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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
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
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 Identification No.)
Incorporation or Organization)
4000 UNION PACIFIC AVENUE, 90023
CITY OF COMMERCE, CALIFORNIA (zip code)
(Address of Principal Executive Offices)
Registrant's telephone number, including area code: (323) 980-8145
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 check mark 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 30, 2003 was $2,447,473,692 based on a $34.32 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, 72,426,655 Shares as of March 12, 2004
Portions of Part III of this report have been incorporated by reference
from the Company's Proxy Statement for the 2004 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 10
Part II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters 11
Item 6. Selected Financial Data 11
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 14
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 22
Item 8. Financial Statements and Supplementary Data 23
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 38
Item 9A. Controls and Procedures 39
Part III
Item 10. Directors and Executive Officers of the Registrant 39
Item 11. Executive Compensation 39
Item 12. Security Ownership of Certain Beneficial Owners and Management 39
Item 13. Certain Relationships and Related Transactions 39
Item 14. Principal Accountant Fees and Services 39
Part IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 40
2
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
Section - "Management's Discussion and Analysis of Financial Condition and
Results of Operations" (including but not limited to those discussed in the
subsection titled "Risk Factors"). The Company undertakes no obligation to
publicly revise these forward-looking statements to reflect events or
circumstances that arise after the date hereof. Readers should carefully review
the risk factors described in this report and 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 and 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 2003, a majority of the
Company's product offerings were comprised of recognizable name-brand
merchandise and were regularly available for reorder. As of March 12, 2004, the
Company operated 194 retail stores with 150 in California, 19 in Texas, 15 in
Arizona and 10 in Nevada. These stores have an average size of approximately
21,500 square feet. The Company's 99 Cents Only Stores generated average net
sales per estimated saleable square foot of $308, which the Company believes is
among the highest in the deep-discount convenience store industry, and average
net sales per store of $4.9 million for stores open the full year in 2003.
The Company opened its first 99 Cents Only Store 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 eight 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 189 stores and 3,190,528 estimated saleable square feet at
December 31, 2003, 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. Through March 12, 2004,
the Company had opened 6 new stores and closed one store. It also plans to open
an additional 42 new stores during the remainder of the year. The Company plans
to continue its store square footage expansion in 2004 at a targeted growth rate
of 25% per year. The Company estimates that the California, Texas, Arizona and
Nevada markets have the potential for over 425, 99 Cents Only Stores. The
Company intends to continue to expand in California, Texas, Arizona and Nevada
in 2004 and 2005. 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 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 5.3% of the Company's net sales in 2003.
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 2003, the Company
purchased merchandise from more than 999 suppliers, including Colgate-Palmolive,
Eveready Battery, General Electric, General Mills, Gerber Products, Hershey
Foods, Johnson & Johnson, Kellogg's, Kraft, Mattel, Mead, Nabisco, Nestle,
Procter & Gamble, Revlon, SmithKline Beecham and Unilever.
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
division were $46.0 million in 2003. 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 194 existing 99 Cents Only Stores,
average approximately 21,450 gross square feet. From January 1, 1999 through
December 31, 2003, the Company has opened 130 new stores with an average of
approximately 23,500 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 almost all employees
with tenure of more than six months with the Company receive an annual
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grant of stock options. As of December 31, 2003, the Company's employees held
options to purchase an aggregate of 4,428,672 shares, or 6.1% of the shares of
Common Stock on a fully diluted basis.
GROWTH STRATEGY
Management believes that future growth will primarily result from new store
openings facilitated by the following:
Growth in Existing Territories. As of March 12, 2004 the Company has 194 99
Cents Only Stores. There are 150 stores located in California, 19 in Texas, and
15 in Arizona and 10 in Nevada. By continuing to develop store growth in its
current markets, the Company believes it can leverage its brand awareness in
these regions and take advantage of its existing warehouse and distribution
facilities, regional advertising and other management and operating
efficiencies. The Company plans to open 48 new 99 Cents Only Stores in 2004. Of
the 48 planned new stores, approximately 15 new stores will be located in
California, 26 in Texas, six in Arizona and one in Nevada. The Company had
opened 6 new stores and closed one California store through March 12, 2004.
Three stores were in California, 2 were in Texas and one was in Arizona. The
Company plans to continue its store square footage expansion in 2004 at a
targeted rate of 25% per year. The Company estimates that the markets in
California, Texas, Arizona and Nevada have the potential for over 425 99 Cents
Only Stores.
Continued Expansion into Texas. On February 4, 2003 the Company announced
the purchase of a 741,000 square foot modern distribution center in the Houston
area, to service its store expansion in Texas, started in mid 2003. The
distribution facility was acquired for $23 million cash and came fully racked
including an automated pick to belt conveyor system. It also contained
refrigerated and frozen storage space. The Company installed the "High Jump"
supply chain management system in this warehouse and opened the first stores in
Houston Texas on June 19, 2003. As of March 12, 2004, the Company had opened 18
new stores in the Houston area and one in Dallas. The Texas stores average
21,400 sellable square feet, which is similar in size to new stores opened in
Northern California. Since January 1999 new stores opened average 18,500 salable
square feet. The Company believes Texas has the potential for over 150 stores.
The Company plans to add approximately 26 new stores in Texas in 2004.
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 10 stores in Nevada, 15 in Arizona and 19
in Texas.
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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1999 2000 2001 2002 2003
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99 Cents Only Stores net retail sales $ 312,306 $ 402,071 $ 522,019 $ 663,983 $ 816,348
99 Cents Only Stores annual net sales growth rate 30.7% 28.7% 29.8% 27.2% 22.9%
99 Cents Only Stores store count at beginning of year 64 78 98 123 151
New stores 18 20 26 28 38
Stores closed 4(a) - 1(a) - -
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Total store count at year-end 78 98 123 151 189
Average 99 Cents Only Stores net sales per store open the
full year(b) $ 4,433 $ 4,487 $ 4,647 $ 4,750 $ 4,906
Estimated saleable square footage at year-end for 99 Cents
Only Stores 1,102,369 1,424,280 1,892,949 2,428,681 3,190,528
Average net sales per estimated saleable square foot(b) $ 332 $ 318 $ 319 $ 309 $ 308
Change in comparable 99 Cents Only Stores net sales 6.1% 2.0% 5.9% 3.2% 5.4%
(a) Stores closed due to relocation to a larger nearby site.
