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99 CENTS ONLY STORES 10-K 2007 Documents found in this filing:UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
Commission
file number 1-11735
99¢
Only Stores
(Exact
name of registrant as specified in its charter)
Registrant's
telephone number, including area code: (323) 980-8145
Securities
registered pursuant to Section 12(b) of the Act:
Securities
registered pursuant to Section 12(g) of the Act: None
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 the Securities Act.
Yes £
No x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes £
No x
Indicate
by check mark whether the registrant: (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports) and (2) has been subject to such filing requirements
for
the last 90 days. Yes £
No x
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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
one)
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
Yes
£
No
x
The
aggregate market value of Common Stock held by non-affiliates of the Registrant
on September 30, 2006 was $554,394,779 based on a $11.83 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, 69,937,297 Shares as of February 28, 2007
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¢ 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 potential investors and 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 Annual Report, for the reasons, among others, discussed in
the
Section “Management’s Discussion and Analysis of Financial Condition and Results
of Operations” and “Risk Factors.” The Company undertakes no obligation to
publicly revise these forward-looking statements to reflect events or
circumstances that arise after the date hereof. Readers should carefully review
the risk factors described in this Annual 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.
EXPLANATORY
NOTE REGARDING DATE OF FILING AND SUBSEQUENT EVENT
ANALYSIS
The
consolidated financial statements as of and for the period ended March 31,
2006,
including footnote disclosures, are reflective of the ultimate resolution of
various uncertainties and contingent matters which existed as of March 31,
2006.
In recording estimated carrying amounts of certain assets and liabilities,
the
Company considered the impact of events and transactions which occurred during
the extended period of time subsequent to March 31, 2006 through the issuance
date of these consolidated financial statements.
EXPLANATORY
NOTE REGARDING CHANGE IN FISCAL YEAR
On
December 30, 2005 the Company changed its fiscal year-end from December 31
to
March 31 (see “Notes to Consolidated Financial Statements”). Unless specifically
indicated otherwise, any reference to “2006” or “fiscal 2006” relates to as of
or for the year ended March 31, 2006 and any reference to “2004” and “2003” or
“fiscal 2004”and “fiscal 2003” relate to as of or for the years ended December
31, 2004 and 2003, respectively. References to fiscal 2007 refer to the period
from April 1, 2006 to March 31, 2007. The transition period, January 1 to March
31, 2005, is referred to as the “transition period”.
Item
1.
Business
99¢
Only
Stores (the “Company”) is a deep-discount retailer of consumable general
merchandise with an emphasis on name-brand products. The Company’s stores offer
a wide assortment of regularly available consumer goods as well as a broad
variety of closeout merchandise. As of March 31, 2006, the Company operated
232
retail stores with 164 in California, 36 in Texas, 21 in Arizona, and 11 in
Nevada. These stores averaged approximately 22,200 gross square feet. In fiscal
2006, the Company’s stores open for the full year generated average net sales
per estimated saleable square foot of $250, which the Company believes is among
the highest in the deep discount retail industry, and average net sales per
store of $4.3 million, which the Company believes is the highest among all
dollar store chains. The Company entered the Texas market in June 2003. In
fiscal 2006, 186 non-Texas stores open for the full year averaged net sales
of
$4.7 million per store and $283 per estimated saleable square foot and the
36
Texas stores open for the full year averaged net sales of $2.3 million per
store
and $111 per estimated saleable square foot.
The
Company competes in the deep-discount retail industry, which it believes is
one
of the fastest growing retail sectors in the United States. The Company opened
its first 99¢ Only Stores in 1982 and believes that it operates the nation’s
oldest existing single-price-point general merchandise chain. From January
1,
2005 through March 31, 2006 (which includes the transition period and fiscal
2006), the Company opened 15 new stores, including three in Texas, relocated
one
smaller California store and closed one store due to eminent domain. In fiscal
2006, the Company slowed its planned new store growth rate to focus on the
improvement of its systems infrastructure, business processes, and internal
controls to better enable the Company to support its existing stores and
establish a foundation for accelerated growth. For fiscal 2007 the Company
expanded its store base, opening 19 stores. Of the store openings, five stores
are located in the Company’s Texas markets. Starting in fiscal 2008, the Company
plans to increase its store opening rate by expanding in existing markets and
new markets to be served primarily by its existing distribution centers as
the
first step in the Company’s long-term plan to become a premier nationwide
deep-discount retailer.
