores. There
can be no assurance that the Company will be able to open the planned number
of new stores according to its store-opening schedule 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. Moreover, 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" and "--Expansion Plans."
Small Store Base
The Company opened its first store in 1989, opened a total of 18 stores
through March 1999, and presently operates eleven stores. From December 1994
to June 1997, the Company closed six 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 material adverse effect on the Company's
business, financial condition and operating results. Although the Company
believes that it has carefully planned for the implementation of its expansion
program, 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--Overview," "--Properties."
Competition
The warehouse club and discount retail businesses are highly competitive.
The Company currently competes in several of its markets against other
warehouse clubs and discount retailers, including Costco, Kmart and Wal-Mart.
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. While the Company expects that the size
of many of the markets in which it operates or expects to enter will deter
entry by most 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.
The Company's gross margin and operating income are generally lower for those
stores in markets where traditional warehouse clubs and discount retailers
14
also operate stores. 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."
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, including Michael
J. Rose, the Company's founder, Chairman of the Board, President and Chief
Executive Officer, Allan C. Youngberg, the Company's Vice President-Chief
Financial Officer, Secretary and Treasurer and Terence R. Buckley, the
Company's Director of Pacific Expansion. None of the Company's executive
officers or key employees, including Messrs. Rose, Youngberg and Buckley, are
subject to employment agreements that would prevent them from leaving the
Company. 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 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 and in fiscal 1996 declined $4.9 million, or 3.5%, to $134.8
million from $139.7 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 decline in 1996 was primarily due to the comparison between a 52-
week year in 1996 and a 53-week year in 1995 and to the closure of one store;
comparable store sales were also down as a result of the opening of a second
Guam store.
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 (4.9)%, (0.5)% and 9.9% in fiscal 1996, 1997 and 1998, respectively.
These factors may result in future comparable store sales increases that are
lower than those experienced in fiscal 1998. 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."
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."
15
Dependence on Systems; Year 2000 Compliance
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 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.
Such failures and interruptions may result from the inability of certain
systems (including those of the Company and, in particular, of third-party
vendors to the Company) to recognize the Year 2000. The Year 2000 issue is the
result of computer programs being written using two digits, rather than four,
to define the applicable year. Any of the Company's computer programs that
have time-sensitive software may recognize a date using "00" as the year 1900
rather than the Year 2000. If not addressed, the direct result of the Year
2000 issue could be a system failure or miscalculations, causing disruption of
operations, including a temporary inability to process customer transactions,
order merchandise, accurately track inventory and revenue, or engage in
similar normal business activities.
The Company has substantially completed the necessary changes to its systems
and has planned to complete steps necessary to be fully Year 2000 compliant by
July 1, 1999. The most significant of which was the upgrading of its corporate
computer hardware and operating systems that was completed on January 31,
1999. The Company's failure to implement its Year 2000 corrections in a timely
fashion or in accordance with its current cost estimates, or the failure of
third-party vendors to correct their Year 2000 problems, 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--Year 2000 Compliance" and "--Business--Operations."
Control by Directors and Executive Officers
The Company's directors and executive officers and their affiliates
beneficially own, in the aggregate, approximately 34.4% 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.
Antitakeover 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 advanced 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
16
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 all existing store locations, except its store
in St. Thomas, which the Company owns. The stores average approximately 29,300
square feet and range in size from approximately 22,000 square feet to
approximately 39,000 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.
Approximate
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........ 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
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 has also agreed to terms for a lease for a build-to-suit store in
Aruba, Netherlands Antilles, and is awaiting approval of its business license
before executing the Lease. The store will be 27,000 square feet and will be
built to Company specifications. The lease has a 10-year term with options to
extend for an additional 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. The Company leases
approximately 40,000 square feet for its distribution facility in Union City,
California, which lease expires on December 31, 1999. The Company also leases
approximately 430 square feet of office space in Auckland, New Zealand. Such
lease term will expire on July 1, 1999, but can be renewed thereafter on a
month-to-month basis. The Company believes that its corporate offices and
distribution facilities will be sufficient to meet the Company's needs through
the end of fiscal 1999. The Company expects it will be able to renew the
Bellevue, Washington and Union City, California leases annually; however, the
Company believes it will be able to find suitable replacement facilities if
either facility lease is not extended.
17
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 27, 1998.
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 20, 1999, was 3,539,961.
High and low sales prices for the Company's Common Stock for the periods
indicated since July 23, 1998, the date the Common Stock began trading, 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 1998 (ended December 27, 1998)
Third Quarter (from July 23, 1998)............................. 7.125 3.750
Fourth Quarter................................................. 7.250 3.875
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. The
date of commencement of the Initial Public Offering was July 23, 1998. 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.
18
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)
Fiscal Year Ended
---------------------------------------------------
Dec. 25, Dec. 31, Dec. 29, Dec. 28, Dec. 27,
1994 1995 1996 1997 1998
-------- -------- -------- -------- --------
Income Statement Data:
Net sales............... $117,204 $139,652 $134,820 $124,865 $133,861
Gross profit............ 16,351 19,477 20,996 20,468 22,324
Operating Expenses:
Store.................. 10,512 14,949 15,843 14,543 15,100
General and
administrative........ 2,210 2,728 3,039 3,225 4,139
Store opening.......... 643 600 0 327 747
Store closing.......... 840 400 918 1,346 238
Operating income........ 2,146 800 1,196 1,027 2,100
Interest expense, net... (160) (555) (605) (427) (257)
Other income (expense).. 176 150 0 (40) (10)
Income before income
taxes.................. 2,162 395 591 560 1,833
Income tax provision
(benefit).............. 982 145 221 197 640
Net income.............. $ 1,180 $ 250 $ 370 $ 363 $ 1,193
Earnings per common
share:
Basic.................. $ 0.59 $ 0.13 $ 0.19 $ 0.18 $ 0.45
Diluted................ $ 0.53 $ 0.11 $ 0.17 $ 0.17 $ 0.43
Weighted average common
shares outstanding,
assuming dilution...... 2,210 2,198 2,147 2,124 2,759
Selected Operating Data:
Island stores:
Net sales.............. $ 97,809 $120,010 $111,413 $111,480 $125,433
Store contribution
(2)................... $ 6,547 $ 4,958 $ 5,212 $ 5,635 $ 6,690
Stores opened.......... 1 2 0 0 3
Stores closed.......... 0 1 0 0 1
Stores open at end of
period................ 6 7 7 7 9
Average net sales per
square foot (1)(3).... $ 699 $ 547 $ 535 $ 536 $ 596
Comparable-store net
sales increase
(decrease) (1)(3)..... 0.1% (18.5)% (5.0)% (0.2)% 10.9%
Mainland stores:
Net sales.............. $ 19,394 $ 19,642 $ 23,407 $ 10,684 $ 6,782
Store contribution
(2)................... $ (707) $ (430) $ (415) $ (160) $ (94)
Stores opened.......... 3 2 0 0 0
Stores closed.......... 2 0 1 2 0
Stores open at end of
period................ 2 4 3 1 1
Average net sales per
square foot (1)....... $ 223 $ 244 $ 217 $ 244 $ 293
Comparable-store net
sales increase
(decrease) (1)(3)..... 17.6% 8.9% (4.2)% (3.2)% (6.4)%
Total stores open at end
of period.............. 8 11 10 8 10
Total comparable-store
net sales increase
(decrease) (1)(3)...... 0.9% (15.8)% (4.9)% (0.5)% 9.9%
Consolidated Balance
Sheet Data:
Working capital........ $ 4,710 $ 3,429 $ 3,635 $ 3,814 $ 9,241
Total assets........... $ 21,907 $ 28,525 24,856 22,815 37,217
Line of credit......... 622 3,500 1,500 376 0
Long-term debt, less
current maturities.... 798 2,237 1,965 1,169 2,036
Total shareholders'
equity................ 8,704 8,957 9,327 9,670 19,596
- --------
(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.
