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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 1-11735
99 CENTS ONLY STORES
(Exact name of registrant as specified in its charter)
CALIFORNIA 95-2411605
(State or other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
4000 UNION PACIFIC AVENUE,
CITY OF COMMERCE, CALIFORNIA 90023
(Address of Principal Executive Offices) (zip code)
Registrant's telephone number, including area code: (323) 980-8145
Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EXCHANGE ON WHICH REGISTERED
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COMMON STOCK, NO PAR VALUE NEW YORK STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Security Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports) and (2) has been subject to such filing
requirements for the last 90 days. Yes [X] No [ ]
Indicate by check mark 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 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. [X]
Indicate by checkmark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2) Yes [X] No [ ]
The aggregate market value of Common Stock held by non-affiliates of the
Registrant on June 28, 2002 was $1,213,783,600 based on a $25.65 closing price
for the Common Stock on such date. For purposes of this computation, all
executive officers and directors have been deemed to be affiliates. Such
determination should not be deemed to be an admission that such executive
officers and directors are, in fact, affiliates of the Registrant.
Indicate the number of shares outstanding of each of the issuer's classes of
stock as of the latest practicable date.
Common Stock, No Par Value, 70,426,655 Shares as of March 28, 2003
Portions of Part III of this report have been incorporated by reference
from the Company's Proxy Statement for the 2003 Annual Shareholders meeting.
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TABLE OF CONTENTS
Part I Page
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Item 1. Business. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Item 2. Properties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . 9
Part II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters. . . . . . . . . . 10
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations . 12
Item 7A. Quantitative and Qualitative Disclosures About Market Risk. . . . . . . . . . . . . . . 21
Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . 22
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. . 37
Part III
Item 10. Directors and Executive Officers of the Registrant. . . . . . . . . . . . . . . . . . . 38
Item 11. Executive Compensation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
Item 12. Security Ownership of Certain Beneficial Owners and Management. . . . . . . . . . . . . 38
Item 13. Certain Relationships and Related Transactions. . . . . . . . . . . . . . . . . . . . . 38
Item 14. Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
Part IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K . . . . . . . . . . . . 39
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SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION
This Report contains statements that constitute "forward-looking
statements" within the meaning of Section 21E of the Exchange Act and Section
27A of the Securities Act. The words "expect," "estimate," "anticipate,"
"predict," "believe" and similar expressions and variations thereof are intended
to identify forward-looking statements. Such statements appear in a number of
places in this filing and include statements regarding the intent, belief or
current expectations of 99 Cents Only Stores (the " Company"), its directors or
officers with respect to, among other things (a) trends affecting the financial
condition or results of operations of the Company and (b) the business and
growth strategies of the Company. The shareholders of the Company are cautioned
not to put undue reliance on such forward-looking statements. Such
forward-looking statements are not guarantees of future performance and involve
risks and uncertainties, and actual results may differ materially from those
projected in this Report, for the reasons, among others, discussed in the
Sections - "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Risk Factors." The Company undertakes no obligation
to publicly revise these forward-looking statements to reflect events or
circumstances that arise after the date hereof. Readers should carefully review
the risk factors described in other documents the Company files from time to
time with the Securities and Exchange Commission, including the Quarterly
Reports on Form 10-Q and any Current Reports on Form 8-K filed by the Company.
PART I
ITEM 1. BUSINESS
99 Cents Only Stores (the "Company") is a leading deep-discount retailer of
primarily name-brand, consumable general merchandise. The Company's stores offer
a wide assortment of regularly available consumer goods as well as a broad
variety of first-quality, close-out merchandise. In 2002, a majority of the
Company's product offerings were comprised of recognizable name-brand
merchandise and were regularly available for reorder. As of March 28, 2003, the
Company operated 154 retail stores, 116 in Southern California, 11 in Central
California, 7 in Northern California, 9 in Las Vegas, Nevada and 11 in Phoenix,
Arizona. These stores have an average size of approximately 20,500 square feet.
The Company's 99 Cents Only Stores generated average net sales per estimated
saleable square foot of $309, which the Company believes is among the highest in
the deep-discount convenience store industry, and average net sales per store of
$4.8 million for stores open the full year in 2002.
The Company opened its first 99 Cents Only Stores in 1982 and believes that
it operates the nation's oldest existing single price point general merchandise
chain. The Company competes in the deep-discount industry, which it believes is
one of the fastest growing retail sectors in the United States. In line with the
Company's business strategy, the Company has significantly increased the rate of
store expansion over the last five fiscal years. The Company expanded its 99
Cents Only Stores from 36 stores and 332,100 estimated saleable square feet at
December 31, 1995 to 151 stores and 2,428,681 estimated saleable square feet at
December 31, 2002, representing a compound annual growth rate ("CAGR") of 23%
and 33%, respectively. Historically, the Company's 99 Cents Only Stores have
been profitable within their first year of operation. In the first quarter of
2003, the Company opened three stores and plans to open an additional 35 net new
stores during the remainder of the year. The Company intends to continue its
planned store square footage expansion over the next several years at a targeted
growth rate of 25% per year. The Company estimates that the California, Nevada
and Arizona markets have the potential for over 275 99 Cents Only Stores. The
Company intends to continue to expand in California, Nevada and Arizona in 2003
and will enter the Texas market in 2003 as well. See "Growth Strategy" for
further discussion of geographic expansion plans.
The Company also sells merchandise through its Bargain Wholesale division
at prices generally below normal wholesale levels to local, regional, and
national discount, drug and grocery stores and independent retailers,
distributors and exporters. Bargain Wholesale complements the Company's retail
operations by allowing the Company to purchase in larger volumes at more
favorable pricing, to be exposed to a broader selection of opportunistic buys
and to generate additional sales with relatively small incremental increases in
operating expenses, contributing to strong overall operating margins for the
Company. Bargain Wholesale represented 7.0% of the Company's net sales in 2002.
INDUSTRY
The Company participates primarily in the deep-discount retail industry,
with its 99 Cents Only Stores. Deep-discount retail is distinguished from other
retail formats by the purchase of close-out and other special-situation
merchandise at prices substantially below original wholesale cost, and the
subsequent sale of this merchandise at prices significantly below regular
retail. This results in a continually changing selection of specific brands of
products. The Company believes that the deep-discount retail industry is one of
the fastest growing retail sectors in the United States.
The sale of close-out or special-situation merchandise develops in response
to the need of manufacturers, wholesalers and others to distribute merchandise
outside their normal channels. Close-out or special-situation merchandise
becomes available for a variety of reasons, including a manufacturer's
over-production, discontinuance due to a change in style, color, size,
formulation or packaging, the inability to move merchandise effectively through
regular channels, reduction of excess seasonal inventory, discontinuation of
test-marketed items and the financial needs of the manufacturer.
Many deep-discount retailers also sell merchandise that can be purchased
from a manufacturer or wholesaler on a regular basis. Although this merchandise
can usually be purchased at less than original wholesale and sold below normal
retail, the discount, if any, is generally less than with close-out merchandise.
Deep-discount retailers sell regularly available merchandise to ensure a degree
of consistency in their product offerings and to establish themselves as a
reliable source of basic goods.
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BUSINESS STRATEGY
The Company's goal is to continue to provide significant value to its
customers on a wide variety of consumable merchandise in an exciting store
environment. The Company's strategies to achieve this goal include the
following:
Focus on "Name-Brand" Consumables. The Company strives to exceed its
customers' expectations of the range and quality of name-brand consumable
merchandise that can be purchased for 99 cents. During 2002, the Company
purchased merchandise from more than 999 suppliers, including Colgate-Palmolive
Company, The Dial Corp., Eveready Battery Company Inc., General Electric
Company, Gerber Products Company, Hershey Foods Corp., Johnson & Johnson, Kraft
General Foods, Inc., Lever Brothers Company, Mattel Inc., The Mead Corporation,
Nabisco Inc., Nestle, The Pillsbury Company, The Procter & Gamble Company,
Revlon Inc. and SmithKline Beecham Corporation.
Broad Selection of Regularly Available Merchandise. The Company's retail
stores offer consumer items in each of the following staple product categories:
food (including frozen and deli items), beverages, health and beauty aids,
household products (including cleaning supplies, paper goods, etc.), housewares
(including glassware, kitchen items, etc.), hardware, stationary and party
goods, seasonal goods, baby products and toys, giftware, pet products and
clothing. The Company supplements its name-brand merchandise with private-label
items. By consistently offering a wide selection of basic household consumable
items, the Company attempts to encourage customers to shop at the stores for
their everyday household needs, which the Company believes leads to a high
frequency of customer visits.
Attractively Merchandised and Well-Maintained Stores. The Company strives
to provide its customers an exciting shopping experience in
customer-service-oriented stores, which are attractively merchandised, brightly
lit and well-maintained. The Company's stores are merchandised and laid out in a
"supermarket" format with items in the same category grouped together. In
addition, the shelves are restocked as needed during the day. By offering
merchandise in an attractive, convenient and familiar environment, the Company
believes its stores appeal to a wide demographic of customers.
Strong Long-Term Supplier Relationships. The Company believes that it has
developed a reputation as a leading purchaser of name-brand, re-orderable and
close-out merchandise at discount prices through its ability to make immediate
buying decisions, experienced buying staff, willingness to take on large volume
purchases and take possession of merchandise immediately, ability to pay cash or
accept abbreviated credit terms, reputation for prompt payment, commitment to
honor all issued purchase orders and willingness to purchase goods close to a
target season or out of season. The Company's relationship with its suppliers is
further enhanced by its ability to minimize channel conflict for the
manufacturer by quickly selling name-brand merchandise without, if requested by
the supplier, advertising or wholesaling the item. Additionally, the Company
believes it has well-maintained, attractively merchandised stores that have
contributed to a reputation among suppliers for protecting their brand image.
Complementary Bargain Wholesale Operation. Bargain Wholesale complements
the Company's retail operations by allowing the Company to purchase in larger
volumes at more favorable pricing, to be exposed to a broader selection of
opportunistic buys and to generate additional sales with relatively small
incremental increases in operating expenses, contributing to strong overall
operating margins for the Company. Net sales in the Company's Bargain Wholesale
were $50.0 million in 2002. The growth strategy for Bargain Wholesale is to
focus on large domestic and international accounts and expansion into new
geographic markets. The Company maintains showrooms in New York City and Chicago
to support its Bargain Wholesale operation, which is based in Los Angeles.
Adherence to Disciplined Cost Controls and Savvy Purchasing. The Company
believes it is able to provide its customers with significant value while
maintaining strong operating margins through an adherence to a disciplined cost
control program. The Company purchases merchandise at substantially discounted
prices as a result of its buyers' knowledge, experience and negotiating ability
and its established reputation among its suppliers. The Company applies this
same approach to its relationships with other vendors and strives to maintain a
lean operating environment focused on increasing net income.
