UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

 

(X) QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended November 3, 2002

 

OR

 

( ) TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

Commission File Number 0-20269

 

DUCKWALL-ALCO STORES, INC.

(Exact name of registrant as specified in its charter)

 

                                                                   Kansas                                48-0201080

 (State or other jurisdiction of            (I.R.S. Employer

                                                    incorporation or organization)           Identification No.)

 

                                                         401 Cottage Street

                                                           Abilene, Kansas                              67410-2832

(Address of principal executive offices)      (Zip Code)

 

 

Registrant's telephone number including area code: (785) 263-3350

 

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___

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

4,259,195 shares of common stock, $.0001 par value (the issuer's only class of common stock), were outstanding as of November 3, 2002.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Duckwall-ALCO Stores, Inc.

And Subsidiaries

 

Notes to Unaudited Consolidated Financial Statements

 

 

(1) Basis of Presentation

 

The accompanying unaudited consolidated financial statements are for interim periods and, consequently, do not include all disclosures required by generally accepted accounting principles for annual financial statements. It is suggested that the accompanying unaudited consolidated financial statements be read in conjunction with the consolidated financial statements included in the Company's fiscal 2002 Annual Report. In the opinion of management of Duckwall-ALCO Stores, Inc., the accompanying unaudited consolidated financial statements reflect all adjustments (consisting of normal recurring accruals) necessary to present fairly the financial position of the Company and the results of its operations and cash flows for the interim periods.

 

(2) Principles of Consolidation

 

The consolidated financial statements include the accounts of Duckwall-ALCO Stores, Inc. and its wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.

 

(3) Adoption of New Accounting Policies (dollars in thousands)

 

Effective January 29, 2001, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Investments and Hedging Activities." SFAS No. 133 requires that all derivative instruments be recorded on the balance sheet at fair value. The accounting for changes in the fair value of a derivative depends on its designation and effectiveness. For derivatives that qualify as effective hedges, the change in fair value has no net impact on earnings until the hedged transaction affects earnings. For derivatives that are not designated as hedging instruments, or for the ineffective portion of a hedging instrument, the change in fair value is recognized in current period earnings.

 

The Company entered into an interest rate swap agreement in December, 2000 with a notional principal amount of $10,000 whereby the Company paid a fixed rate of interest and received interest based on LIBOR for the period from April 15, 2001 to April 15, 2002. The purpose of the interest rate swap agreement was to mitigate the Company's interest rate risk under its revolving credit facility.

 

Prior to January 29, 2001, the Company had accounted for the interest rate swap agreement as a cash flow hedge. Upon adoption of SFAS No. 133, the Company elected to not use hedge accounting for the interest rate swap agreement. Accordingly, a cumulative‑effect‑type adjustment was made to Accumulated Other Comprehensive Income in the amount of $76 on January 30, 2001, which represented the fair value of the interest rate swap at the date of adoption of SFAS No. 133 ($123) net of income tax effect ($47). The cumulative effect adjustment was amortized to earnings over the period from April 15, 2001 to April 15, 2002. During the thirteen weeks ended November 3, 2002 and October 28, 2001, respectively, the Company recorded interest expense of $0 ($0 net of tax), and $31 ($19 net of tax) to amortize the cumulative effect adjustment.

 

 

 

 

 

Effective February 4, 2002, the company adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." Management believes that the adoption of SFAS No. 144 did not have a significant impact on the financial statements. The closings of stores are not reflected as discontinued operations since the effects were not material.

 

 

 

 

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

(Dollars in thousands)

 

The thirteen weeks ended November 3, 2002 and October 28, 2001 are referred to herein as the third quarter of fiscal 2003 and 2002 respectively.

 

As used below the term "competitive market" refers to any market wherein there is one or more national or regional full-line discount stores located in the market served by the Company. The term "non-competitive market" refers to any market where there is no national or regional full-line discount store located in the market served by the Company. Even in a non-competitive market, the Company faces competition from a variety of sources.