19
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This discussion and analysis should be read in conjunction with "Selected
Consolidated Financial Data" and the Company's Consolidated Financial
Statements, including the Notes thereto, included elsewhere in this Report. In
addition to historical information, the following "Management's Discussion and
Analysis of Financial Condition and Results of Operations" contains certain
forward-looking statements that involve known and unknown risks and
uncertainties. The Company's actual results could differ significantly from
those anticipated in these forward-looking statements as a result of certain
factors, including those discussed in "Important Factors Regarding Forward-
Looking Statements" and elsewhere in this Report.
Overview
Background
Cost-U-Less began operations in 1989 by opening a mid-sized warehouse club-
style store in Maui, Hawaii. In early 1992, the Company expanded its
operations by opening additional island stores in other relatively remote
island locations. After experiencing success with its mid-sized store concept,
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 were not profitable and did not meet the Company's
performance expectations. The Company believes that the unanticipated
concurrent expansion of large discount retailers in the Company's mainland
target markets, together with the substantially stronger buying power, broader
name recognition, better ability to afford prime locations for new facilities
(compared to the Company's use of older, abandoned buildings in less popular
locations) and overall greater resources of these competitors, combined to
prevent the success of the Company's mainland stores.
The Company's store concept, however, continued to prove successful in the
more remote, and in many ways more challenging, island markets. The Company
therefore refocused on its core competencies in operating island stores and
began closing its mainland stores. The combined operating losses attributable
to mainland stores, including opening and closing expenses (but excluding any
allocation for related general and administrative or interest expenses) in
fiscal 1993 through 1997 totaled $5.8 million. 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. To date, the Company's island
stores have been located in the Hawaiian Islands, U.S. Territories and
recently, two stores were opened in Fiji in the third and fourth quarter of
1998 and a store in Curacao, Netherlands Antilles on March 2, 1999.
Historically, the Company's island stores have been profitable within the
first year of operation. The Company's expansion strategy focuses primarily on
foreign island markets.
Store Economics
The Company benefits from attractive store-level economics and favorable
returns on investment at its island stores, which the Company believes will
help drive and support its planned expansion. The Company's seven island
stores open during all of fiscal 1998 generated average per store net sales of
$17.6 million, average net sales per square foot of $596, average annual per
store contribution of approximately $993,000 and average annual per store
contribution before depreciation of approximately $1.1 million. The Company
determines store contribution by deducting store expenses from gross profit.
The Company uses the entire interior space of its store, including receiving
and office space, in calculating average net sales per square foot. In August
1995, the Company began a program aimed at increasing its gross margin. The
Company (i) added higher margin items, such as fresh meat and perishables, to
its product mix, (ii) negotiated lower freight rates, (iii) improved and
increased item selection in its stores, including offering sizes that generate
higher margins than traditional warehouse pack sizes, and (iv) emphasized
local ethnic items in addition to popular U.S. brand names. As a result of
this program, the Company increased its gross margin from 14.0% in fiscal 1995
to 16.7% in fiscal 1998.
20
Since June 1995, the Company has also upgraded its inventory control systems
by (i) adding bar code scanning at all store cash registers, receiving docks
and distribution facilities, (ii) installing security cameras in some of its
stores, and (iii) implementing an employee incentive program designed to
reward, among other things, reductions in inventory shrink rates. Implementing
these systems has reduced the Company's inventory shrink expense from 0.6% of
net sales in fiscal 1995 to 0.33% in fiscal 1998.
Distribution Facilities
The Company receives, consolidates and loads merchandise at its distribution
facilities, then ships merchandise to its island stores in fully loaded
containers. The Company does not own or operate a warehouse facility and
manages its in-store inventory primarily by electronically monitoring sell-
through of merchandise and maintaining efficient distribution facilities. The
Company's method of inventory management has enabled the Company to achieve
inventory turns of 7.7 for fiscal 1998 and 1997, which represents an
improvement over the 7.2 inventory turns for fiscal 1996. In-store inventory
turns (excluding product in transit to stores and in the distribution
facilities) were 9.5 for fiscal 1998 and 1997, compared to 8.5 for fiscal
1996.
Store Openings
The Company expenses store opening costs as incurred. Store opening expenses
include payroll, travel and other costs incurred by the Company in connection
with site selection, licensing, permitting, lease negotiations and
construction supervision, as well as training for new store managers. The
Company anticipates that in fiscal 1999 and 2000 its required investment to
open a new store will be approximately $1.8 million, including approximately
$250,000 for opening expenses, $800,000 for store fixtures and equipment and
$750,000 for inventory. The Company expects to carry approximately $1.5
million of inventory, including $300,000 of inventory in transit. Typically,
50% of the Company's inventory is vendor-financed, resulting in the $750,000
average per-store inventory investment by the Company.
Store Closings
The Company's store closing expenses consist primarily of costs related to
(i) buying out the unexpired portion of the store lease and writing off the
net book value of leasehold improvements and (ii) repairing facilities prior
to their return to the lessor. The Company expenses these items in the period
when the decision is made to close the store.
Wholesale Activities
Beginning in 1997, the Company has sold merchandise from its distribution
facilities at wholesale prices to retailers that, the Company believes, resell
the merchandise in markets not currently served by the Company. In fiscal 1997
and 1998, gross margin on the Company's wholesale sales averaged 10.9%.
Because there are lower handling expenses associated with the Company's
wholesale operations, the Company believes that these operations provide it
with a profit opportunity that does not detract from its primary business of
retail sales. These wholesale activities declined to $1.6 million in 1998 from
$2.7 in 1997. To reverse this trend, the Company added a new department
manager in February 1999 to develop new business by targeting both new and
existing relationships.
21
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 29, December 28, December 27,
1996 1997 1998
------------ ------------ ------------
Net sales............................. 100.0% 100.0% 100.0%
Gross profit.......................... 15.6 16.4 16.7
Operating Expenses:
Store............................... 11.7 11.6 11.3
General and administrative.......... 2.3 2.6 3.1
Store opening....................... -- 0.3 0.5
Store closing....................... 0.7 1.1 0.2
Operating income...................... 0.9 0.8 1.6
Interest expense...................... (0.5) (0.3) (0.2)
Income before income taxes............ 0.4 0.5 1.4
Income tax provision.................. 0.1 0.2 0.5
Net income............................ 0.3% 0.3% 0.9%
Fiscal 1998 Compared to Fiscal 1997
Net Sales. Net sales in fiscal 1998 increased $9.0 million, or 7.2%, to
$133.9 million from $124.9 million in the prior year. The increase was
primarily due to same store sales increase of 9.9%, which was offset by the
loss of sales from two closed stores in 1997 that exceeded the sales gain from
two new stores in 1998, and further offset by a decrease in wholesale sales
from $2.7 million in 1997 to $1.6 million in 1998.
Gross Profit. Gross profit increased to $22.3 million from $20.5 million,
which resulted from the same store sales gains and an increase in 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, increased sales in higher-margin departments such as
the fresh meat and perishable departments, and decreased distribution costs
resulting from a higher volumes.
Store Expenses. Store expenses increased $557,000, or 3.8%, to $15.1 million
from $14.5 million, and decreased as a percentage of net sales to 11.3% from
11.6%. The increase in dollars and reduction in percentage of net sales was
primarily due to the sales increases at existing stores.
General and Administrative Expenses. General and administrative expenses
increased $914,000, or 28.3%, to $4.1 million from $3.2 million, and increased
as a percentage of net sales to 3.1% from 2.6%. The increase was primarily due
to an increase in the number and salaries of 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
accounting and audit fees, attorney fees, travel costs, director and officer
liability premiums and administrative costs associated with investor relations
activities.