Focus on Larger Stores in Convenient Locations. The Company's 99 Cents Only
Stores are conveniently located in freestanding buildings, neighborhood shopping
centers (anchored by 99 Cents Only Stores or co-anchored with a supermarket
and/or a drug store), regional shopping centers or downtown central business
districts where the Company believes consumers are more likely to do their
regular household shopping. The Company's 154 existing 99 Cents Only Stores,
average approximately 20,500 gross square feet. From January 1, 1997 through
December 31, 2002, the Company has opened 115 new stores with an average of
approximately 20,500 gross square feet and currently targets new store locations
between 18,000 and 28,000 gross square feet. The Company's larger 99 Cents Only
Stores allow a more effective display of a wider assortment of merchandise,
carry deeper stock positions and provide customers with a more inviting and
convenient environment that the Company believes encourages customers to shop
longer and buy more. The Company's decision to target larger stores is based in
part on the higher average annual net sales per store and operating income
typically achieved by these stores. In the past, as part of its strategy to
expand retail operations, the Company has at times opened larger new stores in
close proximity to existing stores where the Company determined that the trade
area could support a larger store. In some of these situations, the Company
retained its existing store so long as it continued to contribute store-level
operating income. While this strategy was designed to increase revenues and
store-level operating income, it has had a negative impact on comparable store
net sales as some customers migrated from the existing store to the larger new
store. The Company believes that this strategy has impacted its historical
comparable sales growth.
Experienced Management Team and Depth of Employee Option Grants. 99 Cents
Only Stores' management team has many years of retail experience and has
demonstrated its skills through a proven track record of financial performance.
The Company's management strongly believes that employee ownership of the
Company's stock helps build employee pride in the stores, which significantly
contributes to the success of the Company and its operations. Accordingly, all
members of the Company's management (other than David Gold, the Company's Chief
Executive Officer, Howard Gold, Senior Vice President of Distribution, Jeff
Gold, Senior Vice President of Real Estate and Information Systems, Eric
Schiffer, President and Karen Schiffer, Senior Buyer) and all employees with
tenure of more than six months with the Company receive an annual grant of
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stock options. As of December 31, 2002, the Company's employees held options to
purchase an aggregate of 5,260,782 shares, or 7.5% of the fully diluted shares
of Common Stock outstanding.
GROWTH STRATEGY
Management believes that future growth will primarily result from new store
openings facilitated by the following:
Growth in Existing Territories - California, Nevada and Arizona. The
Company's 154 99 Cents Only Stores are located in California, Nevada and
Arizona. By focusing the majority of its 2003 growth in the current markets, the
Company believes it can leverage its brand awareness in the region and take
advantage of its existing warehouse and distribution facility, regional
advertising and other management and operating efficiencies. The Company plans
to open at least 38 net new 99 Cents Only Stores in 2003. Of the 38 planned net
new stores, at least 23 will be located in California, Nevada and Arizona. The
Company opened three new stores during the first three months of 2003 and plans
to open the remaining stores planned for California, Nevada and Arizona during
the remainder of 2003. The Company has secured sites for three additional store
locations and has signed twenty letters of intent to lease or purchase
prospective store sites in these states. Generally, the Company expects that at
least 50% of the letters of intent will become store sites. The Company intends
to continue its planned store square footage expansion over the next several
years at a targeted rate of 25% per year. The Company estimates that the markets
in California, Nevada, and Arizona have the potential for over 275 99 Cents Only
Stores.
Expansion into Texas. On February 4, 2003 the Company announced the
purchase of a 741,000 square foot distribution center in Houston, to service its
planned store expansion in Texas in 2003 and beyond. The facility was acquired
for $23 million cash and is fully racked including a pick to belt conveyor
system. It also contains refrigerated and frozen storage space. The Company has
announced that it plans to open approximately 15 of its planned 38 new stores in
2003 in Houston and the surrounding areas. Currently the Company has a total of
11 letters of intent regarding leases for Houston locations. In connection with
the opportunity to acquire this warehouse facility, the Company accelerated its
retail expansion plans into Texas to mid-year 2003 from early 2004. The Company
expects that additional fixed overhead associated with this distribution
facility during 2003 will be approximately $1.0 million per quarter. The
Company believes Texas has the potential for over 175 stores.
Portable Format Facilitates Geographic Expansion. The Company believes that
its concept of consistently offering a broad selection of name-brand
consumables, at value pricing, in a convenient store format is portable to most
other densely populated areas of the country. In November 1999, the Company
opened its first 99 Cents Only Stores outside the state of California in Las
Vegas, Nevada and now has a total of 9 stores in Las Vegas, Nevada and 11 in
Phoenix, Arizona in 2002. As disclosed above, the Company also plans to add new
stores in Texas in 2003.
Acquisitions. The Company considers lease acquisition or purchase
opportunities as they become known to the Company and may make acquisitions of a
chain, or chains, of clustered retail sites in densely populated regions,
primarily for the purpose of acquiring favorable locations.
RETAIL OPERATIONS
The Company's retail stores offer customers a wide assortment of regularly
available consumer goods, as well as a broad variety of first-quality, close-out
merchandise, generally at a significant discount from normal retail. All
merchandise sold in the Company's 99 Cents Only Stores retail stores sells for
99 cents per item or 99 cents for two or more items.
The following table sets forth relevant information with respect to the
growth of the Company's existing 99 Cents Only Stores operations (dollar amounts
in thousands, except sales per square foot):
YEAR ENDED DECEMBER 31,
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1998 1999 2000 2001 2002
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99 Cents Only Stores net retail sales. . . . . . . . . . $238,868 $ 312,306 $ 402,071 $ 522,019 $ 663,983
99 Cents Only Stores annual net sales growth rate. . . . 28.4% 30.7% 28.7% 29.8% 27.2%
99 Cents Only Stores store count at beginning of year. . 53 64 78 98 123
New stores . . . . . . . . . . . . . . . . . . . . . . . 13 18 20 26 28
Stores closed. . . . . . . . . . . . . . . . . . . . . . 2(a) 4(a) - 1(a) -
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Total store count at year-end. . . . . . . . . . . . . . 64 78 98 123 151
Average 99 Cents Only Stores net sales per store open
the full year(b). . . . . . . . . . . . . . . . . . . . $ 4,147 $ 4,433 $ 4,487 $ 4,647 $ 4,750
Estimated saleable square footage at year-end for 99
Cents Only Stores. . . . . . . . . . . . . . . . . . . . 822,900 1,102,369 1,424,280 1,892,949 2,428,681
Average net sales per estimated saleable square foot(b). $ 335 $ 332 $ 318 $ 319 $ 309
Change in comparable 99 Cents Only Stores net sales. . . 4.3% 6.1% 2.0% 5.9% 3.2%
(a) Stores closed due to relocation to a larger nearby site.
(b) For stores open for the entire fiscal year for 99 Cents Only Stores.
Merchandising. All of the Company's stores offer a broad variety of
first-quality, name-brand and other close-out merchandise as well as a wide
assortment of regularly available consumer goods. The Company also carries a
line of private label consumer products made exclusively for the
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Company. The Company believes that the success of its 99 Cents Only Stores
concept arises from the value inherent in selling primarily name-brand
consumables, most of which retail elsewhere from $1.19 to $9.99, for only 99
cents per item or group of items. Each store typically carries over six thousand
different stock keeping units (SKU).
Although a majority of the merchandise purchased by the Company is
available for reorder, the mix of specific brands of merchandise frequently
changes, depending upon the availability of close-out and other
special-situation merchandise at suitable prices. Since commencing its closeout
purchasing strategy in 1976, the Company has not experienced difficulty in
obtaining name brand closeouts as well as re-orderable merchandise at attractive
prices. Management believes that continuously changing specific name-brands
found in its stores from one week to the next encourages impulse and larger
volume purchases, results in customers shopping more frequently and helps to
create a sense of urgency, awareness and excitement. Unlike many discount
retailers, the Company rarely imposes limitations on the quantity of specific
items that may be purchased by a single consumer.
The Company targets value-conscious consumers from a wide range of
socio-economic backgrounds with diverse demographic characteristics. Purchases
are by cash, credit or debit card. The Company's stores do not accept checks or
manufacturers' coupons. The Company's stores are open every day with opening
hours designated to meet the needs of family consumers.
Store Size, Layout and Locations. As of March 28, 2003, the Company had 154
99 Cents Only Stores averaging approximately 20,500 gross square feet. Since
January 1, 1998, the Company has opened 106 new stores that average 22,600 gross
square feet and currently targets new store locations between 18,000 and 28,000
gross square feet. The Company's larger 99 Cents Only Stores allow it to more
effectively display a wider assortment of merchandise, carry deeper stock
positions and provide customers with a more, what management believes, inviting
and convenient environment that encourages customers to shop longer and buy
more. The Company's decision to target larger stores is based in part on higher
average annual store revenues typically achieved by these stores.
The Company's stores are conveniently located in freestanding buildings,
neighborhood shopping centers (anchored by 99 Cents Only Stores, a supermarket
and/or a drug store), regional shopping centers or downtown central business
districts where the Company believes consumers are more likely to do their
regular household shopping.
The Company strives to provide stores that are attractively merchandised,
brightly lit, well-maintained, "destination" locations. The layout of each of
the Company's stores is customized to the actual size and configuration of the
individual location. The interior of each store is, however, designed to reflect
a uniform format, featuring attractively displayed products in windows,
consistent merchandise display techniques, bright lighting, lower shelving
height that allows unobstructed visibility throughout the store, distinctive
color scheme, interior and exterior signage and customized check-out counters,
floors, price tags, shopping carts and shopping bags. The Company emphasizes a
strong visual presentation in all key traffic areas of the store. Merchandising
displays are maintained throughout the day, change frequently and often
incorporate seasonal themes. The Company believes that due to the continuously
changing brand-names, the lower shelving height and the absence of aisle
description signs, the typical customer tends to shop the whole store.
As of December 31, the Company leased 129 of its 151 99 Cents Only Stores
retail locations and owned 22 store locations. The Company typically seeks
leases with an initial five-year to ten-year term and with one or more five-year
renewal options. See "Item 2 Properties." The Company identifies potential sites
through a network of contacts within the brokerage and real estate communities,
information provided by vendors, customers and employees and through other
efforts of the Company's real estate department. Most leases have renewal
options ranging from three to ten years. Except for 11 relocations to larger
stores, the Company has never closed any of its 99 Cents Only Stores.
Store Management. Substantially all merchandise decisions with respect to
pricing and advertising are made at the Company's headquarters. The Company
employs 26 district managers and two regional managers responsible for store
operations. Each district manager is responsible for up to seven stores.
Reporting to each district manager is one merchandising supervisor responsible
for store merchandising in that district. The store managers also report to the
district manager. These district managers are supervised by the two regional
managers that report to the Company's Vice President of Retail Operations.
District managers visit each store in their district at least twice a week and
focus on the implementation of the Company's policies, operations and
merchandising philosophy. District managers also help train store management and
assist store management with scheduling. The Vice President of Retail Operations
also supervises a cashier's training school located at the Company's corporate
offices. Each merchandising supervisor and his crew (usually six to ten
experienced stock people) visit each of the stores at least once a week and help
the store managers to maintain and improve the appearance of the sales floor,
move merchandise sections, organize the stockroom and train store personnel.