 

RESULTS OF OPERATIONS

 

Thirteen and Thirty-Nine Weeks Ended November 3, 2002 Compared to Thirteen and Thirty-Nine Weeks Ended October 28, 2001.

 

The Company continues to execute its basic strategy of opening stores in under-served markets that have no competition from national or regional full-line discount retailers. During the third quarter of fiscal 2003 the Company opened 2 ALCO stores, which were in new, non-competitive markets and closed one store, resulting in a quarter end total of 265 stores. For the thirty-nine week period ending November 3, 2002, the Company opened four stores and closed three stores. As of November 3, 2002, over 80% of the stores were located in non-competitive markets. Through the third quarter, the Company has completed the remodel of 29 of the planned 32 ALCO stores targeted for the completion in the current fiscal year.

 

Net sales for the third quarter of fiscal 2003 decreased $1,426 or 1.5% to $93,381 compared to $94,807 for the third quarter of fiscal 2002. When sales are compared to the similar period in the prior year, which ended on November 4, 2001, sales decreased $1,313 or 1.4%, with same store sales declining $3,146 or 3.4%. Sales were negatively impacted by a reduction in advertising, the absence of last year's federal income tax rebate checks, a modest impact from the implementation of a warehouse management software package, a weak farm economy in many of the company's markets, and a general softness in retail spending.

 

Net sales for the thirty-nine week period ending November 3, 2002 increased $5,264 or 1.8% to $293,628 compared to $288,364 in the comparable thirty-nine week period of the prior fiscal year. When sales are compared to the similar thirty-nine week period in the prior year, which ended on November 4, 2001, sales rose $5,215, or 1.8%, with same store sales rising $715, or 0.3%.

 

Gross margin for the third quarter of fiscal 2003 increased $276 or 0.8% to $32,818 compared to $32,542 in the third quarter of fiscal 2002. Gross margin as a percentage of sales was 35.1% for the third quarter of fiscal 2003 compared to 34.3% for the third quarter of fiscal 2002. This was primarily due to lower markdowns and reduced shrinkage.

 

Gross margin for the thirty-nine week period ended November 3, 2002 was $99,524, which was $4,154 or 4.4% higher than last year's thirty-nine week gross margin of $95,370. As a percent of net sales, gross margin for the thirty-nine week period ended November 3, 2002 was 33.9% compared to 33.1% in the thirty-nine week period of the prior fiscal year. The improvement in gross margin percentage was attributable to a mix of sales that included more higher margin items, lower markdowns, and reduced shrinkage.

 

Selling, general and administrative expense increased $379 or 1.3% to $29,894 in the third quarter of fiscal 2003 compared to $29,515 in the third quarter of fiscal 2002. As a percentage of net sales, selling, general and administrative expenses in the third quarter of fiscal 2003 was 32.0%, compared to 31.1% in the third quarter of fiscal 2002. The increase in the selling, general and administrative expense was due to higher distribution center labor costs related to the launch of a new warehouse management software package, higher store payroll expenses and higher insurance costs.

 

Selling, general and administrative expenses increased $3,448 or 4.0% to $89,646 for the thirty-nine week period ended November 3, 2002 compared to $86,198 for the comparable thirty-nine week period of the prior fiscal year. Selling, general and administrative expense as a percent of net sales was 30.5% for the thirty-nine week period ending November 3, 2002 compared to 29.9% for the thirty-nine week period ended October 28, 2001. The increase in the selling, general, and administrative expense was due to reduced marketing support from vendors and insurance costs mentioned above, along with higher incentive compensation.

 

Depreciation and amortization expense increased $155 or 9.6% to $1,778 in the third quarter of fiscal 2003 compared to $1,623 in the third quarter of fiscal 2002. Depreciation and amortization expense increased $344 or 7.3% to $5,082 for the thirty-nine week period ended November 3, 2002 compared to $4,738 in the comparable thirty-nine week period of the prior fiscal year.