(b) For stores open for the entire fiscal year.
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 Company. The
Company believes that the success of its 99 Cents Only Stores concept arises
from the value inherent in selling primarily name-brand
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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 12, 2004, the Company had
194, 99 Cents Only Stores averaging approximately 21,500 gross square feet.
Since January 1, 1999, the Company has opened 130 new stores that average 23,500
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 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, 2003 the Company leased 159 of its 189, 99 Cents Only
Stores retail locations and owned 30 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. Except for 10
relocations to larger stores, and one store closed due to a fire and one other
store closed due to eminent domain, the Company has never closed any of its 99
Cents Only Stores.
Store Management. The Company employs 32 district managers and three
regional managers responsible for store operations. The regional managers report
to the Company's vice president of retail operations. Each district manager is
responsible for up to seven stores with the store managers reporting to district
managers. Also, reporting to each district manager is one merchandising
supervisor. Typically the Company's stores are staffed with a manager and two or
three assistant managers. Store managers and assistant managers train store
employees and implement Company policy. District managers visit each store in
their district periodically and focus ensuring store management is properly
implementing the Company's policies, operations and merchandising philosophy.
District managers also help train store management. Additionally the Vice
President of retail store administration supervises a group of manager trainers
as well as a management training school located at the Company's corporate
offices.
Advertising. Advertising expenditures were $3.4 million, $3.1 million and
$3.8 million for 2001, 2002 and 2003, respectively, or 0.6%, 0.4% 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, 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 occasionally uses a direct mail
campaign for new customers who own homes in more upscale neighborhoods.
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 2003, Bargain Wholesale sold
merchandise to other wholesalers, small local retailers, large regional and
national retailers and exporters. During
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2003, no single customer accounted for more than 4.0% 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. In
2004, the Company plans to open a showroom in its Katy, Texas distribution
center.
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 2003. During 2003, the Company purchased
merchandise from more than 999 suppliers, including Colgate-Palmolive, Dial,
Eveready Battery, General Electric, General Mills, Gerber Products, Hershey
Foods, Johnson & Johnson, Kellogg's, Kraft, Mattel, Mead, Nabisco, Nestle,
Pfizer, Procter & Gamble, Revlon, and SmithKline Beecham and Unilever. Many of
these companies have been supplying products to the Company in excess of twenty
years.
A significant portion of the merchandise purchased by the Company in 2003
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 2003, 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 2.3% of total merchandise purchased in 2003. 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.
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 almost
adjacent to its main distribution facility. In 2003, the Company purchased two
additional distributions centers. (i) on January 28, 2003 the Company completed
its purchase of a 741,000 square foot distribution center in the Houston, Texas
area, to service its planned store expansion in Texas in 2003 and beyond. The
facility was acquired for $23 million in cash and contains built in refrigerated
and frozen storage space. (ii) on December 31, 2003, the Company completed the
purchase of a 66,000 square foot deli & frozen distribution center in the City
of Commerce. The facility was acquired for $8.4 million in cash. Most of the
Company's merchandise is shipped by truck directly from manufacturers and other
7
suppliers to the Company's warehousing and distribution facilities. The Company
maintains a fleet of vehicles, which are used to deliver merchandise to many of
its Southern California stores (both by Company employed truck drivers and
contract employees). 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
internal fleet and outside carriers and contracted or owner operated truck
drivers by a combination of filling outbound trucks to capacity and instituting
a backhaul program whenever possible. The Company also uses outside carriers to
pick up shipments at local ports and rail yards. The size of the Company's
distribution centers and warehouses allows storage of bulk one-time close-out
purchases and seasonal or holiday items without incurring additional costs. The
Company also uses common carriers to deliver to all stores outside of Southern
California including its stores in Texas, Arizona and Nevada. The Company
believes that its current warehouse and distribution facilities will be able to
support distribution to approximately 225 stores within an approximate 500 mile
radius. There can be no assurance that the Company's existing warehouses will
provide adequate storage space for the Company's long-term storage needs.
INFORMATION SYSTEMS
In 2003, the Company completed the installation of Highjump's "Warehouse
Advantage" Warehouse Management System in its Katy, Texas Distribution Center.
The Highjump system utilizes radio frequency technology including Voice Directed
Picking from Voxware, which increases picking accuracy and delivers real time
inventory to the Company's Unix based Inventory system. The Company plans to
begin installation of the Highjump Warehouse Management System in its Commerce
facility in 2004. The Company operates financial, accounting, human resource and
payroll system using Lawson Software's Financial and Human Resource Suites on an
INFORMIX database running 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 in each store, was upgraded in 2003. 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. The Company's Point of Sale System (POS) continued to
be upgraded in 2003 as well. 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 21 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 for acquiring close-out merchandise 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, 2003, the Company had 7,620 employees: 6,828 in its retail
operation, 554 in its warehouse and distribution facility, 224 in its corporate
offices and 14 in its Bargain Wholesale division. None of the Company's
employees is party to a collective bargaining agreement (although the truck
drivers in the Company's main California warehouse (approximately 56 employees)
recently elected to be represented by a union). The Company considers relations
with its employees to be good. The Company offers certain benefits, including
health insurance, employee discount purchase plan, 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 almost 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.
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 12, 2004 the Company leased 164 of its 194 existing stores
and the Company owned its main California warehouse and distribution facility
(where its executive offices are located). The Company owns three other
warehouses (i) a warehouse and distribution center in Katy, Texas with an
ammonia based refrigeration system in part of the facility, (ii) a deli & frozen
warehouse and distribution center in the City of Commerce, California and (iii)
the Company also owns a warehouse facility in Eagan, Minnesota that is currently
being marketed for lease or sale. 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 several above-ground propane tanks at its warehouse and
distribution facilities. 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
8
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 12, 2004, the Company owned 30 and leased 164 of its 194 store
locations. The Company also has escrow deposits on five 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, $2.2 million
and $2.1 million in 2001, 2002 and 2003, 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, 2003, information
relating to the expiration dates of the Company's current stores leases:
EXPIRING EXPIRING EXPIRING EXPIRING
2004 2005-2007 2008-2010 2011 AND BEYOND
---- --------- --------- ---------------
15(a) 57 42 40
(a) Includes three 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 almost
adjacent to its main distribution facility.
On January 28, 2003 the Company purchased a 741,000 square feet warehouse
and distribution center in Houston, to service its planned store expansion in
Texas in 2003 and beyond. See "Growth Strategy - Expansion in Texas."