Typically the Company's stores are staffed with a manager and two or three
assistant managers. Store managers are responsible for assessing their
respective store's stocking needs and ordering accordingly.
Advertising. Advertising expenditures were $2.7 million, $3.4 million and
$3.1 million for 2000, 2001 and 2002, respectively, or 0.6%, 0.6% and 0.4% of
net sales, respectively. The Company manages its advertising without the
assistance of an outside agency. The Company allocates the majority of its
advertising budget to newspaper and radio advertising. The Company's advertising
strategy emphasizes the offering of nationally recognized, name-brand
merchandise at significant savings. The Company minimizes its advertising
expenditures by an efficient implementation of its advertising program combined
with word-of-mouth publicity, locations with good visibility and efficient
signage. Because of the Company's distinctive grand opening promotional
campaign, which includes the sale of nine televisions for 99 cents each and nine
microwave ovens for 99 cents each, grand openings often attract long lines of
customers and receive media coverage. The Company believes that one of its
biggest challenges is attracting affluent customers to shop its stores. The
Company also uses a direct mail campaign for new customers who are homeowners in
more upscale neighborhoods.
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BARGAIN WHOLESALE
Bargain Wholesale conducts its wholesale operations through its 15,000
square foot product showroom located at the Company's warehouse and distribution
facility. The Company's showrooms in New York and Chicago also continue to
support Bargain Wholesale's operations. In 2002, Bargain Wholesale sold
merchandise to other wholesalers, small local retailers, large regional and
national retailers and exporters. During 2002, no single customer accounted for
more than 10.0% of Bargain Wholesale's net sales. The Company advertises its
wholesale operations primarily through direct mail. The Company plans to expand
its wholesale operations by focusing on the needs of large domestic and
international accounts, expansion into new geographic markets, increasing its
marketing and promotional programs, increasing the number of trade shows at
which it exhibits, focusing on its showrooms in Chicago and New York City,
enhancing customer service and aggressively contacting its customers on a more
frequent basis through telephone, facsimile and mail.
The Company's wholesale product line is substantially similar to its retail
product line. Bargain Wholesale provides merchandise for the "dollar"
promotional aisles of certain supermarkets and drugstores. The Company offers
15-day payment terms to its Bargain Wholesale customers who meet the Company's
credit standards. Customers located abroad, certain smaller customers or others
who do not meet the Company's credit standards must pay cash upon pickup or
before shipment of merchandise.
Bargain Wholesale complements the Company's retail operations by allowing
the Company to purchase in larger volumes at more favorable pricing, to be
exposed to a broader selection of opportunistic buys and to generate additional
net sales with relatively small incremental increases in operating expenses
contributing to strong overall margins for the Company. Bargain Wholesale also
allows the Company to purchase goods which it would not otherwise purchase for
distribution through its 99 Cents Only Stores and provides the Company with a
channel by which it may distribute merchandise at prices other than 99 cents.
PURCHASING
The Company's purchasing department staff consists of 13 buyers managed by
the Company's Vice President of Purchasing. The Company's Chief Executive
Officer also participates in the Company's purchasing activities. The Company's
buyers purchase for 99 Cents Only Stores and Bargain Wholesale. The Company
believes a primary factor contributing to its success is its ability to identify
and take advantage of opportunities to purchase merchandise with high customer
interest at lower than regular wholesale prices. The Company purchases most of
its merchandise directly from the manufacturer. The Company's other sources of
merchandise include wholesalers, manufacturers' representatives, importers,
barter companies, auctions, professional finders and other retailers. The
Company develops new sources of merchandise primarily by attending industry
trade shows, advertising, marketing brochures and referrals.
The Company has no continuing contracts for the purchase of merchandise and
must continuously seek out buying opportunities from both its existing suppliers
and new sources. No single supplier accounted for more than 2.3% of the
Company's total purchases in 2002. During 2002, the Company purchased
merchandise from more than 999 suppliers, including Colgate-Palmolive Company,
The Dial Corp., Eveready Battery Company Inc., General Electric Company, Gerber
Products Company, Hershey Foods Corp., Johnson & Johnson, Kraft General Foods
Inc., Lever Brothers Company, Mattel Inc., The Mead Corporation, Nabisco Inc.,
Nestle, The Pillsbury Company, The Procter & Gamble Company, Revlon Inc. and
SmithKline Beecham Corporation. Many of these companies have been supplying
products for the Company in excess of fifteen years.
A significant portion of the merchandise purchased by the Company in 2002
was close-out or special-situation merchandise. The Company has developed strong
relationships with many manufacturers and distributors who recognize that their
special-situation merchandise can be moved quickly through the Company's retail
and wholesale distribution channels. The sale of closeout or special-situation
merchandise develops in response to the need of manufacturers, wholesalers and
others to distribute merchandise outside their normal channels. The Company's
buyers search continuously for close-out opportunities. The Company's experience
and expertise in buying merchandise has enabled it to develop relationships with
many manufacturers that often offer some or all of their close-out merchandise
to the Company prior to attempting to sell it through other channels. The key
elements to these supplier relationships include the Company's (i) ability to
make immediate buy decisions, (ii) experienced buying staff, (iii) willingness
to take on large volume purchases and take possession of merchandise
immediately, (iv) ability to pay cash or accept abbreviated credit terms, (v)
reputation for prompt payment, (vi) commitment to honor all issued purchase
orders and (vii) willingness to purchase goods close to a target season or out
of season. The Company believes the relationship with its suppliers is further
enhanced by its ability to minimize channel conflict for the manufacturer by
quickly selling name-brand merchandise without, if requested by the supplier,
advertising or wholesaling the item.
In 2002, re-orderable merchandise accounted for a majority of the
Company's purchases. The Company's strong relationships with many manufacturers
and distributors, along with its ability to purchase in large volumes, also
enable the Company to purchase re-orderable name-brand goods at discounted
wholesale prices. The Company focuses its purchases of re-orderable merchandise
on a limited number of SKUs, which allows the Company to make purchases in large
volumes.
The Company is continuously developing new private label consumer products
to broaden the assortment of merchandise that is consistently available. The
Company also has an in-house import operation, which primarily purchases
re-orderable merchandise. The Company imports products from various European,
South American and Asian countries. Merchandise directly imported by the Company
accounted for approximately 4.3% of total merchandise purchased in 2002. The
Company primarily imports merchandise in product categories which the Company
believes are not brand sensitive to consumers, such as kitchen items,
house-wares, toys, seasonal products, pet-care and hardware.
-7-
WAREHOUSING AND DISTRIBUTION
The Company owns an 880,000 square foot, single level warehouse and
distribution facility located on approximately 23 acres in the City of Commerce,
California. The Company's headquarters are located in this facility. The Company
also leases an additional 180,000 square foot of warehouse storage space
adjacent to its main distribution facility and 15,000 square feet of deli and
frozen product storage space. All of the three sites are located near downtown
Los Angeles and have close access to the Southern California freeway and rail
systems and the ports of Los Angeles and Long Beach. The main distribution
facility has 129 dock doors available for receiving or shipping, and racking
with over 10,000 pallet positions. Most of the Company's merchandise is shipped
by truck directly from manufacturers and other suppliers to the Company's
warehouse and distribution facility. The Company maintains a fleet of vehicles,
which are used to deliver merchandise to its stores. Full truck deliveries are
made from its distribution center to each store typically three or more times a
week. Product is delivered to a store the day after the store places a scheduled
order. The Company utilizes its fleet by a combination of filling outbound
trucks to capacity and instituting a backhaul program whenever possible. The
Company also uses its own vehicles to pick up certain shipments at local ports
and rail yards. The size of the Company's distribution center allows storage of
bulk one-time close-out purchases and seasonal or holiday items without
incurring additional costs. The Company believes that its current warehouse and
distribution facilities will be able to support distribution to approximately
200 stores in California and areas within a 450 mile radius. There can be no
assurance that the Company's existing warehouse will provide adequate storage
space for the Company's long-term storage needs.
On February 4, 2003 the Company announced the purchase of a 741,000 square
foot distribution center near Houston, Texas, to service its planned store
expansion in Texas in 2003 and beyond. The Company believes Texas has the
potential for over 175 stores and that this facility can adequately support
those stores. See "Growth Strategy - Expansion into Texas."
INFORMATION SYSTEMS
In 2002, the Company completed the installation of the first phase of its
financial, accounting, human resource and payroll system which utilizes an
INFORMIX database to run on an IBM UNIX operating system. The Company also
operates a separate IBM UNIX based inventory control system developed in house.
The Company's proprietary store ordering system, which utilizes radio frequency
hand held scanning devices, continued to be upgraded in 2002. This system also
has improved the overall order processing turn around time as well as the
inventory availability in the stores and is processed using a back office PC
system at each retail location. The Company utilizes a Wide Area Network (WAN)
for voice and data communications among the stores, the warehouse and the
administrative functions. In February 2002, the Company completed the
implementation of its Point of Sale System (POS) in all 99 Cents Only Stores.
The system has expedited the customer check-out process and provided product
category sales data necessary to better service the Company's customers by
improving the information about the in stock inventory at the individual store
level. The Company's information systems staffing consists of 15 employees. The
Company believes that its management information systems and inventory control
systems along with future initiatives to upgrade warehouse management systems
will be adequate to support the Company's current needs. The Company intends to
continue to enhance its systems to support its future planned store growth and
to take advantage of new proven technology.
COMPETITION
The Company faces competition in both the acquisition of inventory and sale
of merchandise from other wholesalers, discount stores, single price point
merchandisers, mass merchandisers, food markets, drug chains, club stores and
other retailers. Industry competitors also include a large number of privately
held companies and individuals. In some instances these competitors are also
customers of the Company's Bargain Wholesale division. There is increasing
competition with other wholesalers and retailers, including other deep-discount
retailers, for the purchase of quality close-out and other special-situation
merchandise. Some of these competitors have substantially greater financial
resources and buying power than the Company. The Company's ability to compete
will depend on many factors including the success of its purchase and resale of
such merchandise at lower prices than the competition. The Company may face
intense competition in the future from new entrants in the deep-discount retail
industry, among others, that could have an adverse effect on the Company's
business and results of operations.
EMPLOYEES
At December 31, 2002, the Company had 5,985 employees: 5,331 in its retail
operation, 460 in its warehouse and distribution facility, 180 in its corporate
offices and 14 in its Bargain Wholesale division. None of the Company's
employees is party to a collective bargaining agreement. The Company considers
relations with its employees to be good. The Company offers certain benefits,
including health insurance, 401(k) benefits to its full time employees and an
executive deferred compensation plan. All members of management (other than
David Gold, the Company's Chief Executive Officer, Howard Gold, Senior Vice
President of Distribution, Jeff Gold, Senior Vice President of Real Estate and
Information Systems, Eric Schiffer, President and Karen Schiffer, Senior Buyer)
and all full-time employees with tenure of six months, receive an annual grant
of stock options.