 

Provision for asset impairment and store closure was $0 in the third quarter of both fiscal 2003 and 2002.

 

Provision for asset impairment and store closure was $6 for the thirty-nine week period ended November 3, 2002 compared to ($8) for the comparable thirty-nine week period of the prior fiscal year.

 

Income from operations decreased $258 or 18.4% to $1,146 in the third quarter of fiscal 2003 compared to $1,404 in the third quarter of fiscal 2002. Income from operations as a percentage of net sales was 1.2% in the third quarter of fiscal 2003 compared to 1.5% in the third quarter of fiscal 2002.

 

Income from operations increased $348 or 7.8% to $4,790 for the thirty-nine week period ended November 3, 2002 compared to $4,442 the comparable thirty-nine week period of the prior fiscal year.

 

Interest expense decreased $333 or 45.1% in the third quarter of fiscal 2003 compared to the third quarter of fiscal 2002. Interest expense decreased $1,011 or 45.6% to $1,205 for the thirty-nine week period ended November 3, 2002 compared to $2,216 in the comparable thirty-nine week period of the prior fiscal year. Interest expense decreased because of lower rates as well as lower levels of borrowing due to reduced levels of inventory.

 

Net earnings for the third quarter of fiscal 2003 were $469, an increase of $57 or 13.8% over the net earnings of $412 for the third quarter of fiscal 2002. Net earnings increased $891 or 64.7% to $2,269 in the third quarter of fiscal 2003 compared to $1,378 in the thirty-nine week period of the prior fiscal year.

 

LIQUIDITY AND CAPITAL RESOURCES

 

The Company's primary sources of funds are cash flows from operations, borrowings under its revolving loan credit facility, mortgage financing and vendor trade credit financing (increases in accounts payable).

 

At November 3, 2002 working capital (defined as current assets less current liabilities) was $100,366 compared to $71,101 at the end of fiscal 2002. The increase in working capital was due to the classification of the revolving loan as a long-term liability as it was replaced by a Senior Secured Revolving credit facility that is due in April 2006.

 

Operating activities used cash in the amount of $3,601 and $2,720 in the thirty-nine week period of fiscal 2003, and 2002 respectively. The increase in the amount of cash used by operating activities in the thirty-nine week period of fiscal 2003 compared to the thirty-nine week period of fiscal 2002 was primarily due to a reduction of income taxes payable.

 

Cash used in investing activities in the thirty-nine week period of fiscal 2003 and 2002 totaled $5,501 and $4,235 respectively. Total anticipated cash payments for acquisition of property and equipment in fiscal 2003, principally for store buildings and store and warehouse fixtures and equipment, are approximately $7,500.

 

The Company generated cash from financing activities in the thirty-nine week period of fiscal 2003 in the amount of $8,887 and $2,317 in the thirty-nine week period of fiscal 2002. Cash was generated by increasing the revolver and cash was used to make principal payments on long-term notes and capital leases.

 

 

 

 

 

 

BUSINESS OPERATIONS AND SEGMENT INFORMATION

 

The Company's business activities include operation of ALCO discount stores in towns with populations which are typically less than 5,000 not served by other regional or national full-line discount chains and Duckwall variety stores that offer a more limited selection of merchandise which are primarily located in communities of less than 2,500 residents.

 

For financial reporting purposes, the Company has established two operating segments: "ALCO Discount Stores", and "All Other", which includes the Duckwall variety stores and other business activities, such as general office, warehouse and distribution activities.

 

 

Income from operations as reflected in the above segment information has been determined differently than income from operations in the accompanying consolidated statements of operations as follows:

Intercompany Sales

Intercompany sales represent transfers of merchandise from the warehouse to ALCO discount stores and Duckwall variety stores.