Store Closing Expenses. Store closing expenses decreased to $238,000 from
$1.3 million. One store was closed in June 1998 in connection with the
completion of a new store in St. Thomas. The Company closed two domestic
stores in 1997. The closed store in 1998 was the Company's only island store
not built to company specifications and was damaged in a hurricane in
September 1995. As a result of the landlord's failure to properly repair the
facility, the Company reached an agreement with the landlord for an early
termination of the lease.
Interest Expense. Interest expense declined $170,000 to $257,000 in fiscal
1998 due primarily to an increase in interest income of $96,000 from interest
bearing deposits on the net Initial Public Offering proceeds received in late
July 1998 and a reduction in average outstanding borrowings.
22
Other Expenses. Other expenses were comprised of insurance deductibles for
property and business interruption claims, including those related to the
effects of Hurricane Georges in USVI in September 1998 and Typhoon Paka in
Guam in December 1997.
Fiscal 1997 Compared to Fiscal 1996
Net Sales. 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 decrease was
primarily due to store closures, which reduced sales by $12.3 million, and a
decline in comparable store sales of $577,000. This decrease in comparable
store sales was largely attributable to the Company's Hawaii stores, for which
sales decreased $1.7 million in fiscal 1997 compared to fiscal 1996. The
Company believes that the decrease in sales for its Hawaii stores was
primarily due to a long-term statewide recession and a significant increase in
the level of competition in the Hawaii market. The decrease in net sales was
partially offset by $2.7 million in wholesale sales and by a comparable store
sales increase in the Company's other island stores of $1.5 million, or 1.7%.
Gross Profit. Gross profit decreased to $20.5 million from $21.0 million,
which resulted from a comparable store gross profit increase of $966,000 in
fiscal 1997, offset by a $1.7 million decline in gross profit attributable to
store closures in fiscal 1997. Gross margin increased to 16.4% in fiscal 1997
from 15.6% in fiscal 1996. The increase in gross margin was due to the closure
of three low-margin mainland stores, increased sales in higher-margin
departments such as the fresh meat and perishable departments, and decreased
distribution costs in its island stores.
Store Expenses. Store expenses decreased $1.3 million, or 8.2%, to $14.5
million from $15.8 million, and decreased as a percentage of net sales to
11.6% from 11.7%. The decrease was primarily due to a reduction in store
expenses from closed stores of $2.0 million. This reduction was offset by an
increase in store expenses for existing stores of $673,000, primarily from
wage rate increases associated with pay raises provided by the Company to its
hourly employees during the first three years of employment, the increased
rate at which the Company accrues vacation pay, increased rent associated with
consumer price index increases and utility usage relating to added
refrigeration capabilities.
General and Administrative Expenses. General and administrative expenses
increased $186,000, or 6.1%, to $3.2 million from $3.0 million, and increased
as a percentage of net sales to 2.6% from 2.3%. The increase was primarily due
to an increase in the number of corporate employees hired to support the
Company's planned expansion and increased accounting and tax preparation fees
related to incorporation of U.S. Territory stores as wholly owned
subsidiaries.
Store Opening Expenses. The Company incurred store opening expenses of
$327,000 in fiscal 1997. The Company did not incur any store opening expenses
in fiscal 1996. Fiscal 1997 store opening expenses were primarily due to
payroll and travel costs associated with site selection, licensing, permitting
and lease negotiations for new stores.
Store Closing Expenses. Store closing expenses increased to $1.3 million
from $918,000 due to closing two stores in fiscal 1997 compared to closing one
store in fiscal 1996. Accrued store closing expenses of $15,000 at December
28, 1997 were paid predominantly in the first quarter of fiscal 1998. Accrued
store closing expenses of $320,000 at December 29, 1996 were paid
predominantly in the first quarter of fiscal 1997.
Interest Expense. Interest expense declined $178,000 in fiscal 1997 due to a
decrease in average outstanding borrowings to $3.7 million in fiscal 1997 from
$6.0 million in fiscal 1996.
Other Expenses. Other expenses were comprised of insurance deductibles for
property and business interruption claims, including those related to the
effects of Typhoon Paka in Guam in December 1997.
23
Fiscal 1996 Compared to Fiscal 1995
Net Sales. Net sales in fiscal 1996 declined $4.9 million, or 3.5%, to
$134.8 million from $139.7 million. The decrease was due to a number of
factors. Fiscal 1996 was a 52-week year while fiscal 1995 was a 53-week year,
with an additional $2.3 million in sales attributable to the extra week. In
fiscal 1996, the Company closed one store, which further reduced net sales by
$7.0 million, though this reduction was offset by sales increases of $9.0
million in fiscal 1996 in the four stores that the Company opened in fiscal
1995. The Company opened no new stores in fiscal 1996. Comparable store sales
decreased 4.9% in fiscal 1996, primarily due to opening an additional Guam
store in a neighboring town during March 1995. Excluding the original Guam
store, comparable store island sales increased 1.1%, or $856,000.
Gross Profit. The Company's gross profit increased to $21.0 million from
$19.5 million. Gross margin increased to 15.6% from 14.0%. The increase in
gross profit resulted from a comparable store gross profit increase of
$822,000 and a $1.5 million increase from four stores opened in fiscal 1995,
offset by a $758,000 loss of gross profit from a store closure at the end of
fiscal 1995. The increase in gross margin was primarily due to sales in
higher-margin produce and meat departments, increased selection of other
higher-margin items, decreased freight and distribution costs and increased
prices on non-price-sensitive items.
Store Expenses. Store expenses increased $894,000, or 6.0%, to $15.8 million
from $14.9 million and increased as a percentage of net sales to 11.7% from
10.7%. The increase was attributable to a $1.8 million increase from stores
opened during fiscal 1995 and a $469,000 increase in store expenses related to
increased depreciation, utilities and maintenance expenses associated with new
refrigeration equipment, the increased rate at which the Company accrues
vacation pay, and professional fees associated with store lease negotiations
and incorporation of the island stores, offset by a $1.2 million reduction of
store expenses for stores closed in fiscal 1996. The increase in store
expenses as a percentage of net sales was primarily due to the effect of
opening a second store in Guam during fiscal 1995, which increased total store
expenses for the two Guam stores by $401,000 in fiscal 1996 compared to fiscal
1995.
General and Administrative Expenses. General and administrative expenses
increased $311,000, or 11.4%, to $3.0 million from $2.7 million and increased
as a percentage of net sales to 2.3% from 2.0%. The increase was primarily due
to additional personnel and costs related to four new stores opened in fiscal
1995.
Store Opening Expenses. In fiscal 1995 the Company incurred store opening
expenses of $600,000 for four new stores: one in Guam, one in American Samoa
and two in California. The Company did not incur any store opening expenses in
fiscal 1996.
Store Closing Expenses. Store closing expenses increased to $918,000 from
$400,000. The Company closed one mainland store in December 1996, which
necessitated buying out a long-term lease, and closed the Maui, Hawaii store
in December 1995. The Maui store was near the end of its lease term, and the
Company did not renew the lease because of the continued recession in Hawaii
and the opening of two new large-format discount retail stores in the same
town. Accrued store closing expenses of $392,000 at December 31, 1995 were
paid predominantly in the first quarter of fiscal 1996.
Interest Expense. Interest expense increased $50,000 due to an increase in
average outstanding borrowings to $6.0 million in fiscal 1996 from $4.4
million in fiscal 1995.
Other Income. Other income in fiscal 1995 of $150,000 was comprised of an
insurance recovery for business interruption claims related to the effects of
Hurricane Marilyn in St. Thomas in September 1995.