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
exposing the Company to a broader selection of opportunistic buys and generating
additional sales with relatively small incremental operating expenses. Bargain
Wholesale represented 3.8% of the Company’s total sales in fiscal 2006.
Change
in Fiscal Year End
On
December 30, 2005, the Company’s Board of Directors approved a change in the
fiscal year-end from December 31 to March 31. The Board determined this was
in
the best interests of the Company’s shareholders, because this change separates
year-end procedures such as physical inventories from the Christmas holiday
season, helps to enhance operational focus on holiday period execution and
reduces fiscal year end costs associated with accounting and audit procedures.
With new auditors recently engaged at the time of this change, the Company
believes this was an appropriate time to make this beneficial transition, which
also allowed additional time to perform Sarbanes-Oxley Section 404 assessment,
remediation and audit procedures for the period covered in this
report.
Industry
The
Company participates primarily in the deep-discount retail industry with its
99¢
Only Stores. Deep-discount retail is distinguished from other retail formats
in
that substantial portions of purchases are acquired at prices substantially
below original wholesale cost through closeouts, manufacturer overruns, and
other special-situation merchandise transactions. As a result, a substantial
portion of the product mix is comprised of a frequently changing selection
of
specific brands and products. Special-situation merchandise is complemented
by
re-orderable merchandise which is also often purchased below normal wholesale
prices. Deep-discount retail is also distinguished by offering this merchandise
to customers at prices significantly below typical retail prices.
The
Company considers closeout merchandise as any item that is not generally
re-orderable on a regular basis. Closeout 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, changes in nutritional label guidelines, the inability
to move merchandise effectively through regular channels, reduction of excess
seasonal inventory, discontinuation of test-marketed items, products close
to
their “best when used by” date, and the financial needs of the supplier.
Most
deep-discount retailers also sell merchandise that can be purchased from a
manufacturer or wholesaler on a regular basis. Although this merchandise can
often be purchased at less than normal wholesale and sold below normal retail,
the discount, if any, is generally less than with closeout merchandise.
Deep-discount retailers sell regularly available merchandise to provide a degree
of consistency in their product offerings and to establish themselves as a
reliable source of basic goods.
The
Company also sells wholesale merchandise, which is generally obtained through
the same or shared opportunistic purchases of the retail operations and sold
through its Bargain Wholesale division. The Company maintains showrooms at
the
Company’s main distribution facility in California and at the Company’s
distribution facility outside Houston, Texas. Additionally, the Company has
a
showroom located in Chicago. Advertising of wholesale merchandise is conducted
primarily at trade shows and by catalog mailings to past and potential
customers. Wholesale customers include a wide and varied range of major national
and regional retailers, as well as smaller retailers, distributors, and
wholesalers.
Wholesale
sales are recognized in accordance with the shipping terms agreed upon on the
sales order. Wholesale sales are generally recognized under FOB origin where
title and risk of loss pass to the buyer when the merchandise leaves the
Company’s distribution facility.
Business
Mission and Strategy
The
Company’s mission is to provide a primary shopping destination for
price-sensitive consumers and a fun treasure-hunt shopping experience for other
value conscious consumers for food and other basic household items. The
Company’s core strategy is to offer only good to excellent values on a wide
selection of quality food and basic household items with a focus on name brands
and an exciting assortment of surprises, all for 99¢ or less, in attractively
merchandised, clean and convenient stores. The Company’s strategies to achieve
its mission 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¢ or less.
During fiscal 2006, the Company purchased merchandise from more than 999
suppliers, including 3M, American Greetings, Colgate-Palmolive, Con Agra, Dole,
Eveready Battery, General Mills, Georgia Pacific, Heinz, Hershey Foods, Johnson
& Johnson, Kellogg’s, Kraft, Mattel, Nestle, Procter & Gamble, Revlon,
and Unilever.