 

Intercompany Expense Allocations

General and administrative expenses incurred at the general office have not been allocated to the ALCO Discount Stores for purposes of determining income from operations for the segment information.

 

Warehousing and distribution costs including freight applicable to merchandise purchases, have been allocated to the ALCO Discount Stores segment based on the Company's customary method of allocation for such costs (primarily as a stipulated percentage of merchandise purchases).

 

Inventories

Inventories are based on the FIFO method for segment information purposes and on the LIFO method for the consolidated statements of operations.

 

Leases

All leases are accounted for as operating leases for purposes of determining income from operations for purposes of determining the segment information for the ALCO Discount Stores whereas capital leases are accounted for as such in the consolidated statements of operations.

 

 

 

CHANGE IN ACCOUNTING PRINCIPLES

 

Effective January 29, 2001, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Investments and Hedging Activities." See additional discussion in Note 3 to Unaudited Consolidated Financial Statements.

 

In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long‑Lived Assets (SFAS No. 144). SFAS No. 144 addresses significant issues relating to the implementation of SFAS No. 121, "Accounting for the Impairment of Long‑Lived Assets and for Long‑Lived Assets to Be Disposed Of," and develops a single accounting method under which long‑lived assets that are to be disposed of by sale are measured at the lower of book value or fair value less cost to sell. Additionally, SFAS No. 144 expands the scope of discontinued operations to include all components of an entity with operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS No. 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001 and its provisions are to be applied prospectively. This accounting principle was adopted by the Company effective February 4, 2002. Management believes that the adoption of SFAS No. 144 did not have a significant impact on the financial statements. The closings of stores are not reflected as discontinued operations since the effects were not material.

 

NEW ACCOUNTING STANDARDS

 

Statement of Financial Accounting Standard No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity." The provisions of this statement are effective for exit or disposal activities initiated after December 31, 2002.

 

 

MARKET RISK DISCLOSURE

 

The revolving credit facility has a floating interest rate that is affected by changes in market interest rates. The Company entered into an interest rate swap in December 2000 with a notional principal amount of $10,000 whereby the Company paid a fixed rate of interest and received interest based on LIBOR for the period April 15, 2001 to April 15, 2002 to mitigate a portion of its interest rate risk under the revolving credit facility.

 

On April 15, 2002, the Company replaced the existing line of credit with a new line of credit with Fleet Retail Finance Inc. that expires in April 2006. The credit line available is $70,000, which carries a variable rate of interest.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Based on an evaluation of disclosure controls and procedures for the period ended November 3, 2002 conducted by our President and Chief Financial Officer, we conclude that our disclosure controls and procedures are effective. The President and Chief Financial Officer conducted this evaluation in November, 2002.

 

The company has in place a system of internal controls which it believes are adequate. There have been no significant deficiencies or material weaknesses identified and we have not made any significant changes in our internal controls or in other factors that could significantly affect internal controls.

 

 

 

OTHER INFORMATION

 

PART II

 

Item 1. Legal Proceedings

No legal proceedings except those covered by insurance occurred during the thirteen-week period ended November 3, 2002.

 

Item 2. Changes in Securities

                                    Not applicable

 

Item 3. Defaults Upon Senior Securities

                                    Not Applicable

 

Item 4. Submission of Matters to a Vote of Security Holders

                                    Not Applicable

 

Item 5. Other Information

                                    None

 

Item 6. Exhibits and Reports on Form 8-K

                                    (a) None

                                    (b) Current Report on Form 8-K (Item 4) dated on September 16, 2002

SIGNATURES

 

 

 

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934 the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

 

DUCKWALL-ALCO STORES, INC.

(Registrant)

 

 

 

 

                                                                                                           Date, December 16, 2002          /s/ Richard A. Mansfield

                                               Richard A. Mansfield

                                               Vice President -                                               Finance

                                               Chief Financial Officer

 

 

                                               Signing on behalf of  

                                               the registrant and as

                                               principal financial

                                               officer