TRADEMARKS AND SERVICE MARKS
"99 Cents Only Stores", "99 Cents", "Rinso" and "Halsa" are registered
trademarks of the Company and are listed on the United States Patent and
Trademark Office Principal Register. "Bargain Wholesale" is a service mark used
by the Company. Management believes that the Company's trademarks, service marks
and trade names are an important but not critical element of the Company's
merchandising strategy.
-8-
ENVIRONMENTAL MATTERS
Under various federal, state and local environmental laws and regulations,
a current or previous owner or occupant of real property may become liable for
the costs of removal or remediation of hazardous substances at such real
property. Such laws and regulations often impose liability without regard to
fault. As of March 28, 2003 the Company leased 131 of its 154 existing stores
and the Company owned its main California warehouse and distribution facility
(where its executive offices are located). The Company also owns a warehouse
facility in Eagan, Minnesota that is currently leased to Universal
International, a former subsidiary of the Company. In connection with such
properties, the Company could be held liable for the costs of remedial actions
with respect to hazardous substances. In addition, the Company operates one
underground diesel storage tank and one above-ground propane tank at its
warehouse and distribution facility. Although the Company has not been notified
of, and is not otherwise aware of, any specific current environmental liability,
claim or non-compliance, there can be no assurance that the Company will not be
required to incur remediation or other costs in the future in connection with
its leased properties or its storage tanks or otherwise. In the ordinary course
of its business, the Company from time to time handles or disposes of ordinary
household products that are classified as hazardous materials under various
federal, state and local environmental laws and regulations. The Company has
adopted policies regarding the handling and disposal of these products, and has
implemented a training program for employees on hazardous material handling and
disposal. There can be no assurance, however, that such policies or training
will be successful in assisting the Company in avoiding violations of
environmental laws and regulations relating to the handling and disposal of such
products in the future.
AVAILABLE INFORMATION
The Company makes available free of charge its annual report on Form 10-K,
quarterly reports on Form 10-Q and current reports on Form 8-K through a
hyperlink from the "Investor Relations" portion of its website, www.99only.com,
--------------
to the Securities and Exchange Commission's website, www.sec.gov. Such reports
-----------
should be available on the same day that they are electronically filed with or
furnished to the Securities and Exchange Commission by the Company.
ITEM 2. PROPERTIES
As of March 28, 2003, the Company owned 23 and leased 131 of its 154 store
locations. The Company also has escrow deposits on four additional locations for
future openings. The Company currently leases 12 store locations and a parking
lot associated with one of these stores from the Gold Family. Our annual rental
expense for these facilities totaled approximately $1.9 million, $1.9 million
and $2.2 million in 2000, 2001 and 2002, respectively. We believe that our lease
terms are just as favorable to us as they would be for an unrelated party. Under
our current policy, we enter into real estate transactions with our affiliates
only for the renewal or modification of existing leases and on occasions where
we determine that such transactions are in our best interests. Moreover, the
independent members of our Board of Directors must unanimously approve all real
estate transactions between us and our affiliates. They must also determine that
such transactions are equivalent to a negotiated arm's-length transaction with a
third party. We cannot guarantee that we will reach agreements with the Gold
family on renewal terms for the properties we currently lease from them. Also,
even if we agree to such terms, we cannot be certain that our independent
directors will approve them. If we fail to renew one of these leases, we could
be forced to relocate or close the leased store. Any relocations or closures we
experience will be costly and could adversely affect our business. One of our
outside directors, Ben Schwartz, is a trustee of a trust that owns a property on
which a single 99 Cents Only Stores is located. Management believes that the
Company's stable operating history, excellent credit history and ability to
generate substantial customer traffic give the Company significant leverage when
negotiating lease terms. Most of the Company's leases provide for fixed rents,
subject to periodic adjustments. Certain of the Company's store leases contain
provisions that grant the Company a right of first refusal to acquire the
subject site.
The following table sets forth, as of December 31, 2002, information
relating to the expiration dates of the Company's current stores leases:
EXPIRING EXPIRING EXPIRING EXPIRING
2003 2004-2006 2007-2009 2010 AND BEYOND
--------- --------- --------- ---------------
7(a) 49 35 39
(a) Includes two stores leased on a month-to-month basis.
The Company purchased its main warehouse, distribution and executive office
facility, located in the City of Commerce, California in 2000. The Company also
leases an additional 180,000 square feet of warehouse storage space adjacent to
its main distribution facility and 15,000 square feet of deli and frozen product
storage space which is also located in the vicinity.
On February 4, 2003 the Company acquired a 741,000 square foot distribution
center in Houston, to service its planned store expansion in Texas in 2003 and
beyond. See "Growth Strategy - Expansion in Texas."
ITEM 3. LEGAL PROCEEDINGS
The Company is periodically subject to legal actions, which arise in the
ordinary course of its business. The Company does not believe that any pending
action is material to its results of operations or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
-9-
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the New York Stock Exchange under
the symbol "NDN." The following table sets forth, for the calendar periods
indicated, the high and low closing prices per share of the Common Stock as
reported by the New York Stock Exchange. All stock prices have been restated to
reflect a four-for-three stock split effected in the form of a stock dividend
distributed on April 3, 2002.
Price Range
--------------
High Low
------ ------
2001:
-----
First Quarter. . . . . . . . . . . . $19.93 $13.35
Second Quarter . . . . . . . . . . . 23.04 16.28
Third Quarter. . . . . . . . . . . . 27.38 20.03
Fourth Quarter . . . . . . . . . . . 29.86 23.52
2002:
-----
First Quarter. . . . . . . . . . . . $28.75 $24.86
Second Quarter . . . . . . . . . . . 32.60 24.91
Third Quarter. . . . . . . . . . . . 25.49 20.70
Fourth Quarter . . . . . . . . . . . 29.80 20.31
2003:
-----
First Quarter through March 28, 2003 $28.48 $20.83
As of March 28, 2003, the Company had approximately 22,422 holders of the
Common Stock including 534 shareholders of record.
The Company has not paid any cash dividends with respect to the Common
Stock. The Company presently intends to retain future earnings to finance its
development and expansion and therefore does not anticipate the payment of any
cash dividends in the foreseeable future. Payment of future dividends, if any,
will depend upon future earnings and capital requirements of the Company and
other factors, which the Board of Directors considers appropriate.
The Company has one stock option plan (the 1996 Stock Option Plan). The
plan is a fixed plan, which provides for the granting of non-qualified and
incentive options to purchase up to 17,000,000 shares of common stock of which
6,199,566 are available for future option grants. Options may be granted to
officers, employees, directors and consultants. Grants may be at fair market
value at the date of grant or at a price determined by the compensation
committee consisting of four outside members of the board of directors (the
"Committee"). Options vest over a three-year period, one-third one year from the
date of grant and one third per year thereafter. Options expire ten years from
the date of grant. The Company accounts for its stock option plan under APB
Opinion No. 25 under which no compensation cost has been recognized in fiscal
2000, 2001 and 2002.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth, selected financial and operating data of
the Company for the periods indicated. The Consolidated Financial Statements for
years 1998 through 2001 were audited by Arthur Andersen LLP (Andersen) which has
ceased operations. A copy of the report previously issued by Andersen on our
financial statements as of December 31, 2000 and 2001 and for each of the three
years in the period ended December 31, 2001 is included elsewhere in this Form
10-K. Such report has not been reissued by Andersen. The following information
should be read in conjunction with "Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations" and "Item 8. Financial
Statements and Supplementary Data" of the Company and notes thereto included
elsewhere in this Form 10-K.
YEAR ENDED DECEMBER 31
-----------------------------------------------------
(Amounts in thousands, except per share and operating data)
Statements of Income Data: 1998 1999 2000 2001 2002
--------- --------- --------- --------- ---------
Net sales:
99 Cents Only Stores. . . . . . . . . . . $238,868 $312,306 $402,071 $522,019 $663,983
Bargain Wholesale (e) . . . . . . . . . . 53,202 47,652 49,876 56,250 49,959
--------- --------- --------- --------- ---------
Total sales . . . . . . . . . . . . . . . . 292,070 359,958 451,947 578,269 713,942
Cost of sales . . . . . . . . . . . . . . . . 183,044 218,496 275,395 350,421 427,356
--------- --------- --------- --------- ---------
Gross profit. . . . . . . . . . . . . . . . . 109,026 141,462 176,552 227,848 286,586
Selling, general and administrative expenses:
Operating expenses. . . . . . . . . . . . 62,424 80,089 107,981 141,544 178,374
Depreciation and amortization . . . . . . 4,506 5,927 8,666 12,354 17,711
--------- --------- --------- --------- ---------
Total operating expenses . . . . . . . . . 66,930 86,016 116,647 153,898 196,085
Operating income. . . . . . . . . . . . . . . 42,096 55,446 59,905 73,950 90,501
Other (income) net. . . . . . . . . . . . . . (1,428) (1,059) (3,617) (5,931) (4,847)
--------- --------- --------- --------- ---------
-10-
(CONTINUED FROM PREVIOUS PAGE)
AS OF DECEMBER 31
-------------------------------------------------------------
(Amounts in thousands, except per share and operating data)
1998 1999 2000 2001 2002
--------- ----------- ----------- ----------- -----------
Income from continuing operations before provision
for income taxes . . . . . . . . . . . . . . . . . 43,524 56,505 63,522 79,881 95,348
Provision for income taxes . . . . . . . . . . . . 17,032 22,367 24,664 31,438 36,374
--------- ----------- ----------- ----------- -----------
Income from continuing operations. . . . . . . . . $ 26,492 $ 34,138 $ 38,858 $ 48,443 $ 58,974
--------- ----------- ----------- ----------- -----------
Income (loss) from discontinued operations net of
income tax provision of $910 in 1998 and
income tax benefit of $2,111 and $700 in 1999
and 2000 respectively. . . . . . . . . . . . . . 201 (3,167) (1,050) - -
(Loss) on disposal of discontinued operations
including a provision of $1,200 for operating
losses during phase-out period, net of income
tax benefit of $2,613. . . . . . . . . . . . . . - (9,000) - - -
--------- ----------- ----------- ----------- -----------
Net income . . . . . . . . . . . . . . . . . . . . $ 26,693 $ 21,971 $ 37,808 $ 48,443 $ 58,974
========= =========== =========== =========== ===========
Earnings per common share from continuing
operations (d):
Basic. . . . . . . . . . . . . . . . . . . . . $ 0.41 $ 0.51 $ 0.58 $ 0.70 $ 0.84
Diluted. . . . . . . . . . . . . . . . . . . . $ 0.40 $ 0.50 $ 0.56 $ 0.69 $ 0.83
(Loss) per common share from discontinued
operations (d):
Basic. . . . . . . . . . . . . . . . . . . . . - ($0.05) ($0.02) - -
Diluted. . . . . . . . . . . . . . . . . . . . - ($0.05) ($0.02) - -
(Loss) per common share from disposal of
discontinued operations (d):
Basic. . . . . . . . . . . . . . . . . . . . . - ($0.13) - - -
Diluted. . . . . . . . . . . . . . . . . . . . - ($0.13) - - -
Earnings per common share (d):
Basic. . . . . . . . . . . . . . . . . . . . . $ 0.42 $ 0.33 $ 0.56 $ 0.70 $ 0.84
Diluted. . . . . . . . . . . . . . . . . . . . $ 0.41 $ 0.32 $ 0.55 $ 0.69 $ 0.83
Weighted average number of common shares
outstanding:
Basic. . . . . . . . . . . . . . . . . . . . . 64,075 66,487 67,650 68,815 69,938
Diluted. . . . . . . . . . . . . . . . . . . . 65,486 67,954 68,945 70,009 71,181
COMPANY OPERATING DATA:
- -----------------------
Sales Growth
99 Cents Only Stores . . . . . . . . . . . . . 28.4% 30.7% 28.7% 29.8% 27.2%
Bargain Wholesale (e). . . . . . . . . . . . . 18.7% (10.4)% 4.7% 12.8% (11.2)%
Total Company sales. . . . . . . . . . . . . . 26.5% 23.2% 25.6% 28.0% 23.5%
Gross margin . . . . . . . . . . . . . . . . . . . 37.3% 39.3% 39.1% 39.4% 40.1%
Operating margin . . . . . . . . . . . . . . . . . 14.4% 15.4% 13.3% 12.8% 12.7%
Income from continuing operations: . . . . . . . . 9.1% 9.5% 8.6% 8.4% 8.3%
RETAIL OPERATING DATA (A):
- --------------------------
99 Cents Only Stores at end of period. . . . . . . 64 78 98 123 151
Change in comparable stores
Net sales (b). . . . . . . . . . . . . . . . . . . 4.3% 6.1% 2.0% 5.9% 3.6%
Average net sales per store open the full year . . $ 4,147 $ 4,433 $ 4,487 $ 4,647 $ 4,750
Average net sales per estimated saleable square
foot (c). . . . . . . . . . . . . . . . . . . . . $ 335 $ 332 $ 318 $ 319 $ 309
Estimated saleable square footage at year end. . . 822,900 1,102,369 1,424,280 1,892,949 2,428,681
-11-
(CONTINUED FROM PREVIOUS PAGE)
AS OF DECEMBER 31,
------------------------------------------------
(Amounts in thousands, except per share and operating data)
1998 1999 2000 2001 2002
-------- -------- -------- -------- --------
Balance Sheet Data:
Working capital. . . . . . . . . . . . . . . . . . . $ 81,439 $105,637 $166,779 $194,302 $206,486
Total assets . . . . . . . . . . . . . . . . . . . . 194,167 224,015 277,285 352,158 439,910
Capital lease obligation, including current portion 8,005 7,251 - 1,677 1,637
Total shareholders' equity . . . . . . . . . . . . . $164,365 $195,540 $253,533 $319,643 $396,615
(a) Includes retail operating data solely for the Company's 99 Cents Only
Stores.