Liquidity and Capital Resources
The Company has historically financed its operations with internally
generated funds; the Company's credit facilities and private equity
transactions. 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."
24
Net cash provided by operations was $2.3 million, $4.6 million and $245,000
for fiscal years 1996, 1997 and 1998, respectively. The decrease in net cash
provided by operations in 1998 was primarily due to an increase in inventory
for the two new stores in Fiji compared to 1996 and 1997, when the Company
closed four stores and reduced inventories in both years.
Net cash used in investing activities was $2.0 million, $899,000 and $7.2
million for fiscal year 1996, 1997 and 1998, respectively. The increase in
cash used in 1998 was due to of the construction of a new store in St. Thomas
and equipment for new stores. In addition, the Company improved its corporate
computer systems and acquired most of the equipment for the new store in
Curacao that opened March 2, 1999. In 1996 and 1997, the Company did not open
any new stores. Investment activity in 1996 and 1997 was primarily for various
store equipment upgrades.
Net cash provided by (used in) financing activities was $(1.8) million,
$(2.7) million and $10.2 million for fiscal year 1996, 1997 and 1998,
respectively. The increase in cash from financing activities was a result of
the sale of 1,540,000 shares through the Company's Initial Public Offering and
Concurrent Reg. S Placement that provided net proceeds of $8.7 million in July
1998, and long term loans totaling $3.0 million in connection with the
construction of the new St. Thomas store. The cash used by financing
activities in 1996 and 1997 reflects a reduction in the outstanding balance of
the Company's bank credit facilities.
On May 1, 1998, the Company renewed and increased its line of credit with
Seafirst Bank to $7.0 million, which expires May 1, 1999. The credit line
matures annually and the Company is currently in the process of renewing the
credit line for another year, which it expects to complete before May 1, 1999.
Borrowings under the credit facilities bear interest at Seafirst's prime rate
(8.5% at December 27, 1998) or at LIBOR plus 1.5%. 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. The Company is in compliance with such
covenants. There were no borrowings under the line of credit as of December
27, 1998. The Company does expect to utilize the credit facilities later in
the year as a result of new store openings. In addition, the Company is also
negotiating for a $2.0 million credit facility for the construction of its
store in St. Maarten.
The new St. Thomas store has been constructed at a total cost of $2.9
million plus $600,000 for equipment and fixtures. The Company obtained $3.0
million in financing from Seafirst Bank and Banco Popular de Puerto Rico
("Banco Popular") for its new store in St. Thomas. The financing included a
$1.0 million note with Seafirst Bank, payable with interest at 7.77%, maturing
on April 30, 2000 and is secured by the same collateral securing the line of
credit. As of December 27, 1998, the Company owned $725,000 on the loan. The
financing also included a $2.0 million note with Banco Popular payable with
interest at the bank's prime rate plus 1.0% (9.5% at December 27, 1998)
maturing on June 1, 2013. The note is secured by a first priority leasehold
mortgage on the St. Thomas store and is governed by a loan agreement
containing certain covenants applicable to the Company's subsidiary that owns
such store, including covenants requiring the subsidiary to maintain a minimum
debt service ration and loan to value ratio. In addition, without the consent
of the lender, the subsidiary is not permitted to (i) subject its assets to
liens or incur indebtedness, (ii) enter into a merger or other business
combination, (iii) dispose of assets except in the ordinary course of
business, (iv) make capital expenditures or pay dividends in excess of
specified limits, or (v) issue or purchase any of its stock or permit any
change in ownership or outstanding stock. The subsidiary is currently in
compliance with such covenants.
The Company estimates that its total cash outlay for opening a typical
island store will be approximately $1.8 million. The Company plans to open
three stores in 1999 in addition to the Curacao store that opened on March 2,
1999, and six stores in 2000. When opening a new store, as well as on an on-
going basis, the Company
25
expects to finance a substantial portion of its merchandise inventory cost by
using a combination of vendor and bank financing. However, there can be no
assurance that this level of financing will be available in the future on
terms acceptable to the Company.
The Company believes that the amounts available on its current credit
facility, existing cash available for working capital purposes, new credit
facilities for the construction of the St. Maarten store, and cash flow from
future operations will be sufficient to open the stores planned in its
expansion in 1999 and 2000. Additional increases in the Company's existing
line of credit and additional long term debt for both new store construction
and equipment will be obtainable as needed. However, there are no assurances
that such financing will be available when the Company needs it.
Year 2000 Compliance
The Year 2000 issue is the result of computer programs being written using
two digits, rather than four, to define the applicable year. Any of the
Company's computer programs that have time-sensitive software may recognize a
date using "00" as the year 1900 rather than the Year 2000. If not addressed,
the direct result of the Year 2000 issue could be a system failure or
miscalculations, causing disruption of operations, including a temporary
inability to process customer transactions, order merchandise, accurately
track inventory and revenue, or engage in similar normal business activities.
The Company believes that all of its material systems are Year 2000-
compliant, and expects that its total costs to make all its systems Year 2000-
compliant will be less than $100,000. The Company has contacted all of it
inventory suppliers plus other vendors and suppliers with which its systems
interface and exchange data or upon which it business depends, such as banks,
security alarm monitoring providers, refrigeration equipment suppliers and
maintenance providers and other service suppliers. These efforts are designed
to minimize the extent to which the Company's business will be vulnerable in
the event of the failure of these third parties to remedy their own Year 2000
issues.
Although most of the Company's hardware and software are Year 2000
compliant, some programming changes are not scheduled to be completed on
certain custom programs until July 1, 1999. In addition, the back room
software at the Company's stores runs on stand alone PC's running in a DOS
environment that requires modifications to be Year 2000 compliant. Upon
completion of an upgrade to the corporate system software, scheduled to be
completed by July 1, 1999, this backroom system will be obsolete. Contingency
plans are in place to modify the existing backroom software and hardware
should the upgrade not be completed before Year 2000.
Management believes that sourcing product from alternative vendors that are
Year 2000 compliant will minimize any potential interruption in product, if
one or more vendors are not able to deliver product in accordance with terms
of any purchase order. The availability of power is considered a significant
concern by management. Although most of the local power companies servicing
the islands that the Company operates has acknowledged Year 2000 compliance,
the Company's back-up generators can provide a secondary source of power. The
Company has experienced disruption in power for extended periods of time on
numerous occasions as a result of hurricanes and believes that the backup
generators will allow the stores to continue to operate should any power
outages occur as a result of Year 2000 problems.
The Company's contingency plans are currently under development and expected
to be completed by October 1, 1999. Such plans will include, but not be
limited to: 1) power disruption, 2) vendor replacement, 3) communication
alternatives, 4) manual processes for temporary delays resulting from
programming changes to correct unforeseen Year 2000 problems.
Costs of the Year 2000 project and the estimated completion date are based
on management's best estimates, which are derived utilizing numerous
assumptions. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from the estimates.
Specific factors that might cause
26
material differences include, but are not limited to, the availability and
cost of outside programmers and computer consultants, reliance on utilities in
foreign countries that may or may not be Year 2000 compliant and similar
uncertainties.
The Company's failure to implement its Year 2000 corrections in a timely
fashion or in accordance with its current cost estimates, or the failure of
third-party vendors to correct their Year 2000 problems, could have a material
adverse effect on the Company's business, financial condition and operating
results. See Business--Important Factors Regarding Forward-Looking
Statements."
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company does operate stores in foreign countries and does have limited
risks associated with foreign currencies. However, sales are primarily made in
cash 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 lack of trade credit and borrowing in
foreign countries and that the Company's exposure is not concentrated in any
single currency, management does not believe that it experiences any
significant market risk from foreign currencies.