On December 31, 2003, the Company purchased a 66,000 square feet deli and
frozen warehouse and distribution center located in the City of Commerce,
California.
Also, the Company is in escrow to purchase a 180,000 square foot warehouse
facility that is currently being leased by the Company.
ITEM 3. LEGAL PROCEEDINGS
Melgoza vs. 99 Cents Only Stores (Los Angeles Superior Court; Case No. BC
295342)
On May 7, 2003, the plaintiff, a former Store Manager, filed a putative
class action on behalf of himself and others similarly situated. The suit
alleges that the Company improperly classified Store Managers in the Company's
California stores as exempt from overtime requirements as well as meals and rest
period requirements under California law. Each store typically had one Store
Manager and two or three Assistant Store Managers. Pursuant to the California
Labor Code, the suit seeks to recover unpaid overtime compensation, penalties
for failure to provide meal and rest periods, waiting time penalties for former
employees, interest, attorney fees, and costs. The suit also charges, pursuant
to California's Business and Professions Code section 17200, that the Company
engaged in unfair business practices by failing to make such payments, and seeks
payment of all such wages (in the form of restitution) for the four-year period
preceding the filing of the case through the present. Plaintiff is now seeking
leave to file an amended complaint that would (1) expand the class to include
not only all current and former Store Managers who worked for the Company from
May 7, 1999 but also all current and former Assistant Managers who worked for
the Company during the same period; and (2) claims for additional penalties on
behalf of all purported class members under California's new Labor Code Private
Attorney General Act of 2004. The Company is vigorously asserting defenses to
the various claims.
In view of the inherent difficulty of predicting the outcome of legal
matters, the Company cannot state with confidence what the eventual outcome of
this matter will be. However, based on current knowledge, this matter is not
presently expected to have a material adverse effect on the Company's financial
condition or overall liquidity, although it could have a material adverse effect
on the Company's results of operations for the accounting period in which it is
resolved.
9
Others:
The Company is named as a defendant in various other legal matters arising
in the normal course of business. In management's opinion, none of these other
matters will have a material effect on the Company's financial position, results
of operations or overall liquidity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
10
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.
Price Range
-----------
High Low
------ ------
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. . . . . . . . . . . . . . . . . $28.48 $20.83
Second Quarter . . . . . . . . . . . . . . . . 35.09 25.66
Third Quarter. . . . . . . . . . . . . . . . . 36.02 31.74
Fourth Quarter . . . . . . . . . . . . . . . . 33.79 24.87
2004:
-----
First Quarter through March 12, 2004 $29.65 $25.20
As of March 12, 2004, the Company had approximately 30,849 holders of the
Common Stock and an additional 528 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, as
amended). 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 5,268,045 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 2001, 2002 and 2003.
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 1999 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: 1999 2000 2001 2002 2003
------------- ----------- ----------- ----------- -----------
Net sales:
99 Cents Only Stores. . . . . . . . . $ 312,306 $ 402,071 $ 522,019 $ 663,983 $ 816,348
Bargain Wholesale (e) . . . . . . . . 47,652 49,876 56,250 49,959 46,112
------------- ----------- ----------- ----------- -----------
Total sales. . . . . . . . . . . . 359,958 451,947 578,269 713,942 862,460
Cost of sales . . . . . . . . . . . . . 218,496 275,395 350,421 427,356 516,686
------------- ----------- ----------- ----------- -----------
Gross profit. . . . . . . . . . . . . . 141,462 176,552 227,848 286,586 345,774
Selling, general and administrative
expenses:
Operating expenses. . . . . . . . . . 80,089 107,981 141,544 178,374 234,626
Depreciation and amortization.. . . . 5,927 8,666 12,354 17,711 23,763
------------- ----------- ----------- ----------- -----------
Total operating expenses . . . . . 86,016 116,647 153,898 196,085 258,389
Operating income. . . . . . . . . . . . 55,446 59,905 73,950 90,501 87,384
Other (income) net. . . . . . . . . . . (1,059) (3,617) (5,931) (4,847) (4,457)
------------- ----------- ----------- ----------- -----------
11
(CONTINUED FROM PREVIOUS PAGE)
AS OF DECEMBER 31
-----------------
(Amounts in thousands, except per share and operating data)
1999 2000 2001 2002 2003
----------- ----------- ----------- ----------- -----------
Income from continuing operations
before provision
for income taxes . . . . . . . . . . . . . 56,505 63,522 79,881 95,348 91,842
Provision for income taxes . . . . . . . . 22,367 24,664 31,438 36,374 35,313
----------- ----------- ----------- ----------- -----------
Income from continuing operations. . . . . $ 34,138 $ 38,858 $ 48,443 $ 58,974 $ 56,529
----------- ----------- ----------- ----------- -----------
Income (loss) from discontinued
operations net of income tax benefit of
2,111 and $700 in 1999 and
2000 respectively. . . . . . . . . . . . (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 . . . . . . . . . . . . . . . . $ 21,971 $ 37,808 $ 48,443 $ 58,974 $ 56,529
=========== =========== =========== =========== ===========
Earnings per common share from
continuing
operations:
Basic. . . . . . . . . . . . . . . . . . $ 0.51 $ 0.58 $ 0.70 $ 0.84 $ 0.79
Diluted. . . . . . . . . . . . . . . . . $ 0.50 $ 0.56 $ 0.69 $ 0.83 $ 0.78
(Loss) per common share from
discontinued operations:
Basic. . . . . . . . . . . . . . . . . . ($0.05) ($0.02) - - -
Diluted. . . . . . . . . . . . . . . . . ($0.05) ($0.02) - - -
(Loss) per common share from disposal
of discontinued operations:
Basic. . . . . . . . . . . . . . . . . . ($0.13) - - - -
Diluted. . . . . . . . . . . . . . . . . ($0.13) - - - -
Earnings per common share:
Basic. . . . . . . . . . . . . . . . . . $ 0.33 $ 0.56 $ 0.70 $ 0.84 $ 0.79
Diluted. . . . . . . . . . . . . . . . . $ 0.32 $ 0.55 $ 0.69 $ 0.83 $ 0.78
Weighted average number of common
shares outstanding:
Basic. . . . . . . . . . . . . . . . . . 66,487 67,650 68,815 69,938 71,348
Diluted. . . . . . . . . . . . . . . . . 67,954 68,945 70,009 71,181 72,412
COMPANY OPERATING DATA:
- -----------------------
Sales Growth
99 Cents Only Stores . . . . . . . . . . 30.7% 28.7% 29.8% 27.2% 23.0%
Bargain Wholesale. . . . . . . . . . . . (10.4)% 4.7% 12.8% (11.2)% (7.7)%
Total Company sales. . . . . . . . . . . 23.2% 25.6% 28.0% 23.5% 20.8%
Gross margin . . . . . . . . . . . . . . . 39.3% 39.1% 39.4% 40.1% 40.1%
Operating margin . . . . . . . . . . . . . 15.4% 13.3% 12.8% 12.7% 10.1%
Income from continuing operations: . . . . 9.5% 8.6% 8.4% 8.3% 6.6%
RETAIL OPERATING DATA (A):
- --------------------------
99 Cents Only Stores at end of period. . . 78 98 123 151 189
Change in comparable stores
Net sales (b). . . . . . . . . . . . . . . 6.1% 2.0% 5.9% 3.6% 4.8%
Average net sales per store open the
full year. . . . . . . . . . . . . . . . . $ 4,433 $ 4,487 $ 4,647 $ 4,750 $ 4,929
Average net sales per estimated saleable
square foot (c). . . . . . . . . . . . . . $ 332 $ 318 $ 319 $ 309 $ 308
Estimated saleable square footage at
year end . . . . . . . . . . . . . . . . . 1,102,369 1,424,280 1,892,949 2,428,681 3,190,528
Balance Sheet Data:
Working capital. . . . . . . . . . . . . $ 105,637 $ 166,779 $ 194,302 $ 215,747 $ 217,902
Total assets . . . . . . . . . . . . . . 224,015 277,285 352,158 442,576 553,238
Capital lease obligation, including
current portion. . . . . . . . . . . . . 7,251 - 1,677 1,637 1,593
Total shareholders' equity . . . . . . . $ 195,540 $ 253,533 $ 319,643 $ 396,615 $ 489,886
(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.
13
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 increased its net sales, operating income and income
from continuing operations in each year from 1999 to 2002. In 2003, 99 Cents
Only Stores had net sales of $862.5 million, operating income of $87.4 million
and net income of $56.5 million. Sales increased 20.8% over 2002. Operating
income and net income decreased 3.4% and 4.1% respectively from 2002. From 1999
through 2003, the Company had a compound annual growth rate in net sales,
operating income and net income of 21.7%, 14.4% and 16.2%, respectively.
During the three years ending December 31, 2003, average annual net sales
per estimated saleable square foot (computed for 99 Cents Only Stores open for
the full year) declined from $318 per square foot to $308 per square foot. This
trend reflects the Company's determination to target larger locations for new
store development. Existing stores average approximately 21,500 gross square
feet. From January 1, 2001 through December 31, 2003, the Company opened 92 new
stores (including one relocation in 2001) that average approximately 24,700
gross square feet. The Company currently targets new store locations between
18,000 and 28,000 gross square feet. Although it is the Company's experience
that larger stores generally have lower average net sales per square foot than
smaller stores, larger stores generally achieve higher average annual store
revenues and operating income. During the three years ending December 31, 2003,
average annual net sales per store (computed for 99 Cents Only Stores open for
the full year) increased from $4.5 million to $4.9 million.
The Company's management believes that future growth will primarily result
from new store openings facilitated by growth in our existing territories and
expansion into new territories. The Company has now expanded into Texas, and
expects to continue to open new stores in Texas as well as in California, Nevada
and Arizona. The Company believes that its concept of consistently offering a
broad selection of name-brand consumables, at value pricing, in a convenient
store format is portable to most other densely populated areas of the country.
The Company considers lease acquisitions or purchase opportunities as they
become known to the Company and may make acquisitions of a chain, or chains, of
clustered retail sites in densely populated regions, primarily for the purpose
of acquiring favorable store locations. See "Growth Strategy" and Risk Factor
"We Depend on New Store Openings for Future Growth."
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. Should a greater amount
of claims occur compared to the estimates, reserves recorded may not be
sufficient and additional expenses, which may be significant, could be incurred.
The Company does not discount for the time value of money its projected future
cash outlays for its existing workers compensation claims.
Universal International (Discontinued Operations)
In December 1999, the Company determined it would be in its best interest,
and that of its shareholders, to focus its efforts on increasing the growth rate
of 99 Cents Only Stores. In conjunction with its revised growth strategy, the
Company decided to sell its Universal International, Inc. and Odd's-n-End's,
Inc. subsidiaries (together "Universal"). Universal operated a multi-price point
variety chain, with 65 stores located in the Midwest, Texas and New York, under
the trade names Only Deals and Odd's-N-End's. Among other factors at that time,
the Company considered its successful opening of its first 99 Cents Only Stores
outside of Southern California, in Las Vegas, Nevada. Given the success of the
Las Vegas, Nevada stores, the Company believed that the 99 Cents Only Stores
concept was portable to areas outside of Southern California. As a result, the
Company has focused greater management resources to increasing its store growth
rate and expanding aggressively into Nevada, Arizona and in 2003, Texas.
14
The Company adopted a definitive plan to sell Universal within one year, as
set forth by guidelines for the accounting treatment of discontinued operations.