(b) Change in comparable stores net sales compares net sales for all stores
open at least 15 months.
(c) Computed based upon estimated total saleable square footage of stores open
for the entire period.
(d) All earnings per share amounts have been restated to reflect the
four-for-three stock split distributed on April 3, 2002.
(e) In 1998, Bargain Wholesale sales includes $12.0 million inter-company sales
to Universal billed at cost. In 2001 Bargain Wholesale sales include $4.7
million of sales to Universal billed at a 10% mark-up
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following management's discussion and analysis should be read in
connection with "Item 6. Selected Financial Data," and "Item 8. Financial
Statements and Supplementary Data."
GENERAL
99 Cents Only Stores has increased its net sales, operating income and
income from continuing operations in each of the last five years. In 2002, it
had net sales of $713.9 million, operating income of $90.5 million and income
from continuing operations of $59.0 million, representing a 23.5%, 22.4% and
21.7% increase over 2001, respectively. From 1998 through 2002, the Company had
a compound annual growth rate in net sales, operating income and income from
continuing operations of 25.3%, 23.7% and 25.5%, respectively.
During the three years in the period ending December 31, 2002, average net
sales per estimated saleable square foot (computed on 99 Cents Only Stores open
for a full year) declined from $319 per square foot to $309 per square foot.
This trend reflects the Company's determination to target larger locations for
new store development. Existing stores average approximately 20,500 gross square
feet. From January 1, 2000 through December 31, 2002, the Company opened 74 new
stores (including one relocation in 2001) that average approximately 22,500
gross square feet. The Company currently targets new store locations between
18,000 and 28,000 gross square feet. Although it is the Company's experience
that larger stores generally have lower average net sales per square foot than
smaller stores, larger stores generally achieve higher average annual store
revenues and operating income.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements requires management to make
estimates and assumptions that affect reported earnings. These estimates and
assumptions are evaluated on an on-going basis and are based on historical
experience and on other factors that management believes are reasonable.
Estimates and assumptions include, but are not limited to, the areas of customer
receivables, inventories, self-insurance reserves, and commitments and
contingencies.
The Company believes that the following represent the areas where more
critical estimates and assumptions are used in the preparation of the financial
statements:
Investments: The Company records its investments, which are comprised
primarily of investment grade federal and municipal bonds and commercial paper,
at fair value. Any premium or discount recognized in connection with the
purchase of an investment is amortized over the term of the investment. The
Company accounts for its investments in marketable securities in accordance with
Financial Accounting Standards Board No. 115 as trading securities.
Long-lived asset impairment: The Company records impairments when the
carrying amounts of long-lived assets are determined not to be recoverable.
Impairment is assessed and measured by an estimate of future cash flows expected
to result from the use of the asset and its eventual disposition. Changes in
market conditions can impact estimated future cash flows from use of these
assets and additional impairments may be required should such changes occur.
Self-insurance reserves: The Company is self-insured in relation to
worker's compensation claims in California. The Company provides for losses of
estimated known and incurred but not reported insurance claims. These estimates
are based on reported claims and actuarial valuations.
-12-
Should a greater amount of claims occur compared to the estimates, reserves
recorded may not be sufficient and additional expenses, which may be
significant, could be incurred.
UNIVERSAL INTERNATIONAL (DISCONTINUED OPERATIONS)
In December 1999, the Company determined it would be in its best interest,
and that of its shareholders, to focus its efforts on increasing the growth rate
of 99 Cents Only Stores. In conjunction with its revised growth strategy, the
Company decided to sell its Universal International, Inc. and Odd's-n-End's,
Inc. subsidiaries (together "Universal"). Universal operated a multi-price point
variety chain, with 65 stores located in the Midwest, Texas and New York, under
the trade names Only Deals and Odd's-N-End's. Among other factors at that time,
the Company considered its successful opening of its first 99 Cents Only Stores
outside the state of California, in Las Vegas, Nevada. Given the success of the
Las Vegas, Nevada stores, the Company believed that the 99 Cents Only Stores
concept was portable to areas outside the state of California. As a result, the
Company has focused greater management resources to increasing its store growth
rate and has expanded more rapidly in Nevada and Arizona and will be expanding
into Texas in 2003.
The Company adopted a definitive plan to sell Universal within one year, as
set forth by guidelines for the accounting treatment of discontinued operations.
The Company engaged an investment-banking firm to evaluate and identify
potential buyers for the Universal business and expected to sell Universal
within the one-year time frame. The investment banking firm's marketing process
focused upon selling the business as a going concern. From June 2000 through
August 2000, sales presentations were delivered to both strategic buyers and
financial buyers. This process did not generate the expected interest level from
potential buyers that had been anticipated. The highest offer for the Universal
business was significantly less than the Company's expectations. As a result of
the difficulties encountered in trying to sell Universal and the necessity to
complete the process by December 31, 2000, it was decided by the Board of
Directors to be in the Company's and the shareholders' best interest to sell
Universal for the Company's carrying value as of the close of business on
September 30, 2000 to Universal Deals, Inc. and Universal Odd's-n-End's, Inc.,
both of which are owned 100% by David and Sherry Gold, both significant
shareholders of 99 Cents Only Stores. Mr. Gold is also Chairman and CEO of 99
Cents Only Stores. The sale was effective as of the close of business on
September 30, 2000. The purchase price for Universal was paid in cash and was
equal to the Company's carrying book value of the assets of Universal at
September 30, 2000 or $33.9 million. The net assets at September 30, 2000
included $29.2 million in inventory, net fixed assets of $7.6 million and $0.6
million of other assets. These assets were offset by $3.5 million of accounts
payable, accrued and other liabilities. In connection with this transaction, 99
Cents Only Stores provided certain ongoing administrative services to Universal
in 2000 and 2001 pursuant to a service agreement for a management fee of 6% of
Universal sales revenues. During fiscal year 2000, the Company recorded an
additional net loss from discontinued operations of $1.1 million, net of tax
benefit of $0.7 million, for operating losses incurred through the date of sale,
in excess of the amounts originally provided in 1999. In the fourth quarter of
2000, the Company received $1.3 million in management fees under the service
agreement with Universal. The Company also received $0.4 million in lease
payments for rental of a distribution facility to Universal. During 2001, the
Company received $3.7 million in fees under the service agreement, $1.4 million
in lease payments and sold $4.7 million in merchandise at a 10% mark-up. In 2002
the Company received $1.5 million in management fees under the service agreement
from Universal and $1.4 million in lease payments. It also purchased $0.4
million of closeout inventory from Universal. Resolution of Universal post
closing business issues has required the extension of the service agreement and
lease arrangement with 99 Cents Only Stores to a date ending some time in 2003.