Item 8. Financial Statements and Supplementary Data
The following consolidated financial statements and supplementary data are
included beginning on page 35 of this Report:
Page
----
Report of Ernst & Young LLP, Independent Auditors....................... 28
Consolidated Financial Statements:
Consolidated Balance Sheets........................................... 29
Consolidated Statements of Income..................................... 30
Consolidated Statements of Shareholders' Equity....................... 31
Consolidated Statements of Cash Flows................................. 32
Notes to Consolidated Financial Statements............................ 33
27
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 27, 1998 and December 28, 1997 and the related
consolidated statements of income, shareholders' equity, and cash flows for
each of the years ended December 27, 1998, December 28, 1997, and December 29,
1996. 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 generally accepted auditing
standards. 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 27, 1998 and December 28, 1997 and the
consolidated results of its operations and its cash flows for each of the
years ended December 27, 1998, December 28, 1997, and December 29, 1996, in
conformity with generally accepted accounting principles. 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
March 5, 1999
28
COST-U-LESS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
December 27, December 28,
1998 1997
------------ ------------
ASSETS
------
Current assets:
Cash and cash equivalents.......................... $ 4,289 $ 1,028
Receivables (net of allowance of $143 and $25 in
1998 and 1997, respectively)...................... 1,696 1,023
Refundable income taxes............................ 157 179
Inventories........................................ 16,685 12,271
Prepaid expenses................................... 210 137
Deferred tax assets................................ 511 671
------- -------
Total current assets............................. 23,548 15,309
Property and equipment, net.......................... 12,712 6,847
Deposits and other assets............................ 816 518
Deferred tax assets.................................. 141 141
------- -------
Total assets..................................... $37,217 $22,815
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable................................... $11,420 $ 8,953
Accrued expenses................................... 1,809 1,235
Income taxes payable............................... 23 141
Line of credit..................................... -- 376
Current portion of long-term debt.................. 633 384
Current portion of capital lease obligations....... 422 406
------- -------
Total current liabilities........................ 14,307 11,495
Deferred rent........................................ 524 481
Long-term debt, less current portion................. 2,036 --
Capital lease obligations, less current portion...... 754 1,169
------- -------
Total liabilities................................ 17,621 13,145
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--3,539,961 and 1,999,961............... 12,305 3,525
Retained earnings.................................... 7,358 6,165
Accumulated other comprehensive income............... (67) (20)
------- -------
Total shareholders' equity....................... 19,596 9,670
------- -------
Total liabilities and shareholders' equity....... $37,217 $22,815
======= =======
See accompanying notes.
29
COST-U-LESS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except share and per share data)
Fiscal Year Ended
--------------------------------------
December 27, December 28, December 29,
1998 1997 1996
------------ ------------ ------------
Net sales.............................. $ 133,861 $ 124,865 $ 134,820
Merchandise costs...................... 111,537 104,397 113,824
--------- --------- ---------
Gross profit........................... 22,324 20,468 20,996
Operating expenses:
Store................................ 15,100 14,543 15,843
General and administrative........... 4,139 3,225 3,039
Store openings....................... 747 327 --
Store closings....................... 238 1,346 918
--------- --------- ---------
Total operating expenses............... 20,224 19,441 19,800
--------- --------- ---------
Operating income....................... 2,100 1,027 1,196
Other income (expense):
Interest expense, net................ (257) (427) (605)
Other................................ (10) (40) --
--------- --------- ---------
Income before income taxes............. 1,833 560 591
Income tax provision................... 640 197 221
--------- --------- ---------
Net income............................. $ 1,193 $ 363 $ 370
========= ========= =========
Earnings per common share:
Basic................................ $ 0.45 $ 0.18 $ 0.19
========= ========= =========
Diluted.............................. $ 0.43 $ 0.17 $ 0.17
========= ========= =========
Weighted average common shares
outstanding........................... 2,664,192 1,999,961 1,999,961
========= ========= =========
Weighted average common shares
outstanding, assuming dilution........ 2,758,939 2,123,784 2,146,745
========= ========= =========
See accompanying notes.
30
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 31,
1995........................ 1,999,961 $ 3,525 $5,432 $-- $ 8,957
Net income and
comprehensive income...... -- -- 370 -- 370
--------- ------- ------ ---- -------
Balance at December 29,
1996........................ 1,999,961 3,525 5,802 -- 9,327
Net income................. -- -- 363 -- 363
Other comprehensive income
(loss), foreign currency
translation adjustments... -- -- -- (20) (20)
-------
Comprehensive income....... 343
--------- ------- ------ ---- -------
Balance at December 28,
1997........................ 1,999,961 3,525 6,165 (20) 9,670
Net income................. -- -- 1,193 -- 1,193
Other comprehensive income
(loss), foreign currency
translation adjustments... -- -- -- (47) (47)
-------
Comprehensive income....... 1,146
Initial public offering:...
Sale of common stock, net
of $2,075 of offering
costs................... 1,540,000 8,705 -- -- 8,705
Stock compensation........... -- 75 -- -- 75
--------- ------- ------ ---- -------
Balance at December 27,
1998........................ 3,539,961 $12,305 $7,358 $(67) $19,596
========= ======= ====== ==== =======
See accompanying notes.
31
COST-U-LESS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Fiscal Year Ended
--------------------------------------
December 27, December 28, December 29,
1998 1997 1996
------------ ------------ ------------
OPERATING ACTIVITIES:
Net income............................ $1,193 $ 363 $ 370
Adjustments to reconcile net income to
net cash provided by operating
activities:
Depreciation.......................... 1,092 917 1,089
Writedown of property and equipment... 195 637 713
Deferred tax (benefit) provision...... 42 (253) (20)
Stock compensation.................... 75 -- --
Reserve for bad debts................. 118 -- 25
Cash provided by (used in) changes in
operating assets and liabilities:
Receivables......................... (791) (308) 605
Refundable income taxes............. 22 208 128
Inventories......................... (4,414) 2,667 1,660
Prepaid expenses.................... (73) 179 (108)
Deposits and other assets........... (180) (193) 31
Accounts payable.................... 2,467 352 (1,860)
Accrued expenses.................... 456 (142) (496)
Deferred rent....................... 43 151 129
------ ------ ------
Net cash provided by operating
activities....................... 245 4,578 2,266
INVESTING ACTIVITY:
Purchases of property and equipment... (7,152) (899) (2,006)
FINANCING ACTIVITIES:
Proceeds from sale of common stock.... 8,705 -- --
Net (repayments) under line of
credit............................... (376) (1,125) (2,000)
Proceeds from long-term debt.......... 3,000 -- 1,747
Principal payments on long-term debt.. (715) (1,246) (1,151)
Payments of capital lease
obligations.......................... (399) (375) (406)
------ ------ ------
Net cash provided by (used in)
financing activities............. 10,215 (2,746) (1,810)
Effects of foreign exchange rate
changes on cash...................... (47) -- --
------ ------ ------
Net increase (decrease) in cash and cash
equivalents............................ 3,261 933 (1,550)
Cash and cash equivalents:
Beginning of period................... 1,028 95 1,645
------ ------ ------
End of period......................... $4,289 $1,028 $ 95
====== ====== ======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid during the period for:
Interest............................ $ 409 $ 442 $ 619
Income taxes........................ $ 577 $ 102 $ 107
SUPPLEMENTAL DISCLOSURE OF NONCASH
FINANCING AND INVESTING ACTIVITIES:
Property and equipment acquired under
capital lease obligations............ $ -- $ -- $1,660
See accompanying notes.
32
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 "island" markets in U.S. territories and foreign markets throughout
the Pacific and the Caribbean. At December 27, 1998, the Company operated ten
stores located in Hawaii, the U.S. Virgin Islands (USVI), Guam, American
Samoa, Fiji, and California.