Broad
Selection of Regularly Available Merchandise.
The
Company offers consumer items in each of the following staple product
categories: food (including frozen, refrigerated, and produce items), beverages,
health and beauty care, household products (including cleaning supplies, paper
goods, etc.), housewares (including glassware, kitchen items, etc.), hardware,
stationery, party goods, seasonal goods, baby products, toys, giftware, pet
products, plants and gardening, clothing, electronics and entertainment. The
Company carries name-brand merchandise, off-brands and its own private-label
items. The Company believes that by consistently offering a wide selection
of
basic household consumable items, the Company encourages customers to shop
at
the stores for their everyday household needs, which the Company believes leads
to an increased frequency of customer visits.
Fun
Treasure-Hunt Shopping Experience.
The
Company’s practices of buying closeouts and other opportunistic purchases and
selling them for 99¢ or less, typically dramatically below retail prices, helps
to create a sense of fun and excitement. The constantly changing selection
of
these special extreme values, often in limited quantities, helps to create
a
sense of urgency when shopping, increase shopping frequency and to generate
customer goodwill, loyalty and great awareness via word-of-mouth.
Attractively
Merchandised and Well-Maintained Stores.
The
Company strives to provide its customers an exciting shopping experience in
customer-service-friendly stores that are attractively merchandised, brightly
lit and well maintained. The Company’s stores are laid out with items in the
same category grouped together. The shelves are generally restocked throughout
the day. The Company believes that offering merchandise in an attractive,
convenient and familiar environment creates a store that is appealing 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 closeout merchandise at discounted prices. A
number of consistent behaviors have contributed to building the Company’s
reputation, including its willingness and consistent practice over many years
to
take on large volume purchases and take possession of merchandise immediately,
its ability to pay cash or accept abbreviated credit terms, its commitment
to
honor all issued purchase orders, and its willingness to purchase goods close
to
a target season or out of season. The Company’s experienced buying staff, with
the ability to make immediate buying decisions, also enhances its strong
supplier relationships. The Company believes its relationships with suppliers
are further enhanced by its ability to minimize channel conflict for the
manufacturer. 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
be exposed to a broader selection of opportunistic buys and to generate
additional sales with relatively small incremental operating expense. The
Bargain Wholesale division sells to local, regional, national, and international
accounts. The Company maintains showrooms in Los Angeles, where it is based,
as
well as Houston, and Chicago.
Savvy
Purchasing. The
Company purchases merchandise at substantially discounted prices as a result
of
its buyers’ knowledge and experience in their respective categories, its
negotiating ability, and its established reputation among its suppliers. The
Company applies its aggressive negotiating approach to its purchasing of
corporate supplies, construction, and services and strives to maintain a lean
operating environment to reinforce its negotiating posture with suppliers.
Store
Location and Size.
The
Company’s 99¢ Only Stores are conveniently located in freestanding buildings,
neighborhood shopping centers, regional shopping centers or downtown central
business districts, all of which are locations where the Company believes
consumers are likely to do their regular household shopping. As of March 31,
2006, the Company’s 232 existing 99¢ Only Stores average approximately 22,200
gross square feet and the Company currently targets new store locations between
15,000 and 19,000 gross square feet. The Company believes its larger store
size
versus that of other typical “dollar store” chains allows it to more effectively
display a wider assortment of merchandise, carry deeper stock positions, and
provide customers with a more inviting environment that the Company believes
encourages customers to shop longer and buy more. 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 smaller 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. While this strategy was
designed to increase revenues and 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 had a negative
impact on its historical comparable sales growth during the 2004 to fiscal
2005
period.
Experienced
Management Team and Depth of Employee Incentive
Compensation.
99¢ Only
Stores’ management team has many years of retail experience. The Company’s
management believes that employee ownership of the Company has historically
helped build employee pride in its stores. Historically, almost all active
hourly employees with six months tenure and all members of management and the
Board of Directors (other than David Gold, Eric Schiffer, Jeff Gold, and Howard
Gold) were eligible for an annual grant of stock options. As of March 31, 2006,
the Company’s employees held options to purchase an aggregate of 4,532,000
shares of Common Stock, or 6.5% of the outstanding shares of Common Stock.