The following table sets forth for the periods indicated, certain selected
income statement data, including such data as a percentage of net sales:
YEARS ENDED DECEMBER 31
------------------------------------------------------
(Amounts in thousands)
2000 2001 2002
--------- --------- ---------
Net Sales:
99 Cents Only Stores. . . . . . . . . . . . . $402,071 89.0% $522,019 90.3% $663,983 93.0%
Bargain Wholesale . . . . . . . . . . . . . . 49,876 11.0 56,250 9.7 49,959 7.0
--------- ------ --------- ------ --------- ------
Total . . . . . . . . . . . . . . . . . . . . 451,947 100.0 578,269 100.0 713,942 100.0
Cost of sales . . . . . . . . . . . . . . . . 275,395 60.9 350,421 60.6 427,356 59.9
--------- ------ --------- ------ --------- ------
Gross profit. . . . . . . . . . . . . . . . . 176,552 39.1 227,848 39.4 286,586 40.1
Selling, general and administrative expenses:
Operating expenses. . . . . . . . . . . . . . 107,981 23.9 141,544 24.5 178,374 24.9
Depreciation and amortization . . . . . . . . 8,666 1.9 12,354 2.1 17,711 2.5
--------- ------ --------- ------ --------- ------
Total . . . . . . . . . . . . . . . . . . . . 116,647 25.8 153,898 26.6 196,085 27.4
Operating income. . . . . . . . . . . . . . . 59,905 13.3 73,950 12.8 90,501 12.7
Other (income) expense, net . . . . . . . . . (3,617) (0.8) (5,931) (1.0) (4,847) (0.7)
--------- ------ --------- ------ --------- ------
Income from continuing operations before
provision for income taxes . . . . . . . . . 63,522 14.1 79,881 13.8 95,348 13.4
Provision for income taxes. . . . . . . . . . 24,664 5.5 31,438 5.4 36,374 5.1
--------- ------ --------- ------ --------- ------
Income from continuing operations . . . . . . 38,858 8.6 48,443 8.4 58,974 8.3
(Loss) from discontinued operations, net of
income tax benefit of $700 in 2000. . . . . (1,050) (0.2) - - - -
--------- ------ --------- ------ --------- ------
Net income. . . . . . . . . . . . . . . . . . $ 37,808 8.4% $ 48,443 8.4% $ 58,974 8.3%
========= ====== ========= ====== ========= ======
-13-
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Net Sales. Total net sales increased $135.7 million, or 23.5%, from $578.3
million in 2001 to $713.9 million in 2002. 99 Cents Only Stores net sales
increased $142.0 million, or 27.2%, from $522.0 million in 2001 to $664.0
million in 2002. Bargain Wholesale net sales decreased $6.3 million, or 11.2%,
from $56.3 million in 2001 to $50.0 million in 2002. The increase in 99 Cents
Only Stores net sales was attributed to the net effect of 28 new stores opened
in 2002 and the full year effect of 25 net stores opened in 2001. Comparable
stores net sales increased 3.6% from 2001 to 2002. Net sales in 2003 are
expected to be favorably impacted by the full year effect of the 28 new stores
opened in 2002 (constituting an increase in 536,000 saleable square feet) and
the estimated 38 new 99 Cents Only Stores expected to be opened in 2003. The
decrease in Bargain Wholesale net sales was primarily attributed to the absence
of sales to Universal, which were $4.7 million in 2001.
Gross profit. Gross profit, which consists of total net sales, less cost of
sales, increased $58.7 million, or 25.8%, from $227.8 million in 2001 to $286.6
million in 2002. The increase in gross profit dollars was primarily due to
higher sales volume. As a percentage of net sales, gross profit was 40.1% in
2002 versus 39.4% in 2001. This 0.7% variation results from the change in the
ratio of retail versus wholesale sales. The retail gross margin increased to
41.7% of sales in 2002 versus 41.6% in 2001. This was due to product cost and
mix factors. The wholesale margin was 20.1% in 2002 versus 19.3% in 2001. This
change resulted from the absence of $4.7 million in sales to Universal, which
carried a contract margin of 10%.
Selling, general and administrative. Selling, general and administrative
expenses ("SG&A"), which include operating expenses and depreciation and
amortization, increased $42.2 million, or 27.4%, from $153.9 million in 2001 to
$196.1 million in 2002. The increase over 2001 is associated with fiscal year
2002 new store growth and the full year effect of 2001 new store additions and
an incremental provision for workers compensation of $2.2 million. SG&A
increased as a percentage of net sales from 26.6% in 2001 to 27.4% in 2002. The
increase in SG&A expenses in 2002 was offset by $1.5 million in management fees
from Universal (see Universal International above). The increases in SG&A in
2002 were directly attributable to 28 new store openings and to increases in
utility costs, minimum wage increases and the additional field and corporate
support staff hired to support the future new store growth and expansion outside
of the state of California. Additional key staff positions were filled in retail
management, information systems, real estate, distribution, human resources and
buying.
Operating income. Operating income increased $16.6 million, or 22.4%, from
$74.0 million in 2001 to $90.5 million in 2002. Operating income as a percentage
of net sales was 12.8% in 2001 and 12.7% in 2002 primarily due to the increase
in the operating costs discussed above.
Other (income) expense. Other (income) expense relates primarily to the
interest income on the Company's marketable securities, net of interest expense
on the Company's capitalized leases. Interest expense was $0.1 million in 2001
and in 2002. The Company had no bank debt during 2002 or 2001. Interest income
earned on the Company's marketable securities was $3.5 million in 2002 and $4.6
million in 2001. At December 31, 2002, the Company held $146.9 million in
short-term investments and $37.2 million in long-term investments. The Company's
short-term investments are comprised primarily of investment grade federal and
municipal bonds and commercial paper, all with short-term maturities. The
Company generally holds investments until maturity. Also included in both 2002
and 2001 is $1.4 million of income under a lease agreement with Universal for a
distribution facility.
Provision for income taxes. The provision for income taxes in 2002 was
$36.4 million, or 5.1% of net sales, compared to $31.4 million, or 5.4% of net
sales in 2001. The effective combined federal and state rates of the provision
for income taxes were 39.3% and 38.1% in 2001 and 2002, respectively. The
effective combined federal and state tax rates are less than the statutory rates
in each period and were calculated to reflect estimated tax rates after giving
effect for tax credits and the estimated versus the actual tax rate
differential. See Note 6 of "Notes to Financial Statements."
Net Income. As a result of the items discussed above, net income from
continuing operations increased $10.5 million, or 21.7%, from $48.4 million in
2001 to $59.0 million in 2002. Net income as a percentage of net sales was 8.3%
in 2002 and 8.4% in 2001.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Net Sales. Total net sales increased $126.4 million, or 28.0%, from $451.9
million in 2000 to $578.3 million in 2001. 99 Cents Only Stores net sales
increased approximately $119.9 million, or 29.8%, from $402.1 million in 2000 to
$522.0 million in 2001. Bargain Wholesale net sales increased approximately $6.4
million, or 12.8%, from $49.9 million in 2000 to $56.3 million in 2001. The
increase in 99 Cents Only Stores net sales was attributed to the net effect of
25 net new stores opened in 2001 and the full year effect of 20 stores opened in
2000. Comparable stores net sales increased 5.9% from 2000 to 2001. Net sales in
2002 are expected to be favorably impacted by the full year effect of the 25 net
new stores opened in 2001 (constituting an increase in 469,000 saleable square
feet) and the estimated 32 new 99 Cents Only Stores expected to be opened in
2002. The increase in Bargain Wholesale net sales was primarily attributed to
$4.7 million in shipments to Universal.
Gross profit. Gross profit, which consists of total net sales, less cost of
sales, increased approximately $51.2 million, or 29.0%, from $176.6 million in
2000 to $227.8 million in 2001. The increase in gross profit dollars was
primarily due to higher sales volume. As a percentage of net sales, gross profit
was 39.4% in 2001 versus 39.1% in 2000. This 0.3% variation results from the
ratio of retail versus wholesale sales. The retail gross margin increased to
41.6% of sales in 2001 versus 41.3% in 2000. This was due to product cost and
mix factors. The wholesale margin was 19.3% in 2001 versus 21.0% in 2000. This
change results from the $4.7 million in shipments to Universal at a contract
margin of 10%.
Selling, general and administrative. Selling, general and administrative
expenses ("SG&A"), which include operating expenses and depreciation and
amortization, increased $37.3 million, or 32.0%, from $116.6 million in 2000 to
$153.9 million in 2001. The increase over 2000 is associated with year 2001 new
store growth and the full year effect of fiscal year 2000 new stores additions
and an incremental provision for workers compensation of $1.8 million. SG&A
increased as a percentage of net sales from 25.8% in 2000 to 26.6% in 2001. The
increase in SG&A expenses in 2001 was offset by $3.7 million in management fees
from Universal (see Universal International above). The increases in SG&A in
2001 were
-14-
directly attributable to 25 net new store openings and to increases in utility
costs, minimum wage increases and the additional field and corporate support
staff hired to support the future new store growth and expansion outside of the
state of California. Additional key staff positions were filled in retail
management, information systems, real estate, distribution, human resources and
buying.
Operating income. Operating income increased $14.1 million, or 23.5%, from
$59.9 million in the 2000 period to $74.0 million in 2001. Operating income as a
percentage of net sales was 13.3% in 2000 and 12.8% in 2001 primarily due to the
increase in the operating costs discussed above.
Other (income) expense. Other (income) expense relates primarily to the
interest income on the Company's marketable securities, net of interest expense
on the Company's capitalized leases. Interest expense was $0.7 million in 2000
and $0.1 million in 2001. The Company had no bank debt during 2001 or 2000.
Interest income earned on the Company's marketable securities was $4.6 million
in 2001 and $4.0 million in 2000. At December 31, 2001, the Company held $147.6
million in short-term investments and $0.5 million in long-term investments. The
Company's short-term investments are comprised primarily of investment grade
federal and municipal bonds and commercial paper, all with short-term
maturities. The Company generally holds investments until maturity. Also
included in 2001 and 2000 is $1.4 million and $0.4 million respectively, of
income under a lease agreement with Universal for a distribution facility.
Provision for income taxes. The provision for income taxes in 2001 was
$31.4 million, or 5.4% of net sales, compared to $24.7 million, or 5.5% of net
sales in 2000. The effective combined federal and state rates of the provision
for income taxes were 39.4% and 38.8% in 2001 and 2000, respectively. The
effective combined federal and state rates are less than the statutory rates in
each period due to the benefit of certain tax-exempt interest and welfare to
work tax credits. See Note 6 of "Notes to Financial Statements."
Income from continuing operations. As a result of the items discussed
above, net income from continuing operations increased $9.5 million, or 24.4%,
from $38.9 million in 2000 to $48.4 million in 2001. Income from continuing
operations as a percentage of net sales was 8.4% in 2001 and 8.6% in 2000.
Discontinued operations. The Board of Directors approved the sale of
Universal for an amount equal to the carrying value of the Company's investment,
$33.9 million, as of the close of business on September 30, 2000. The Company
recorded an additional loss from discontinued operations of $1.1 million, net of
tax benefit of $0.7 million, for Universal and Odd's-n-End's operating losses
incurred through the date of sale, in excess of the amounts originally provided
in 1999. No additional losses for the discontinued operations were recorded in
2001.
Net Income. As a result of the items discussed above, net income increased
$10.6 million, or 28.1%, from $37.8 million in 2000 to $48.4 million in 2001.
Net income as a percentage of net sales was 8.4% in 2001 and 2000.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company has funded its operations principally from
cash provided by operations, and has not generally relied upon external sources
of financing. The Company's capital requirements result primarily from purchases
of inventory, expenditures related to new store openings and working capital
requirements for new and existing stores. The Company takes advantage of
close-out and other special-situation opportunities, which frequently result in
large volume purchases, and as a consequence, its cash requirements are not
constant or predictable during the year and can be affected by the timing and
size of its purchases.
Net cash provided by operations during 2001 and 2002 was $67.1 and $72.3
million, respectively, consisting primarily of $64.2 million and $78.3 million
of net income adjusted for non-cash items. In 2001, the Company provided $3.0
million in working capital and other activities and in 2002, the Company used
$5.5 million in working capital and other activities. Net cash used in working
capital and other activities primarily reflects the increases in inventories in
the amount of $2.8 million and $16.6 million in 2001 and 2002, respectively.