The Company engaged an investment-banking firm to evaluate and identify
potential buyers for the Universal business and expected to sell Universal
within the one-year time frame from when the Company classified Universal as a
discontinued operation. The investment banking firm's marketing process focused
upon selling the business as a going concern. From June 2000 through August
2000, sales presentations were delivered to both strategic buyers and financial
buyers. This process did not generate the expected interest level from potential
buyers that had been anticipated. The highest offer for the Universal business
was significantly less than the Company's expectations. As a result of the
difficulties encountered in trying to sell Universal and the necessity to
complete the process by December 31, 2000, it was decided by the Board of
Directors to be in the Company's and the shareholders' best interest to sell
Universal for the Company's carrying value as of the close of business on
September 30, 2000 to Universal Deals, Inc. and Universal Odd's-n-End's, Inc.,
both of which are owned 100% by David and Sherry Gold, both significant
shareholders of 99 Cents Only Stores. Mr. Gold is also Chairman and CEO of 99
Cents Only Stores. The sale was effective as of the close of business on
September 30, 2000. The purchase price for Universal was paid in cash and was
equal to the Company's carrying book value of the assets of Universal at
September 30, 2000 or $33.9 million. The net assets at September 30, 2000
included $29.2 million in inventory, net fixed assets of $7.6 million and $0.6
million of other assets. These assets were offset by $3.5 million of accounts
payable, accrued and other liabilities. In connection with this transaction, 99
Cents Only Stores provided certain ongoing administrative services to Universal
in 2000 and 2001 pursuant to a service agreement for a management fee of 6% of
Universal sales revenues. During fiscal year 2000, the Company recorded an
additional net loss from discontinued operations of $1.1 million, net of tax
benefit of $0.7 million, for operating losses incurred through the date of sale,
in excess of the amounts originally provided in 1999. In the fourth quarter of
2000, the Company received $1.3 million in management fees under the service
agreement with Universal. The Company also received $0.4 million in lease
payments for rental of a distribution facility to Universal. During 2001, the
Company received $3.7 million in fees under the service agreement, $1.4 million
in lease payments and sold $4.7 million in merchandise at a 10% mark-up. In 2002
the Company received $1.5 million in management fees under the service agreement
from Universal and $1.4 million in lease payments. It also purchased $0.4
million of closeout inventory from Universal. During 2003 the Company received
$1.4 million in management fees under the service agreement from Universal and
$1.4 million in lease payments. The service and lease agreements with Universal
culminated as of December 15, 2003 and there are no remaining amounts due to or
from Universal under these agreements.
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)
2001 2002 2003
---------- ------- ----------- ------- ----------- -------
Net Sales:
99 Cents Only Stores. . . . . . . . . . . . $522,019 90.3% $663,983 93.0% $816,348 94.7%
Bargain Wholesale . . . . . . . . . . . . . 56,250 9.7 49,959 7.0 46,112 5.3
---------- ------- ----------- ------- ----------- -------
Total . . . . . . . . . . . . . . . . . . . 578,269 100.0 713,942 100.0 862,460 100.0
Cost of sales . . . . . . . . . . . . . . . 350,421 60.6 427,356 59.9 516,686 59.9
---------- ------- ----------- ------- ----------- -------
Gross profit. . . . . . . . . . . . . . . . 227,848 39.4 286,586 40.1 345,774 40.1
Selling, general and administrative expenses:
Operating expenses. . . . . . . . . . . . . 141,544 24.5 178,374 24.9 234,626 27.2
Depreciation and amortization . . . . . . . 12,354 2.1 17,711 2.5 23,763 2.8
---------- ------- ----------- ------- ----------- -------
Total . . . . . . . . . . . . . . . . . . . 153,898 26.6 196,085 27.4 258,389 30.0
Operating income. . . . . . . . . . . . . . 73,950 12.8 90,501 12.7 87,384 10.1
Other (income) expense, net . . . . . . . . (5,931) (1.0) (4,847) (0.7) (4,457) (0.5)
---------- ------- ----------- ------- ----------- -------
Income before provision for income taxes. . 79,881 13.8 95,348 13.4 91,842 10.6
Provision for income taxes. . . . . . . . . 31,438 5.4 36,374 5.1 35,313 4.1
---------- ------- ----------- ------- ----------- -------
Net income. . . . . . . . . . . . . . . . . $ 48,443 8.4% $ 58,974 8.3% $ 56,529 6.5%
========== ======= =========== ======= =========== =======
YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002
Net Sales. Total net sales increased $148.5 million, or 20.8%, from $713.9
million in 2002 to $862.5 million in 2003. 99 Cents Only Stores net sales
increased $152.3 million, or 22.9%, from $664.0 million in 2002 to $816.3
million in 2003. Bargain Wholesale net sales decreased $3.8 million, or 7.7%,
from $50.0 million in 2002 to $46.1 million in 2003. The net effect of 38 new
stores opened in 2003 increased 99 Cents Only Stores net sales by $67.3 million
and the full year effect of 28 net stores opened in 2002 increased sales by
$56.0 million. Comparable stores net sales increased 4.8% in 2003. The decrease
in Bargain Wholesale net sales was primarily attributed to the competitive
pricing environment in the wholesale business, a decline in sales to export
brokers and a greater focus on the growth of the Company's retail business.
Gross profit. Gross profit, which consists of total net sales, less cost of
sales, increased $59.2 million, or 20.7%, from $286.6 million in 2002 to $345.8
million in 2003. 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
2003 and 2002. The retail gross margin decreased to 41.2% of sales in 2003
versus 41.7% in 2002. This percentage variance was due to a 35.2% growth in the
grocery product sales, which have a lower margin than other product categories.
Margins on closeouts vary widely depending on circumstances giving rise to
product availability. See Risk Factor "We depend on our relationships with our
suppliers and the availability of close-out and special-situation merchandise."
The wholesale margin was 19.8% in 2003 versus 20.1% in 2002. Wholesale margin is
generally driven by local competitive pricing factors, which results in lower
sales prices.
Operating Expenses. Operating expenses, increased $56.3 million, or 31.5%,
from $178.4 million in 2002 to $234.6 million in 2003. The 38 new store
additions in 2003 increased operating expenses by $33.2 million. Distribution
costs increased $11.6 million. This includes transportation costs, which
increased $3.5 million due to the addition of new stores in Northern California,
Nevada, Arizona and Texas. The addition
15
of the new Texas distribution center increased distribution costs $2.0 million,
warehouse cost increased $6.1 million due to overall increase in labor cost.
Increases in administrative costs include an increase in California workers
compensation expense of $11.6 million based on store and labor growth in
California. Other administrative cost increases of $4.4 million, include $1.1
million of start up costs in Texas. Additional key administrative staff
positions were filled in information systems, real estate, distribution, human
resources, finance, strategic planning and buying. Operating costs were offset
by $1.4 million in management fees from Universal (see Universal International
above).
Depreciation and Amortization. Depreciation increased $6.1 million. The 38
new store additions increased depreciation by $4.1 million and the new Texas
distribution center increased depreciation $0.5 million. Other increases result
from amortization of information systems costs and depreciation costs of the Los
Angeles distribution center.