With
recent changes in accounting pronouncements affecting the financial reporting
of
stock options, management has determined not to grant stock options to all
employees and will evaluate additional or alternative methods for maintaining
employee loyalty in the future.
Growth
Strategy
The
Company’s long-term growth plan is to become a premier nationwide deep-discount
retailer. Management believes that growth, as of the date of this report, will
primarily result from new store openings in its existing markets that include
California, Texas, Arizona and Nevada.
Growth
in Existing Markets.
By
continuing to develop new stores 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. This focus on growth through existing
distribution facilities will help management to focus on implementing scaleable
systems.
Refined
Store Size for Expansion in Texas.
The
Company opened its first Texas stores in June 2003. Its 741,000 square foot
Houston-area distribution center facility, acquired in early 2003 for $23
million in cash, came with warehouse racking, including an automated
pick-to-belt conveyor system, and refrigerated and frozen storage space. The
Company installed the “High Jump” warehouse management system in this facility.
As of March 31, 2006, the Company had opened a total of 25 stores in the Houston
area and 11 in the Dallas Fort Worth Metroplex. The Texas stores average 20,425
saleable square feet and 26,397 gross square feet, which is larger than the
Company average of 17,414 saleable square feet and 22,204 gross square feet
for
2006. In fiscal 2007, the Company opened five stores in its Texas markets which
are smaller than the average of the existing Texas stores and more aligned
with
the density and unit volumes experienced in this market. The Company currently
believes that there is potential for additional growth in Texas.
Long
Term Geographic Expansion. The
Company’s long term plan is to become a nationwide retailer by opening clusters
of stores in densely populated geographic regions across the country.
The
Company believes that its strategy of consistently offering a broad selection
of
name-brand consumables at value pricing in a convenient store format is portable
to other densely populated areas of the United States. In 1999, the Company
opened its first 99¢ Only Stores location outside the state of California in Las
Vegas, Nevada; Arizona followed in 2001 and Texas in 2003.
Real
Estate Acquisitions. The
Company considers both real estate lease and purchase opportunities and may
consider for future expansion the acquisitions of a chain, or chains, of retail
stores in existing markets or other regions, primarily for the purpose of
acquiring favorable locations in line with its expansion plans.
Retail
Operations
The
Company’s stores offer customers a wide assortment of regularly available
consumer goods, as well as a broad variety of quality, closeout merchandise,
generally at a significant discount from standard retail prices. All merchandise
sold in the Company’s 99¢ Only Stores sells for 99¢ per item or two or more
items for 99¢, except in its Texas stores where items can sell from 9¢ up to
99¢, as long as the price ends in a 9.
The
following table sets forth certain relevant information with respect to the
Company’s retail operations (dollar amounts in thousands, except sales per
square foot):
(a)
Two
smaller stores closed due to the presence of larger nearby 99¢ Only Stores and
one store closed due to eminent domain.
(b)
Store
count includes store activity from January 1, 2005 through March 31, 2006 due
to
the change in fiscal year. The Company operated 223 stores as of March 31,
2005.
(c)
One
store closed due to relocation and one due to an eminent domain
action.
(d)
For
stores open for the entire fiscal year.
(e)
Includes 17 Texas stores open for a full year. Texas stores open for the full
year had average sales of $2.2 million per store in 2004 and average sales
per
saleable square foot of $101. All non-Texas stores open for the full year had
average sales of $4.8 million per store and $293 of average sales per saleable
square foot.
(f)
Includes 36 Texas stores open for a full year. Texas stores open for the full
year had average sales of $2.3 million per store for 12 months ended March
31,
2006 and average sales per saleable square foot of $111. All non-Texas stores
open for the full year had average sales of $4.7 million per store and $283
of
average sales per saleable square foot.
(g)
Change in comparable store net sales compares net sales for all stores open
at
least 15 months.