Net cash used in investing activities during 2001 and 2002 was $87.4 and
$77.5 million. Net cash used in investing activities represents the following:
In 2001, the Company used $46.9 million for the purchase of property and
equipment (including $17.9 million used for the purchase of new store
locations), $4.7 million in investments in two partnerships for the purpose of
obtaining leases on two store locations and $35.8 million for the purchase of
short-term investments. The Company did not repurchase any of its shares under
its stock repurchase program in 2001, which expired during 2002. In 2002, the
Company used $41.6 million for the purchase of property and equipment (including
$19.6 million for the purchase of new store locations) and used $36.0 million
for the purchase of short-term investments.
Net cash provided by financing activities during 2001 and 2002 was $11.4
and $12.9 million, which represents the proceeds from the exercise of
non-qualified stock options. The Company does not maintain any credit facilities
with any bank. However, the Company maintains a cash deposit of approximately
$6.7 million for self-insured workers compensation.
The Company plans to open 38 new 99 Cents Only Stores in 2003. The average
investment per new store opened in 2002, including leasehold improvements,
furniture, fixtures and equipment, inventory and pre-opening expenses, was
approximately $660,000. The Company does not capitalize pre-opening expenses.
The Company's cash needs for new store openings are expected to total
approximately $37.0 million in 2003 including acquired properties. The Company's
total planned expenditures in 2003 for additions to fixtures and leasehold
improvements of existing stores as well as for distribution, systems, expansion
and replacement will be approximately $10.0 million. The Company believes that
its total capital expenditure requirements (including new store openings) will
approximate $47.0 million in 2003. The Company intends to fund its liquidity
requirements in 2003 out of net cash provided by operations, short-term
investments and cash on hand. In addition to the above planned expenditures, on
February 4, 2003 the Company announced the purchase of a 741,000 square foot
distribution center in Houston, to service its planned store expansion in Texas
in 2003 and beyond. The facility was acquired for $23 million in cash and is
fully racked including a pick to belt conveyor
-15-
system. It also contains built in refrigerated and frozen storage space. The
Company has announced that it plans to open approximately 15 of its planned
total 38 new store additions in 2003 in the Houston and surrounding area.
CONTRACTUAL OBLIGATIONS
The following table summarizes our consolidated contractual obligations (in
thousands) as of December 31, 2002. These should be read in conjunction with
"Note 8. Commitments and Contingencies"
Contractual Obligations 2003 2004 2005 2006 2007 Thereafter Total
------- ------- ------- ------- ------- ----------- --------
Capital Lease Obligations $ 169 $ 169 $ 169 $ 169 $ 169 $ 1,525 $ 2,370
Operating Lease Obligations 21,829 20,714 18,207 15,432 11,650 38,611 126,443
------- ------- ------- ------- ------- ----------- --------
$21,998 $20,883 $18,376 $15,601 $11,819 $ 40,136 $128,813
======= ======= ======= ======= ======= =========== ========
LEASE COMMITMENTS
The Company leases various facilities under operating leases except for
two, which were classified as capital leases and will expire at various dates
through 2018. Some of the lease agreements contain renewal options and/or
provide for scheduled increases or increases based on the Consumer Price Index.
Total minimum lease payments under each of these lease agreements, including
scheduled increases, are charged to operations on a straight-line basis over the
life of each respective lease. Certain leases require the payment of property
taxes, maintenance and insurance. Rental expense charged to operations in 2000,
2001 and 2002 was approximately $15.6 million, $19.4 million and $24.9 million,
respectively. The Company typically seeks leases with an initial five-year to
ten-year term and with one or more five-year renewal options. See "Item 2.
Properties." Most leases have renewal options ranging from three to ten years.
SEASONALITY AND QUARTERLY FLUCTUATIONS
The Company has historically experienced and expects to continue to
experience some seasonal fluctuations in its net sales, operating income and net
income. The highest sales periods for the Company are the Christmas and
Halloween seasons. A greater amount of the Company's net sales and operating and
net income is generally realized during the fourth quarter. The Company's
quarterly results of operations may also fluctuate significantly as a result of
a variety of other factors, including the timing of certain holidays (e.g.,
Easter) and the timing of new store openings and the merchandise mix.
SUPPLEMENTARY FINANCIAL INFORMATION
The following table sets forth certain unaudited results of operations for each
quarter during 2001 and 2002. The unaudited information has been prepared on the
same basis as the audited financial statements appearing elsewhere in this
report and includes all adjustments, which management considers necessary for a
fair statement of the financial data shown. The operating results for any
quarter are not necessarily indicative of the results to be attained for any
future period. All earnings per share amounts have been restated to reflect the
four-for-three stock split distributed on April 3, 2002.
YEAR ENDED DECEMBER 31, 2001 YEAR ENDED DECEMBER 31, 2002
------------------------------------------ ------------------------------------------
(Amounts in thousands except per share data)
1ST 2ND 3RD 4TH 1ST 2ND 3RD 4TH
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
--------- --------- --------- --------- --------- --------- --------- ---------
Net sales:
99 Cents Only Stores. . . . $110,212 $122,522 $130,799 $158,486 $149,647 $155,436 $160,424 $198,476
Bargain Wholesale . . . . . 14,758 13,852 13,223 14,417 13,457 12,426 11,839 12,237
Total . . . . . . . . . . 124,970 136,374 144,022 172,903 163,104 167,862 172,263 210,713
Gross profit . . . . . . . . . 48,071 53,179 56,271 70,327 64,242 67,564 68,755 86,025
Operating income . . . . . . . 14,605 16,465 16,763 26,117 19,320 21,024 20,607 29,550
Income from continuing
operations . . . . . . . . . . 9,964 10,929 11,168 16,382 12,470 13,519 13,255 19,730
Net income . . . . . . . . . . $ 9,964 $ 10,929 $ 11,168 $ 16,382 $ 12,470 $ 13,519 $ 13,255 $ 19,730
Earnings per common share
from continuing operations:
Basic . . . . . . . . . . . $ 0.14 $ 0.16 $ 0.16 $ 0.24 $ 0.18 $ 0.19 $ 0.19 $ 0.28
Diluted . . . . . . . . . . $ 0.14 $ 0.16 $ 0.16 $ 0.23 $ 0.18 $ 0.19 $ 0.19 $ 0.28
-16-
(CONTINUED FROM PREVIOUS PAGE)
Net earnings per share:
Basic . . . . . . . . . . . $ 0.14 $ 0.16 $ 0.16 $ 0.24 $ 0.18 $ 0.19 $ 0.19 $ 0.28
Diluted . . . . . . . . . . $ 0.14 $ 0.16 $ 0.16 $ 0.23 $ 0.18 $ 0.19 $ 0.19 $ 0.28
Shares outstanding:
Basic . . . . . . . . . . . 68,403 68,506 68,995 69,325 69,558 69,888 70,043 70,278
Diluted . . . . . . . . . . 69,183 69,499 70,369 70,780 70,925 71,275 71,217 71,362
Percent of net sales:
Net sales:
99 Cents Only Stores. . . . 88.2% 89.8% 90.8% 91.7% 91.7% 92.6% 93.1% 94.2%
Bargain Wholesale . . . . . 11.8 10.2 9.2 8.3 8.3 7.4 6.9 5.8
Total. . . . . . . . . . 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Gross profit . . . . . . . . . 38.5 39.0 39.1 40.7 39.4 40.2 39.9 40.8
Operating income . . . . . . . 11.7 12.1 11.7 15.1 11.8 12.5 12.0 14.0
Income from continuing
operations . . . . . . . . . . 8.0% 8.0% 7.8% 9.5% 7.6% 8.1% 7.7% 9.4%
NEW AUTHORITATIVE PRONOUNCEMENTS
In June 2001, the FASB approved two final statements: SFAS No. 141,
"Business Combinations," which provides guidance on the accounting for business
combinations and was effective July 1, 2001, and SFAS No. 142, "Goodwill and
Other Intangible Assets," which defines when and how goodwill and other
intangible assets are amortized and was effective as of January 1, 2002. These
statements did not have an impact on the Company's financial position or results
of operations.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations" (SFAS 143). This statement addresses financial
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement cost. SFAS 143 is
effective for financial statements issued for fiscal years beginning after June
15, 2002. The adoption of SFAS 143 did not have an impact on the Company's
financial position or results of operations.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" (SFAS 144). This statement
addresses financial accounting and reporting for long-lived assets and retains
requirements to recognize an impairment loss if the carrying value is not
recoverable from its undiscounted cash flows and to measure an impairment loss
as the difference between the carrying value and the fair value of the asset.
SFAS 144 was effective for the financial statements issued for fiscal years
beginning after December 15, 2001 and interim periods within those fiscal years.
The adoption of SFAS 144 did not have an impact on the Company's financial
position or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (SFAS 146). This statement
requires the recognition of costs associated with exit or disposal activities
when they are incurred rather than at the date of a commitment to an exit or
disposal plan. This statement is effective for exit or disposal activities
initiated after December 31, 2002 and is not expected to materially impact the
Company.
In November 2002, the Financial Accounting Standards Board issued FASB
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45").
FIN 45 requires a guarantor to recognize a liability at the inception of a
guarantee equal to the fair value of the obligation undertaken and elaborates on
the disclosures to be made by the guarantor. The disclosure requirements of FIN
45 are required for the fiscal year ended December 31, 2002. The recognition
and measurement provisions of FIN 45 are effective, on a prospective basis, for
guarantees issued by the Company beginning in fiscal 2003. The adoption of FIN
45 is not expected to have a material impact on the Company's financial position
or results of operations.
In December, 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure" (SFAS 148) - an amendment
of SFAS 123 "Accounting for Stock -Based Compensation". The standard is
intended to encourage the adoption of the accounting provisions of SFAS 123. It
is also intended to address constituent concerns about the so-called "ramp-up
effect" on net income that resulted from the application of the transition
guidance originally required by SFAS 123. The transition and annual disclosure
provisions of SFAS 148 are effective for fiscal years ending after December 15,
2002. Under the provisions of SFAS 148, companies that choose to adopt the
accounting provisions of SFAS 123 will be permitted to select from three
transition methods. The Company continues to recognize stock based employee
compensation under APB Opinion No. 25.
RISK FACTORS
INFLATION MAY AFFECT OUR ABILITY TO SELL MERCHANDISE AT THE 99 CENTS PRICE POINT
The Company's ability to provide quality merchandise at the 99 cents price
point is subject to certain economic factors, which are beyond the Company's
control, including inflation. Inflation could have a material adverse effect on
the Company's business and results of operations, especially given the
constraints on the Company to pass on any incremental costs due to price
increases or other factors. The Company believes that it will be able to respond
to ordinary price increases resulting from inflationary pressures by adjusting
the number of items sold at the single price point (e.g., two items for 99 cents
instead of three items for 99 cents) and by changing its selection of
merchandise. Nevertheless, a sustained trend
-17-
of significantly increased inflationary pressure could require the Company to
abandon its single price point of 99 cents per item, which could have a
material adverse effect on the Company's business and results of
operations. See also "We are vulnerable to uncertain economic factors and
changes in the minimum wage" for a discussion of additional risks attendant to
inflationary conditions.