Principles of Consolidation
The Company operates wholly owned subsidiaries in Guam, U.S. Virgin Islands,
American Samoa, Nevada, Republic of Fiji, New Zealand, and Netherlands
Antilles. All significant intercompany balances and transactions have been
eliminated in consolidation.
Fiscal Year
The Company's fiscal year ends on the last Sunday in December. The years
ended December 27, 1998, December 28, 1997, and December 29, 1996 represent
52-week fiscal years.
Cash Equivalents
Highly liquid investments maturing within three months from the date of
purchase are classified as cash equivalents.
Financial Instruments
The carrying value of financial instruments, including cash, receivables,
payables, and long-term debt, approximates market value at December 27, 1998
and December 28, 1997.
Foreign Currency Translations
The U.S. dollar is the functional currency for all locations, except for
Fiji, New Zealand, and Netherlands Antilles. For the Company's Fijian, New
Zealand, and Netherlands Antilles operations, the local currency is the
functional currency and all assets and liabilities are translated at year-end
exchange rates, and all income statement amounts are translated at an average
of month-end rates. Adjustments resulting from this translation are recorded
as a separate component of shareholders' equity as other comprehensive income.
Inventories
Merchandise inventories are recorded at the lower of average cost or market.
Property and Equipment
Property and equipment are carried at cost. Depreciation is provided using
the straightline method over the estimated useful lives of the assets, ranging
from 5 to 15 years. The Company owns its store in St. Thomas, USVI, which is
being depreciated over its estimated useful life of 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.
The Company's policy to recognize impairment losses relating to long-lived
assets is based on several factors, including, but not limited to,
management's plans for future operations, recent operating results, and
projected cash flows.
33
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Advertising Costs
The cost of advertising is expensed as incurred. Advertising expenses
incurred during fiscal years 1998, 1997, and 1996 were not material to the
Company's operating results.
Preopening Costs
Costs incurred in connection with the startup and promotion of new store
openings 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.
Earnings Per Share
Basic earnings per share is computed based on weighted average shares
outstanding. Diluted earnings per share includes the effect of dilutive
securities (options and warrants) except where their inclusion is
antidilutive.
Deferred Rent
Certain of the Company's store leases contain periodic escalation clauses.
The Company expenses rent on a straight-line basis over the life of the lease.
During the initial years of a store lease, cash payments are typically less
than the straight-line expense. The differential is recorded as deferred rent
on the balance sheet.
Comprehensive Income
As of December 29, 1997, the Company adopted Statement No. 130, Reporting
Comprehensive Income. Statement No. 130 establishes new rules for the
reporting and display of comprehensive income and its components; however, the
adoption of this Statement had no impact on the Company's net income or
shareholders' equity. Statement No. 130 requires foreign currency translation
adjustments, which prior to adoption were reported separately in shareholders'
equity to be included in other comprehensive income.
Segment Reporting
Effective January 1, 1997, the Company adopted the Financial Accounting
Standards Board's Statement of Financial Accounting Standards No. 131,
Disclosures about Segments of an Enterprise and Related Information. This
Statement establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports. Statement No. 131 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.
Recent Accounting Pronouncements
In March 1998, the AICPA issued SOP 98-1, Accounting for the Costs of
Computer Software Developed for or Obtained for Internal Use. The Company
plans to adopt the SOP on January 1, 1999. The SOP will require
34
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
the capitalization of certain costs incurred after the date of adoption in
connection with developing or obtaining software for internal use. The Company
currently capitalizes the majority of the costs required to be capitalized
under SOP 98-1 and thus does not expect the adoption of the SOP to have a
material impact on consolidated results of operations, financial position, or
cash flows.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
2. Property and Equipment
Property and equipment consists of the following (in thousands):
December 27, December 28,
1998 1997
------------ ------------
Equipment........................................ $11,898 $8,238
Building......................................... 2,874 --
Leasehold improvements........................... 1,171 1,339
Computer system and software development in
progress........................................ 592 --
Construction in progress......................... -- 94
------- ------
16,535 9,671
Less accumulated depreciation.................... 3,823 2,824
------- ------
Total assets..................................... $12,712 $6,847
======= ======
Equipment under capitalized leases had a cost of $1,669,000 and $1,733,000
and accumulated depreciation of $476,000 and $331,000 at December 27, 1998 and
December 28, 1997, respectively.
3. Bank Line of Credit
At December 27, 1998, the Company had a $7,000,000 line of credit available
from a commercial bank that expires May 1, 1999. Borrowings bear interest at
prime (7.75% at December 27, 1998 or at LIBOR plus 1.5% on amounts with fixed
maturities of 30 days or more) and are secured by various Company assets. As
of December 27, 1998, there were no borrowings outstanding under the line of
credit agreement.
Terms of this line of credit include covenants that require, among other
things, that the Company maintain certain financial ratios. As of December 27,
1998, the Company was in compliance with these covenants.
4. Long-Term Debt
At December 27, 1998, the Company had a $1,000,000 note payable to a bank
with interest at the fixed rate index plus 1.75% (7.77% at December 27, 1998),
maturing April 30, 2000. As of December 27, 1998, there was a balance of
$725,000 under the note agreement and is secured by various Company assets.
At December 27, 1998, the Company had a $2,000,000 note payable to a bank
with interest at the prime rate plus 1% (9.5% at December 27, 1998), maturing
June 2013. As of December 27, 1998, there was a balance of $1,944,000 under
the note agreement. The note is secured by a first leasehold priority mortgage
on the new St. Thomas building.
35
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Maturities of long-term debt during the next five fiscal years and thereafter
are as follows (in thousands):
1999......................... $ 633
2000......................... 358
2001......................... 133
2002......................... 133
Thereafter................... 1,412
------
$2,669
======
5. Income Taxes
The provision for income taxes for the fiscal years ended December 27, 1998,
December 28, 1997, and December 29, 1996, respectively, consists of the
following:
1998 1997 1996
----- ----- ----
(in thousands)
Current:
Federal.............................................. $ 112 $ -- $ 10
Foreign, including U.S. territories.................. 483 463 199
State................................................ 3 (13) 32
----- ----- ----
598 450 241
Deferred:
Federal and state.................................... 273 (268) (76)
Foreign, including U.S. territories.................. (231) 15 56
----- ----- ----
42 (253) (20)
----- ----- ----
$ 640 $ 197 $221
===== ===== ====
A reconciliation between the U.S statutory income tax rate and the effective
rate follows:
1998 1997 1996
----------- ----------- -----------
Amount Rate Amount Rate Amount Rate
------ ---- ------ ---- ------ ----
(dollars in thousands)
Tax at U.S. statutory rate............. $623 34.0% $190 34.0% $201 34.0%
State income taxes, net of federal
benefit............................... 3 .2 (9) (1.6) 21 3.6
Foreign related taxes and other........ 14 .7 16 2.8 (1) (0.2)
---- ---- ---- ---- ---- ----
Income taxes at effective rate......... $640 34.9% $197 35.2% $221 37.4%
==== ==== ==== ==== ==== ====
36
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The significant items comprising the Company's net deferred tax assets are
as follows:
December 27, December 28,
1998 1997
------------ ------------
(in thousands)
Current deferred tax assets and (liabilities):
Uniform capitalization.......................... $ 157 $ 95
Store accruals.................................. --
Vacation pay and bad debts...................... 101 52
Charitable contribution carryovers.............. 35 45
Net operating loss carryforwards................ 283 600
Cash discounts and other........................ (65) (121)
----- -----
Current deferred tax assets, net.............. $ 511 $ 671
===== =====
Long-term deferred tax assets and (liabilities):
Deferred rent................................... $ 178 $ 163
Foreign tax credits............................. 321 434
AMT and other credits........................... 96 85
Other........................................... 121 8
Accelerated depreciation........................ (376) (382)
----- -----
340 308
Less valuation allowance........................ (199) (167)
----- -----
Long-term deferred tax assets, net............ $ 141 $ 141
===== =====
The Company intends to reinvest the unremitted earnings of its non-U.S.
subsidiaries and postpone their remittance indefinitely. Accordingly, no
provision for U.S. income taxes was required on such earnings. It is not
practicable to estimate the tax liabilities which would result upon such
repatriation.