Merchandising. All
of
the Company’s stores offer a broad variety of first-quality, name-brand and
other closeout merchandise as well as a wide assortment of regularly available
consumer goods. The Company also carries private-label consumer products made
for the Company. The Company believes that the success of its 99¢ Only Stores
concept arises in part from the value inherent in selling consumable items
for
only 99¢ or less per item or group of items, many of which are name-brands, and
most of which typically retail elsewhere from $1.19 to $9.99.
Approximately
half of the merchandise purchased by the Company is available for reorder
including many branded consumable items. The mix and the specific brands of
merchandise frequently change, depending upon the availability of closeout
and
other special-situation merchandise at suitable prices. Since commencing its
closeout purchasing strategy for its stores, which first opened in 1982, the
Company has been able to obtain sufficient name-brand closeouts as well as
re-orderable merchandise at attractive prices. Management believes that the
frequent changes in specific name-brands and products 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,
fun
and excitement. Unlike many discount retailers, the Company rarely imposes
limitations on the quantity of specific value-priced 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 card, debit card or EBT (electronic benefit transfers). The Company’s
stores currently do not accept checks or manufacturer’s coupons. The Company’s
stores are open every day except Christmas, with operating hours designed to
meet the needs of families.
Store
Size, Layout and Locations. 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 configuration of the individual location.
The interior of each store is designed to reflect a generally uniform format,
featuring attractively displayed products in windows, consistent merchandise
display techniques, bright lighting, lower shelving height that allows
visibility throughout the store, customized check-out counters and a distinctive
color scheme on its interior and exterior signage, price tags, shopping carts,
baskets 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, changed frequently, and often incorporate seasonal themes.
The Company believes that the frequently changing value priced name-brands,
convenient and inviting layout, and the lower shelving height, help encourage
the typical customer to shop more of the whole store.
Advertising.
Advertising expenditures were $3.8 million, $5.6 million and $4.4 million for
fiscal 2003, 2004 and 2006 respectively, or 0.4%, 0.6% and 0.4% of net retail
sales, respectively. The Company allocates the majority of its advertising
budget to print advertising. The Company’s advertising strategy, which it
manages without the assistance of an outside agency, emphasizes the offering
of
nationally recognized, name-brand merchandise at significant savings. The
Company manages 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 usually includes the sale of nine
televisions or iPods and other high value items for 99¢ each, grand openings
often attract long lines of customers and receive media coverage.
Purchasing
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 appeal and interest at prices lower than regular wholesale. The Company
purchases most merchandise directly from the manufacturer. 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, distributing marketing brochures, cold calling, and
obtaining referrals.
The
Company seldom has 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 5.0% of the Company’s
total purchases in fiscal 2006. During fiscal 2006, the Company purchased
merchandise from more than 999 suppliers, including 3M, American Greetings,
Colgate-Palmolive, Con Agra, Dole, Eveready Battery, General Mills, Georgia
Pacific, Heinz, Hershey Foods, Johnson & Johnson, Kellogg’s, Kraft, Mattel,
Nestle, Procter & Gamble, Revlon, and Unilever. Many of these companies have
been supplying products to the Company for over twenty years.
A
significant portion of the merchandise purchased by the Company in fiscal 2006
was closeout 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 Company’s buyers search continuously
for closeout opportunities. The Company’s experience and expertise in buying
merchandise has enabled it to develop relationships with many manufacturers
that
frequently offer some or all of their closeout 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) commitment to honor all issued
purchase orders and (vi) willingness to purchase goods close to a target season
or out of season. The Company believes its relationships with its suppliers
are
further enhanced by its ability to minimize channel conflict for a manufacturer.
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
Stock Keeping Units (“SKU’s”) per product category, which allows the Company to
make purchases in large volumes.
The
Company develops new private label consumer products to broaden the assortment
of merchandise that is consistently available. The Company also imports
merchandise, especially in product categories such as kitchen items,
house-wares, toys, seasonal products, pet-care and hardware which the Company
believes are not brand sensitive to consumers.