WE DEPEND ON NEW STORE OPENINGS FOR FUTURE GROWTH
Our operating results depend largely on our ability to open and operate new
stores successfully and to manage a larger business profitably. In 2000, 2001
and 2002, we opened 20, 26 and 28 99 Cents Only Stores, respectively (20, 25 and
28 stores respectively, net of relocated stores). As of March 28, 2003, we
opened three stores and expect to open 35 additional stores during the remainder
of 2003 to meet a growth rate of 25%. We also plan to grow retail square footage
at a rate of approximately 25% per year. Our strategy depends on many factors,
including our ability to identify suitable markets and sites for our new stores,
negotiate leases with acceptable terms, refurbish stores, upgrade our financial
and management information systems and controls and manage our operating
expenses. In addition, we must be able to continue to hire, train, motivate and
retain competent managers and store personnel. Many of these factors are beyond
our control. As a result, we cannot assure you that we will be able to achieve
our expansion goals. Any failure by us to achieve our expansion goals on a
timely basis, obtain acceptance in markets in which we currently have limited or
no presence, attract and retain management and other qualified personnel,
appropriately upgrade our financial and management information systems and
control or manage operating expenses could adversely affect our future operating
results and our ability to execute our business strategy.
We also cannot assure you that we will improve our results of operations
when we open new stores. A variety of factors, including store location, store
size, rental terms, the level of store sales and the level of initial
advertising influence if and when a store becomes profitable. Assuming that our
planned expansion occurs as anticipated, our store base will include a
relatively high proportion of stores with relatively short operating histories.
We cannot assure you that our new stores will achieve the sales per saleable
square foot and store-level operating margins currently achieved at our existing
stores. If our new stores on average fail to achieve these results, our planned
expansion could produce a decrease in our overall sales per saleable square foot
and store-level operating margins. Increases in the level of advertising and
pre-opening expenses associated with the opening of new stores could also
contribute to a decrease in our operating margins. Finally, the opening of new
stores in existing markets has in the past and may in the future reduce retail
sales of existing stores in those markets, negatively affecting comparable store
sales.
OUR OPERATIONS ARE CONCENTRATED IN CALIFORNIA
Currently, all but 20 of our 99 Cents Only Stores are located in
California. The Company operates nine stores in Las Vegas, Nevada and 11 stores
in Arizona. The Company expects that it will continue to open additional stores
in California, as well as in Nevada, Arizona and Texas. Accordingly, our results
of operations and financial condition largely depend upon trends in the
California economy. If retail spending declines due to economic slow-down or
recession in California, we cannot assure you that our operations will not be
negatively impacted.
In addition, California historically has been vulnerable to certain natural
disasters and other risks, such as earthquakes, fires, floods and civil
disturbance. At times, these events have disrupted the local economy. These
events could also pose physical risks to our properties.
WE COULD EXPERIENCE DISRUPTIONS IN RECEIVING AND DISTRIBUTION
Our success depends upon whether our receiving and shipment schedules are
organized and well managed. As we continue to grow, we may face unexpected
demands on our warehouse operations, as well as unexpected demands on our
transportation network, which could cause delays in delivery of merchandise to
or from our warehouses to our stores. A fire, earthquake or other disaster at
our warehouses could hurt our business, financial condition and results of
operations, particularly because much of our merchandise consists of closeouts
and other irreplaceable products. Although we maintain standard property and
business interruption insurance, we do not have earthquake insurance on our
properties. Although we try to limit our risk of exposure to potential product
liability claims, we do not know if the limitations in our agreements are
enforceable. We maintain insurance covering damage from use of our products. If
any product liability claim is successful and large enough, our business could
suffer.
WE DEPEND UPON OUR RELATIONSHIPS WITH OUR SUPPLIERS AND THE AVAILABILITY OF
CLOSE-OUT AND SPECIAL-SITUATION MERCHANDISE
Our success depends in large part on our ability to locate and purchase
quality close-out and special-situation merchandise at attractive prices. This
helps us maintain a mix of name-brand and other merchandise at the 99 cents
price point. We cannot be certain that such merchandise will continue to be
available in the future. Further, we may not be able to find and purchase
merchandise in quantities necessary to accommodate our growth. Additionally, our
suppliers sometimes restrict the advertising, promotion and method of
distribution of their merchandise. These restrictions in turn may make it more
difficult for us to quickly sell these items from our inventory. Although we
believe our relationships with our suppliers are good, we do not have long-term
agreements with any supplier. As a result, we must continuously seek out buying
opportunities from our existing suppliers and from new sources. We compete for
these opportunities with other wholesalers and retailers, discount and
deep-discount chains, mass merchandisers, food markets, drug chains, club stores
and various privately-held companies and individuals. Although we do not depend
on any single supplier or group of suppliers and believe we can successfully
compete in seeking out new suppliers, a disruption in the availability of
merchandise at attractive prices could impair our business.
WE PURCHASE IN LARGE VOLUMES AND OUR INVENTORY IS HIGHLY CONCENTRATED
To obtain inventory at attractive prices, we take advantage of large volume
purchases, close-outs and other special situations. As a result, our inventory
levels are generally higher than other discount retailers. At December 31, 2000,
2001 and 2002, we recorded net inventory of $63.7 million, $66.5 million and
$83.2 million respectively. We periodically review the net realizable value of
our inventory and make adjustments to its carrying value when appropriate. The
current carrying value of our inventory reflects our belief that we will realize
the net values recorded on our
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balance sheet. However, we may not be able to do so. If we sell large portions
of our inventory at amounts less than their carrying value or if we write down a
significant part of our inventory, our cost of sales, gross profit, operating
income and net income could suffer greatly during the period in which such event
or events occur.
WE FACE STRONG COMPETITION
We compete in both the acquisition of inventory and sale of merchandise
with other wholesalers, discount and deep-discount stores, single price point
merchandisers, mass merchandisers, food markets, drug chains, club stores and
other retailers. Our industry competitors also include many privately held
companies and individuals. At times, these competitors are also customers of our
Bargain Wholesale division. In the future, new companies may also enter the
deep-discount retail industry. Additionally, we currently face increasing
competition for the purchase of quality close-out and other special-situation
merchandise. Some of our competitors have substantially greater financial
resources and buying power than us. Our capability to compete will depend on
many factors including our ability to successfully purchase and resell
merchandise at lower prices than our competitors. We cannot assure you that we
will be able to compete successfully against our current and future competitors.
WE ARE VULNERABLE TO UNCERTAIN ECONOMIC FACTORS, CHANGES IN THE MINIMUM WAGE AND
WORKERS' COMPENSATION
Our ability to provide quality merchandise at our 99 cents price point
could be hindered by certain economic factors beyond our control, including but
not limited to:
- - increases in inflation;
- - increases in operating costs;
- - increases in employee health care costs;
- - increases in workers' compensation benefits;
- - increases in prevailing wage levels; and
- - decreases in consumer confidence levels.
In January 2001, California enacted a minimum wage increase of $0.50 per
hour with an additional $0.50 increase required in January 2002. In 2001 and
2002, annual payroll expenses as a percentage of sales increased less than 1.0%.
Because we provide consumers with merchandise at a 99 cents fixed price point,
we typically cannot pass on cost increases to our customers.
WE FACE RISKS ASSOCIATED WITH INTERNATIONAL SALES AND PURCHASES
Although international sales historically have not been important to our
overall net sales, they have contributed to historical growth in Bargain
Wholesale's net sales. In addition, some of the inventory we purchase is
manufactured outside the United States. There are many risks associated with
doing business internationally. Our international transactions may be subject to
risks such as:
- - political instability;
- - currency fluctuations;
- - exchange rate controls;
- - changes in import and export regulations; and
- - changes in tariff and freight rates.
The United States and other countries have also proposed various forms of
protectionist trade legislation. Any resulting changes in current tariff
structures or other trade policies could lead to fewer purchases of our products
and could adversely affect our international operations.
WE COULD ENCOUNTER RISKS RELATED TO TRANSACTIONS WITH OUR AFFILIATES
We currently lease 12 of our 99 Cents Only Stores and a parking lot for one
of these stores from certain members of the Gold family and their affiliates.
Our annual rental expense for these facilities totaled approximately $1.9, $1.9
and $2.2 million in each of 2000, 2001 and 2002. In addition, one of our
directors, Ben Schwartz, is a trustee of a trust that owns a property on which a
single 99 Cents Only Store is located. We believe that our lease terms are just
as favorable to us as they would be for an unrelated party. Under our current
policy, we enter into real estate transactions with our affiliates only for the
renewal or modification of existing leases and on occasions where we determine
that such transactions are in our best interests. Moreover, the independent
members of our Board of Directors must unanimously approve all real estate
transactions between the Company and our affiliates. They must also determine
that such transactions are equivalent to a negotiated arm's-length transaction
with a third party. We cannot guarantee that we will reach agreements with the
Gold family on renewal terms for the properties we currently lease from them.
Also, even if we agree to such terms, we cannot be certain that our independent
directors will approve them. If we fail to renew one of these leases, we could
be forced to relocate or close the leased store. Any relocations or closures we
experience will be costly and could adversely affect our business.
WE RELY HEAVILY ON OUR MANAGEMENT TEAM
Our success depends substantially on David Gold and Eric Schiffer, our
Chief Executive Officer and President, respectively. We also rely on the
continued service of our executive officers and other key management. We have
not entered into employment agreements with any of our executive officers and we
do not maintain key person life insurance on them. As we continue to grow, our
success will depend on our ability to identify, attract, hire, train, retain and
motivate other highly skilled management personnel. Competition for such
personnel is intense, and we may not be able to successfully attract, assimilate
or retain sufficiently qualified candidates.
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OUR OPERATING RESULTS MAY FLUCTUATE AND MAY BE AFFECTED BY SEASONAL BUYING
PATTERNS
Historically, our highest net sales and operating income have occurred
during the fourth quarter, which includes the Christmas and Halloween selling
seasons. During 2001 and 2002, we generated approximately 29.9% and 29.5%,
respectively, of our net sales and approximately 35.3% and 32.7%, respectively,
of our operating income during the fourth quarter. If for any reason the
Company's net sales were to fall below norms during the fourth quarter it could
have an adverse impact on our profitability and impair our results of operations
for the entire year. Adverse weather conditions or other disruptions during the
peak holiday season could also affect our net sales and profitability for the
year.
In addition to seasonality, many other factors may cause our results of
operations to vary significantly from quarter to quarter. Some of these factors
are beyond our control. These factors include:
- - the number of new stores and timing of new store openings;
- - the level of advertising and pre-opening expenses associated with new
stores;
- - the integration of new stores into our operations;
- - general economic health of the deep-