Operating income. Operating income decreased $3.1 million, or 3.4%, from
$90.5 million in 2002 to $87.4 million in 2003. Operating income as a percentage
of net sales was 10.1% in 2003 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 2002
and in 2003. The Company had no bank debt during 2002 or 2003. Interest income
earned on the Company's marketable securities was $3.1 million in 2003 and $3.5
million in 2002. At December 31, 2003, the Company held $145.7 million in
short-term investments and $52.8 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 2003
and 2002 is $1.4 million of income under a lease agreement with Universal for a
distribution facility. This agreement ended on December 15, 2003.
Provision for income taxes. The provision for income taxes in 2003 was
$35.3 million, or 4.1% of net sales, compared to $36.4 million, or 5.1% of net
sales in 2002. The effective combined federal and state rates of the provision
for income taxes were 38.4% and 38.2% in 2003 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 7 of "Notes to Financial Statements."
Net Income. As a result of the items discussed above, net income decreased
$2.4 million, or 4.1%, from $59.0 million in 2002 to $56.5 million in 2003. Net
income as a percentage of net sales was 6.5% in 2003 and 8.3% in 2002.
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. 99 Cents Only Stores net
sales increased $79.7 million from the 28 new stores opened in 2002. The full
year effect of 25 net stores opened in 2001 was $49.2 million. Comparable stores
net sales increased 3.6% from 2001 to 2002. 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 10
basis points to 41.7% of sales in 2002 versus 41.6% in 2001, this was due sales
growth in houseplant and counter items. Gross margins will vary from time to
time because of the closeout nature of the business. Margins on closeouts vary
widely depending on circumstances giving rise to product availability. See Risk
Factor "We depend on our relationships with our suppliers and the availability
of close-out and special-situation merchandise". The wholesale margin was 20.1%
in 2002 versus 19.3% in 2001. The wholesale margin increased as a result of the
loss of $4.7 million in sales to Universal in 2001, which carried a lower margin
of 10%.
Operating Expenses. Operating expenses, increased $36.8 million, or 26.0%,
from $141.5 million in 2001 to $178.4 million in 2002. The 28 new stores opened
in 2002 increased operating expenses $25.3 million. Approximately $4.3 million
in cost increases were attributable to utility cost increases associated with
the retrofitting of older stores with expanded frozen and deli selling and
storage space. Minimum wage cost increases were $5.1 million. Growth in
corporate staff positions and field rep staff positions were $1.2 million and
there were other cost increases of $1.0 million. Operating costs were offset by
$1.5 million in management fees from Universal (see Universal International
above).
Depreciation. Depreciation increased $5.4 million in 2002 over 2001. New
store additions accounted for $4.2 of this increase, $1.0 was attributable to
increases in depreciation of computer hardware and software and $0.2 million was
an increase in depreciation of distribution equipment.
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.
16
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 7 of "Notes to Financial Statements."
Net Income. As a result of the items discussed above, net income 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.
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 2002 and 2003 was $72.3 and $79.5
million, respectively, consisting primarily of $75.7 million and $87.3 million
of net income adjusted for non-cash items. The Company provided $12.2 million
and $10.5 million respectively, 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 $16.6 million and $24.2 million in
2002 and 2003, respectively.
Net cash used in investing activities during 2002 and 2003 was $77.5 and
$112.2 million. In 2002, the Company used $41.6 million for the purchase of
property and equipment including $19.6 million used for the purchase of new
store locations, $0.1 million in investments in two partnerships for the purpose
of obtaining leases on two store locations and $36.0 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 2003, the
Company used $97.3 million for the purchase of property and equipment including
$23.0 million for the purchase of a modern distribution center in Houston,
Texas, $8.3 million for a frozen and refrigerated warehouse in Los Angeles,
$39.7 million for new and existing stores, $12.1 million for construction in
progress on future store openings $1.5 million for distribution and warehouse
equipment and $0.6 million for information systems and other corporate needs.
The company also invested $14.4 million for the purchase of short and long-term
investments.
Net cash provided by financing activities during 2002 and 2003 was $12.9
and $25.7 million, which represents the proceeds from the exercise of
non-qualified stock options. The Company does not maintain any credit facilities
with any bank.
The Company plans to open 48 new 99 Cents Only Stores in 2004. The average
investment per new store opened in 2003, including leasehold improvements,
furniture, fixtures and equipment, inventory and pre-opening expenses, was
approximately $1,100,000 and includes 6 stores that were purchased. The Company
does not capitalize pre-opening expenses. The Company's cash needs for new store
openings including acquired properties are expected to total approximately $54.0
million in 2004. The Company's total planned capital expenditures in 2004 for
additions to fixtures and leasehold improvements of existing stores as well as
for distribution and transportation equipment, information systems, expansion
and replacement will be approximately $26.0 million. The Company believes that
its total capital expenditure requirements (including new store openings) will
approximate $80.0 million in 2004. The Company intends to fund its liquidity
requirements in 2004 out of net cash provided by operations, short-term
investments and cash on hand.
CONTRACTUAL OBLIGATIONS
The following table summarizes our consolidated contractual obligations (in
thousands) as of December 31, 2003. These should be read in conjunction with
"Note 8. Commitments and Contingencies"
LESS THAN 1-3 3-5 MORE THAN
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR YEARS YEARS 5 YEARS
Capital Lease Obligations $ 2,551 $ 40 $ 490 $ 398 $ 1,623
Operating Lease Obligations 153,778 26,834 46,174 34,408 46,362
Other Long-Term Liabilities reflected on the
Company's Balance Sheet under GAAP 2,114 - - - 2,114
Total $158,443 $ 26,874 $46,664 $34,806 $ 50,099
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.
17
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 2002 and 2003. 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.