The valuation allowance has been provided due to uncertainty regarding the
full realization of the Company's foreign tax credits and other long-term
deferred tax assets. Foreign tax credit carryforwards expire in 1999 and 2000.
As of December 28, 1998, the Company's Fiji subsidiary has a net operating
loss of approximately $625,000, which will expire in 2006 and 2007. Other net
operating losses in New Zealand and Netherlands Antilles of approximately
$208,000 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 share and per-share information has been restated to reflect
this stock split.
The Company sold 1,380,000 shares of common stock at $7.00 per share in an
Initial Public Offering on July 23, 1998. Concurrent with the Initial Public
Offering, the Company sold 160,000 shares of common stock, at $7.00 per share,
in a placement to the Kula Fund, an affiliate of Commonwealth Development
Corporation, in reliance on Regulation S under the Securities Act of 1933, as
amended. In connection with these transactions, the Company issued warrants at
a nominal price to the Underwriter on the transactions and to the Kula Fund as
follows:
Shares Grant Price Term Vesting Date
------- ----------- ------------------------- -------------
Underwriter Warrants.... 160,000 $10.15 4 years from vesting date July 23, 1999
Kula Fund Warrants...... 117,000 $ 8.40 4 years from vesting date July 28, 1998
37
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Stock Options
On February 28, 1998, the Company adopted the 1998 Stock Incentive
Compensation Plan (the "1998 Plan"). The 1998 Plan includes both stock options
and stock awards, including restricted stock, with a maximum of 500,000 shares
of common stock available for issuance. On May 13, 1998, the shareholders
approved the 1998 Plan. All future option grants will be made under the 1998
Plan. Options issued under the 1998 Plan vest at various terms and expire
after 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 224,214 options
available for future grant under the 1998 Plan at December 27, 1998.
The Company's Amended and Restated 1989 Stock Option Plan (the "1989 Plan")
provides for the granting of incentive and nonqualified stock options to
employees, directors, and consultants of 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
after 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 27, 1998. No
further options will be granted under the 1989 Plan.
A summary of stock option transactions for the years ended December 27,
1998, December 28, 1997, and December 29, 1996:
1998 1997 1996
------------------ ----------------- -----------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
-------- -------- ------- -------- ------- --------
Outstanding, beginning
of year................ 291,009 $5.49 270,320 $4.98 270,320 $ 6.20
Granted............... 442,546 6.96 45,744 9.82 47,497 8.47
Forfeited............. (281,405) 9.08 (25,055) 9.45 (47,497) 13.42
Exercised............. -- -- -- -- -- --
-------- ------- -------
Outstanding, end of
year................... 452,150 5.35 291,009 5.49 270,320 4.98
======== ======= =======
Exercisable, end of
year................... 210,094 3.53 255,340 5.03 206,257 4.51
======== ======= =======
The weighted average fair value of options granted in 1998, 1997, and 1996
was $5.18, $0.09, and $0.42, respectively.
The following table summarizes information related to outstanding options at
December 27, 1998:
Outstanding Exercisable
----------------------------------------------------- ----------------------
Weighted Weighted Weighted
Range of Average Average Average
Exercise Exercise Contractual Exercise
Prices Options Price Life Options Price
-------- ------- -------- ----------- ------- --------
$0.79 - 3.38 84,125 $1.94 2.38 years 84,125 $1.94
3.72 - 5.75 100,640 3.83 6.41 years 92,239 3.72
7.00 267,385 7.00 9.84 years 33,730 7.00
------- -------
452,150 5.35 210,094 3.53
======= =======
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
38
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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
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 has been
recognized.
In 1996, the Company offered employees with options granted with exercise
prices of $16.94 per share the opportunity to surrender those options and
receive new options with an exercise price of $8.47 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. The holders
of 29,789 options elected to exchange their options under this repricing
offer.
As described in Note 1, the Company has elected to account for stock-based
compensation expense in accordance with APB No. 25. Accordingly, for fiscal
years 1998, 1997, and 1996, no compensation expense has been recognized for
stock-based compensation since the grant price equaled the estimated fair
value of the stock on the date of grant. Had compensation cost been recognized
based on the fair value at the grant date for options awarded under the Plan,
pro forma net income and net income per share would have been as follows:
1998 1997 1996
------ ----- -----
(Net income in
thousands)
Net income as reported................................... $1,193 $ 363 $ 370
Net income pro forma..................................... $1,068 $ 357 $ 367
Earnings per common share, basic as reported............. $ 0.45 $0.18 $0.19
Earnings per common share, basic pro forma............... $ 0.40 $0.18 $0.18
Earnings per common share, diluted as reported........... $ 0.43 $0.17 $0.17
Earnings per common share, diluted pro forma............. $ 0.39 $0.17 $0.17
Compensation expense recognized in providing pro forma disclosures may not
be representative of the effects on pro forma net income for future years
because the above amounts include only the amortization for the fair value of
grants made in fiscal years 1998, 1997, and 1996.
The fair value of each option is estimated on the date of grant under the
Black-Scholes option-pricing model using the following assumptions:
1998 1997 1996
------- ------- -------
Risk-free interest rate.............................. 5.50% 6.20% 6.20%
Expected life........................................ 3 years 3 years 3 years
Expected dividend yield.............................. 0% 0% 0%
Volatility........................................... 126% 0% 0%
Warrants
In 1991, the Company issued 29,518 warrants to an officer. The warrants
grant the holder the right to 29,518 shares of the Company's common stock at
$2.37 per share. The warrants are currently exercisable and expire in 2001.
39
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Common Stock Reserved
Common stock reserved for future issuance at December 27, 1998 is as
follows:
Stock options...................................................... 852,300
Warrants........................................................... 306,518
---------
1,158,818
=========
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 following table sets forth the computation of basic and diluted earnings
per share:
Fiscal Year Ended
--------------------------------------
December 27, December 28, December 29,
1998 1997 1996
------------ ------------ ------------
Numerator:
Net income......................... $ 1,193 $ 363 $ 370
Denominator:
Denominator for basic earnings per
share--weighted average shares.... 2,664,192 1,999,961 1,999,961
Effect of dilutive securities:
Stock options and warrants......... 94,747 123,823 146,784
Denominator for diluted earnings
per share--adjusted weighted
average shares and assumed
conversion of stock options and
warrants.......................... 2,758,939 2,123,784 2,146,745
Basic earnings (loss) per common
share............................... $ 0.45 $ 0.18 $ 0.19
Diluted earnings (loss) per common
share............................... $ 0.43 $ 0.17 $ 0.17
7. Segment Information and Store Closures
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 wholesale
sales directly from the Company's distribution facilities.
40
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
These sales are not significant to include as a separate segment and are
aggregated with other income and expenses that are not directly related to the
operations of the stores in the particular segments.