YEAR ENDED DECEMBER 31, 2002 YEAR ENDED DECEMBER 31, 2003
---------------------------- ----------------------------
(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. . . . . . . . $149,647 $155,436 $160,424 $198,476 $184,713 $195,052 $200,567 $236,016
Bargain Wholesale . . 13,457 12,426 11,839 12,237 11,710 11,981 10,969 11,452
Total . . . . . . . 163,104 167,862 172,263 210,713 196,423 207,033 211,536 247,468
Gross profit . . . . . . 64,242 67,564 68,755 86,025 79,398 82,803 82,877 100,695
Operating income . . . . 19,320 21,024 20,607 29,550 22,915 23,069 18,123 23,278
Net income . . . . . . . $ 12,470 $ 13,519 $ 13,255 $ 19,730 $ 14,609 $ 14,836 $ 12,102 $ 14,982
Earnings per
common share:
Basic . . . . . . . . $ 0.18 $ 0.19 $ 0.19 $ 0.28 $ 0.21 $ 0.21 $ 0.17 $ 0.21
Diluted . . . . . . . $ 0.18 $ 0.19 $ 0.19 $ 0.28 $ 0.20 $ 0.21 $ 0.17 $ 0.21
Shares outstanding:
Basic . . . . . . . . 69,558 69,888 70,043 70,278 70,469 71,038 71,929 72,044
Diluted . . . . . . . 70,925 71,275 71,217 71,362 71,536 72,346 73,033 72,779
Percent of net sales:
Net sales:
99 Cents Only
Stores. . . . . . . . 91.7% 92.6% 93.1% 94.2% 94.0% 94.2% 94.8% 95.4%
Bargain Wholesale . . 8.3 7.4 6.9 5.8 6.0 5.8 5.2 4.6
Total. . . . . . . 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Gross profit . . . . . . 39.4 40.2 39.9 40.8 40.4 40.0 39.2 40.7
Operating income . . . . 11.8 12.5 12.0 14.0 11.7 11.1 8.6 9.4
Net income . . . . . . . 7.6% 8.1% 7.7% 9.4% 7.4% 7.2% 5.7% 6.1%
NEW AUTHORITATIVE PRONOUNCEMENTS
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 January 2003, the FASB issued FIN No. 46, "Consolidation of Variable
Interest Entities." FIN 46 establishes a new and far-researching consolidation
accounting model. Although FIN No 46 was initially focused on special purpose
entities, the applicability of FIN No 46 goes beyond such entities and can have
applicability to franchise arrangements, regardless of whether the Company has
voting or ownership control of such franchisee. In response to a number of
comment letters and implementation questions, in December 2003 the FASB issued
FIN No. 46R, which delays the effective date of FIN No 46 for certain entities
until March 31, 2004, as well as provides clarification regarding other
implementation issues. The Company will adopt Fin No 46 in its quarter ending
March 31, 2004. Adoption of Fin No. 46 is not expected to have a significant
impact on the Company's financial position, results of operations or liquidity.
18
RISK FACTORS
INFLATION MAY AFFECT OUR ABILITY TO SELL MERCHANDISE AT THE 99 CENTS PRICE POINT
Our ability to provide quality merchandise at the 99 cents price point is
subject to certain economic factors, which are beyond our control, including
inflation. Inflation could have a material adverse effect on our business and
results of operations, especially given the constraints on our ability to pass
on any incremental costs due to price increases or other factors. We believe
that we will be able to respond to ordinary price increases resulting from
inflationary pressures by adjusting the number of items sold at the single price
point (e.g., two items for 99 cents instead of three items for 99 cents) and by
changing our selection of merchandise. Nevertheless, a sustained trend of
significantly increased inflationary pressure could require us to abandon our
single price point of 99 cents per item, which could have a material adverse
effect on our business and results of operations. See also "We are vulnerable to
uncertain economic factors, changes in the minimum wage and workers'
compensation" for a discussion of additional risks attendant to inflationary
conditions.
WE DEPEND MAINLY ON NEW STORE OPENINGS OUTSIDE OF OUR TRADITIONAL CORE MARKET OF
SOUTHERN CALIFORNIA FOR FUTURE GROWTH
Our sales and operating income growth results depend largely on our ability
to open and operate new stores outside of our traditional core market of
Southern California successfully and to manage a larger business profitably. In
2002 and 2003, we opened 28 and 38 99 Cents Only Stores, respectively. We also
plan to grow retail square footage at a rate of approximately 25% per year. Our
strategy depends on many factors, including our ability to identify suitable
markets and sites for our new stores, negotiate leases with acceptable terms,
refurbish stores, successfully compete against local competition, upgrade our
financial and management information systems and controls and manage our
operating expenses. In addition, we must be able to continue to hire, train,
motivate and retain competent managers and store personnel. Many of these
factors are beyond our control. As a result, we cannot assure you that we will
be able to achieve our expansion goals. Any failure by us to achieve our
expansion goals on a timely basis, obtain acceptance in markets in which we
currently have limited or no presence, attract and retain management and other
qualified personnel, appropriately upgrade our financial and management
information systems and controls or manage operating expenses could adversely
affect our future operating results and our ability to execute our business
strategy.
We also cannot assure you that we will improve our results of operations
when we open new stores. A variety of factors, including store location, store
size, rental terms, competition, the level of store sales and the level of
initial advertising influence if and when a store becomes profitable. Assuming
that our planned expansion occurs as anticipated, our store base will include a
relatively high proportion of stores with relatively short operating histories.
We cannot assure you that our new stores will achieve the sales per saleable
square foot and store-level operating margins currently achieved at our existing
stores. If our new stores on average fail to achieve these results, our planned
expansion could produce a decrease in our overall sales per saleable square foot
and store-level operating margins. Increases in the level of advertising and
pre-opening expenses associated with the opening of new stores could also
contribute to a decrease in our operating margins. Finally, the opening of new
stores in existing markets has in the past and may in the future reduce retail
sales of existing stores in those markets, negatively affecting comparable store
sales.
OUR OPERATIONS ARE CONCENTRATED IN CALIFORNIA
Currently, all but 44 of our 194, 99 Cents Only Stores are located in
California. We operate 10 stores in Las Vegas, Nevada, 15 stores in Arizona and
19 stores in Houston, Texas. We expect that we will continue to open additional
stores in California, as well as in Nevada, Arizona and Texas. Accordingly, our
results of operations and financial condition largely depend upon trends in the
California economy. If retail spending declines due to an economic slow-down or
recession in California, we cannot assure you that our operations will not be
negatively impacted.
In addition, California historically has been vulnerable to certain
natural disasters and other risks, such as earthquakes, fires, floods and civil
disturbance. At times, these events have disrupted the local economy. These
events could also pose physical risks to our properties.
WE COULD EXPERIENCE DISRUPTIONS IN RECEIVING AND DISTRIBUTION
Our success depends upon whether our receiving and shipment schedules are
organized and well managed. As we continue to grow, we may face unexpected
demands on our warehouse operations, as well as unexpected demands on our
transportation network, which could cause delays in delivery of merchandise to
or from our warehouses to our stores. A fire, earthquake or other disaster at
our warehouses could hurt our business, financial condition and results of
operations, particularly because much of our merchandise consists of closeouts
and other irreplaceable products. Although we maintain standard property and
business interruption insurance, we do not have earthquake insurance on our
properties. Although we try to limit our risk of exposure to potential product
liability claims, we do not know if the limitations in our agreements are
enforceable. We maintain insurance covering damage from use of our products. If
any product liability claim is successful and large enough, our business could
suffer.
WE DEPEND UPON OUR RELATIONSHIPS WITH OUR SUPPLIERS AND THE AVAILABILITY OF
CLOSE-OUT AND SPECIAL-SITUATION MERCHANDISE
Our success depends in large part on our ability to locate and purchase
quality close-out and special-situation merchandise at attractive prices. This
helps us maintain a mix of name-brand and other merchandise at the 99 Cents
price point. We cannot be certain that such merchandise will continue to be
available in the future at a price that will be consistent with historical
costs. Further, we may not be able to find and purchase merchandise in
quantities necessary to accommodate our growth. Additionally, our suppliers
sometimes restrict the advertising, promotion and method of distribution of
their merchandise. These restrictions in turn may make it more difficult for us
to quickly sell these items from our inventory. Although we believe our
relationships with our suppliers are good, we do not have long-term agreements
with any supplier. As a result, we must continuously seek out buying
opportunities from our existing suppliers and from new sources. We compete for
these opportunities with other wholesalers and retailers, discount and
deep-discount chains, mass merchandisers, food markets, drug chains, club stores
and various privately-held companies and individuals. Although we do not depend
on any single supplier or group of suppliers and believe we can successfully
compete in seeking out new suppliers, a disruption in the availability of
merchandise at attractive prices could impair our business.
19
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, 2002
and 2003, we recorded net inventory value of $83.2 million and $105.6 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 balance sheet. However, we may not be able to do so. If
we sell large portions of our inventory at amounts less than their carrying
value or if we write down a significant part of our inventory, our cost of
sales, gross profit, operating income and net income could suffer greatly during
the period in which such event or events occur. Margins could also be negatively
affected should the grocery category sales continue to expand in importance and
become a larger percentage of total sales in the future.
WE FACE STRONG COMPETITION
We compete in both the acquisition of inventory and sale of merchandise
with other wholesalers, discount and deep-discount stores, single price point
merchandisers, mass merchandisers, food markets, drug chains, club stores and
other retailers. In the future, new companies may also enter the deep-discount
retail industry. Additionally, we currently face increasing competition for the
purchase of quality close-out and other special-situation merchandise. Some of
our competitors have substantially greater financial resources and buying power
than 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 AND HEALTHCARE COSTS
Our ability to provide quality merchandise at our 99 Cents price point
could be hindered by certain economic factors beyond our control, including but
not limited to:
- - increases in inflation;
- - increases in operating costs;
- - increases in employee healthcare costs;
- - increases in workers' compensation benefits;
- - increases in prevailing wage levels;
- - increases in legal costs;
- - increases in government regulatory cost and
- - decreases in consumer confidence levels.
In January 2001, California enacted a minimum wage increase of $0.50 per
hour with an additional $0.50 increase required in January 2002. In 2001 and
2002, annual payroll expenses as a percentage of sales increased less than 1.0%.
Self-insured workers' compensation reserves are subject to actuarial reviews,
which could increase the overall cost of workers' compensation benefits. Because
we provide consumers with merchandise at a 99 cents fixed price point, we
typically cannot pass on cost increases to our customers.
WE FACE RISKS ASSOCIATED WITH INTERNATIONAL SALES AND PURCHASES
Although international sales historically have not been important to our
overall net sales, they have contributed to historical growth in Bargain
Wholesale's net sales. In addition, some of the inventory we purchase is
manufactured outside the United States. There are many risks associated with
doing business internationally. Our international transactions may be subject to
risks such as:
- - political instability;
- - currency fluctuations;
- - exchange rate controls;
- - changes in import and export regulations; and
- - changes in tariff and freight rates.
The United States and other countries have also proposed various forms of
protectionist trade legislation. Any resulting changes in current tariff
structures or other trade policies could lead to fewer purchases of our products
and could adversely affect our international operations.
WE COULD ENCOUNTER RISKS RELATED TO TRANSACTIONS WITH OUR AFFILIATES
We currently lease 12 of our 99 Cents Only Stores and a parking lot for one
of these stores from certain members of the Gold family and their affiliates.
Our annual rental expense for these facilities totaled approximately $2.2 and
$2.1 million in each of 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.
20
WE RELY HEAVILY ON OUR MANAGEMENT TEAM
Our success depends substantially on David Gold and Eric Schiffer, our
Chief Executive Officer and President, respectively. We also rely on the
continued service of our executive officers and other key management. We have
not entered into employment agreements with any of our executive officers and we
do not maintain key person life insurance on them. As we continue to grow, our
success will depend on our ability to identify, attract, hire, train, retain and
motivate other highly skilled management personnel. Competition for such
personnel is intense, and we may not be able to successfully attract, assimilate
or retain sufficiently qualified candidates.
OUR OPERATING RESULTS MAY FLUCTUATE AND MAY BE AFFECTED BY SEASONAL BUYING
PATTERNS
Historically, our highest net sales and operating income have occurred
during the fourth quarter, which includes the Christmas and Halloween selling
seasons. During 2002 and 2003, we generated approximately 29.5% and 28.7%,
respectively, of our net sales and approximately 32.7% and 26.6% respectively,
of our operating income during the fourth quarter. If for any reason the
Company's net sales were to fall below norms during the fourth quarter it could
have an adverse impact on our profitability and impair our results of operations
for the entire year. Adverse weather conditions or other disruptions during the
peak holiday season could also affect our net sales and profitability for the
year.
In addition to seasonality, many other factors may cause our results of
operations to vary significantly from quarter to quarter. Some of these factors
are beyond our control. These factors include:
- - the number of new stores and timing of new store openings;
- - the level of advertising and pre-opening expenses associated with new stores;
- - the integration of new stores into our operations;
- - general economic health of the deep-discount retail industry;
- - changes in the mix of products sold;
- - unexpected increases in shipping costs;
- - ability to successfully manage our inventory levels;
- - changes in our personnel;
- - fluctuations in the amount of consumer spending;
- - the amount and timing of operating costs and capital expenditures relating to
the growth of our business.
WE ARE SUBJECT TO ENVIRONMENTAL REGULATIONS
Under various federal, state and loc