Island Mainland
Stores Stores Other Totals
-------- -------- ------ --------
(in thousands)
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
Year Ended December 29, 1996
Net sales................................... $111,413 $23,407 $ -- $134,820
Contribution................................ 5,212 (415) 356 5,153
Depreciation................................ 556 272 -- 828
Store closing expense....................... -- 918 -- 918
Operating profit (loss)..................... 5,212 (1,333) 356 4,235
Segment inventories......................... 9,543 2,996 -- 12,539
Segment total assets........................ 16,140 5,154 -- 21,294
Reconciliation of Contribution to Consolidated Income before Income Taxes
Fiscal Year Ended
--------------------------------------
December 27, December 28, December 29,
1998 1997 1996
------------ ------------ ------------
Total contribution for reportable
segments.............................. $ 6,596 $ 5,475 $ 4,797
Other contribution..................... 628 450 356
Administrative expense not allocated to
segments.............................. (4,139) (3,225) (3,039)
Store opening/closing expenses......... (985) (1,673) (918)
Other (expense)........................ (10) (40) --
Interest expense....................... (257) (427) (605)
------- ------- -------
Consolidated income before income
taxes................................. $ 1,833 $ 560 $ 591
======= ======= =======
41
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Reconciliation of Significant Items
Segment Consolidated
Totals Corporate Totals
------- --------- ------------
(in thousands)
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
December 29, 1996
Other significant items
Depreciation..................................... $ 828 $ 261 $ 1,089
Inventories...................................... 12,539 2,399 14,938
Total assets..................................... 21,294 3,562 24,856
Geographic Information
Long-lived
Sales Assets
-------- ----------
(in thousands)
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
======== =======
1996
United States............................................. $ 46,548 $ 4,091
Other foreign countries*.................................. 88,272 3,756
-------- -------
$134,820 $ 7,847
======== =======
- --------
*Including U.S. territories.
42
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In 1996, the Company closed the Maui, Hawaii and San Jose, California stores.
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. The following represents the costs
charged to expense related to the store closures for the indicated fiscal
years:
December 27, December 28, December 29,
1998 1997(1) 1996
------------ ------------ ------------
(in thousands)
Lease buyout......................... $ -- $ 421 $225
Leasehold improvement writeoff....... 210 635 530
Other closure costs.................. 28 290 163
---- ------ ----
$238 $1,346 $918
==== ====== ====
- --------
(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, December 29,
1998 1997 1996
------------ ------------ ------------
(in thousands)
Accrued store closure expense at
beginning of year................. $ 15 $ 320 $392
Store closure expense paid during
year.............................. 253 1,651 990
Accruals for store closures during
year.............................. 238 1,346 918
---- ------ ----
Accrued store closure expense at
end of year....................... $ -- $ 15 $320
==== ====== ====
Total revenues and net operating losses contributed by the stores closed were
as follows:
1997 1996
------ -------
(in thousands)
Total revenues............................................... $3,433 $15,691
====== =======
Store operating losses....................................... $ 243 $ 608
====== =======
The store closure in 1998 was due to a new store replacing the closed store
and is therefore not included.
43
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
8. Lease Commitments
The Company has entered into operating leases for 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.
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:
Operating Capital
Lease Lease
--------- -------
(in thousands)
1999...................................................... $ 4,226 $ 537
2000...................................................... 4,199 761
2001...................................................... 4,190 --
2002...................................................... 3,911 --
2003...................................................... 3,459 --
Thereafter................................................ 15,287 --
------- ------
$35,272 1,298
=======
Amounts representing interest............................. (122)
------
Present value of net minimum lease payments............... $1,176
======
Rent expense under operating leases for the fiscal years ended December 27,
1998, December 28, 1997, and December 29, 1996 totaled $3,702,000, $3,817,000,
and $4,103,000, respectively.
Total minimum capital lease payments include $431,000 of residual value
payments to be paid in fiscal year 2000.
Subsequent to December 27, 1998, the Company entered into a land lease
agreement for property in St. Marteen, Netherlands Antilles. The lease is a
25-year lease with three ten-year renewal options. The Company will construct
a 36,000 square foot store on the property. The monthly rental rate for the
St. Marteen land is $16,000 per month. The lease will be subject to charges
for taxes and insurance that will be paid by the Company. Lease payments will
not begin until the building is completed, which is expected to be completed
by the end of fiscal year 1999.
9. Employee Benefit Plans
The Company maintains a 40l(k) profit-sharing plan covering all eligible
employees. Participating employees may elect to defer and contribute a stated
percentage of their compensation to the plan, not to exceed the dollar limit
set by law. The Company matches 25% of each employee's contribution, up to a
maximum of the first 15% of each employee's compensation. The Company's
matching contributions to the plan approximated $87,000, $75,000, and $70,000
in fiscal 1998, 1997, and 1996, 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 $257,000, $213,000, and $143,000 for fiscal 1998,
1997 and, 1996, respectively.
44
COST-U-LESS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
10. Quarterly Financial Data (Unaudited)
The following is a summary of the Company's unaudited quarterly results of
operations:
Earnings
Store (Loss) Per
Weeks Net Common Share(1)
in Net Gross Income ---------------
Period Sales Profit (Loss) Basic Diluted
------ ------- ------ ------ ------ -------
(in thousands, except store weeks and per-
share data)
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
Fiscal 1997
First quarter (2)................. 130 $31,789 $5,066 $(278) $(0.14) $(0.14)
Second quarter (3)................ 117 31,868 5,240 3 0.00 0.00
Third quarter..................... 104 29,747 4,876 264 0.13 0.12
Fourth quarter.................... 104 31,461 5,286 374 0.19 0.17
- --------
(1) Includes store closure costs of $238,000.
(2) Includes store closure costs of $700,000.
(3) Includes store closure costs of $600,000.
45
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
None.
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 20, 1999, and is incorporated herein by reference. Such Proxy
Statement will be filed within 120 days of December 27, 1998, 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 20, 1999, and is incorporated herein by reference. Such Proxy
Statement will be filed within 120 days of December 27, 1998, 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 20, 1999, and is incorporated herein by reference. Such Proxy
Statement will be filed within 120 days of December 27, 1998, 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 20, 1999, and is incorporated herein by reference. Such Proxy
Statement will be filed within 120 days of December 27, 1998, the Company's
fiscal year end.
46
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. 27 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 34 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
47
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
21.1 Subsidiaries of the Company
24.1 Power of Attorney (see page 49).
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.
(b) Reports on Form 8-K:
None.
48
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 26, 1999 By: /s/ Michael J. Rose
---------------------------------
Michael J. Rose
Chairman of the Board, President
and Chief Executive Officer
Each person whose individual signature appears below hereby authorizes and
appoints Michael J. Rose and Allan C. Youngberg, 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 26th day of March, 1999.
Signature Title
--------- -----
/s/ Michael J. Rose Chairman of the Board, President and Chief
- ------------------------------------ Executive Officer (Principal Executive
Michael J. Rose Officer)
/s/ Allan Youngberg Executive Vice President, Chief Financial
- ------------------------------------ Officer, Secretary and Treasurer
Allan Youngberg (Principal Financial and Accounting
Officer)
/s/ Ashley Emberson-Bain Director
- ------------------------------------
Ashley Emberson-Bain
/s/ David A. Enger Director
- ------------------------------------
David A. Enger
/s/ Donald L. Gevirtz Director
- ------------------------------------
Donald L. Gevirtz
/s/ Wayne V. Keener Director
- ------------------------------------
Wayne V. Keener
/s/ Gary W. Nettles Director
- ------------------------------------
Gary W. Nettles
/s/ George C. Textor Director
- ------------------------------------
George C. Textor
49
SCHEDULE II
COST-U-LESS, INC.
VALUATION AND QUALIFYING ACCOUNTS
Balance
Balance at at End
Beginning of of
Description Period Additions Deductions Period
----------- ------------ --------- ---------- --------
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
Year Ended December 29, 1996:
Reserves and allowances deducted
from asset accounts:
Allowance for doubtful accounts.... $ 0 94,000 69,000 $ 25,000
- --------
(1) Uncollectible accounts written off, net of recoveries.
50
INDEX TO 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
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
21.1 Subsidiaries of the Company
24.1 Power of Attorney (see page 42).
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.