Warehousing
and Distribution
An
important aspect of the Company’s purchasing strategy involves its ability to
warehouse and distribute merchandise quickly and with flexibility. The Company’s
distribution centers are strategically located to enable quick turnaround of
time-sensitive product as well as to provide long-term warehousing capabilities
for one-time closeout purchases and seasonal or holiday items. The large
majority of the merchandise sold by the Company is received, processed for
retail sale if necessary, and then distributed to the retail locations from
Company operated warehouse and distribution facilities.
The
Company utilizes its internal fleet, outside carriers, and contracted or
owner-operated trucks for both outbound shipping and a backhaul program. The
Company also receives merchandise shipped by rail to its Commerce, California
distribution center which has a railroad spur on the property. The Company
uses
only common carriers or owner-operators to deliver to stores outside of Southern
California including its stores in Texas, Arizona and Nevada. The Company
believes that its current California and Texas distribution centers will be
able
to support its anticipated growth throughout fiscal 2008. However, there can
be
no assurance that the Company’s existing warehouses will provide adequate
storage space for the Company’s long-term storage needs, that an opportunistic
purchase may not temporarily pressure warehouse capacity, or that the Company
will not make changes, including capital expenditures, to expand or otherwise
modify its warehousing and distribution operations.
The
Company arranges with vendors of certain merchandise (including some perishable
products such as ice cream and bread) to ship directly to its store locations.
The Company's primary distribution practice, however, is to have merchandise
delivered from its vendors to the Company's warehouses, where it is stored
for
timely shipment to its store locations.
Information
pertaining to warehouse and distribution facilities is described under
Item 2. Properties.
Information
Systems
In
fiscal
2006 and during the subsequent period to the date of this report, the Company
made significant investments in a variety of infrastructural and process areas.
These improvements included upgrades to the data center, networking
infrastructure, and Wide Area Network (“WAN”) intended to improve security and
reliability of processing. The Company has adopted formal control objectives
and
has deployed a compliance and self assessment program for key controls in its
information systems and technology internal controls framework.
Also
during this timeframe, the Company implemented the rollout of Highjump
Software’s “Warehouse Advantage” warehouse management system (WMS) in its cold
storage facility in Commerce, CA and much of its operations within its primary
Commerce distribution center. Each deployment of the Highjump WMS and the
associated Voxware voice-picking system moves the Company closer to its goal
of
real-time detailed inventory control and management.
Additionally,
in fiscal 2006 the first application from Business Objects’ data warehouse and
business intelligence, a store performance dashboard, was rolled out to the
stores for use by store management personnel.
The
Company currently operates financial, accounting, human resources, and payroll
data processing using Lawson Software’s Financial and Human Resource Suites on
an SQL database running on a Windows operating system. Various upgrades and
deployments of new functionality are in progress using the Lawson system,
primarily intended to streamline financial data gathering and
reporting.
The
Company also operates a separate IBM UNIX-based inventory control system
developed in-house. The Company uses an in-house developed proprietary store
ordering system, which utilizes radio frequency hand-held scanning devices
in
each store. This system is processed using a back office personal computer
system at each store.
The
Company has begun the implementation of a new Core Merchandising system (CMS)
which, in combination with the Highjump WMS, will replace the majority of the
functionality of the existing in-house proprietary inventory control and store
ordering systems. During fiscal 2007, the Company implemented operational
changes using existing systems to improve inventory transaction controls and
to
prepare for implementation of the CMS.
The
Company utilizes an in-house developed Point of Sale (“POS’’) barcode scanning
system to record and process retail sales in each of its stores.
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,
wholesalers, and other retailers. Industry competition for acquiring closeout
merchandise also includes a large number of retail and wholesale 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 closeout 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 its competitors. In addition, the Company may face intense
competition in the future from new entrants in the deep-discount retail industry
that could have an adverse effect on the Company’s business and results of
operations.
Employees
At
March
31, 2006, the Company had 9,690 employees: 8,849 in its retail operation, 504
in
its warehousing and distribution operation, 264 in its corporate offices and
73
in its Bargain Wholesale division. The Company considers relations with its
employees to be good. The Company offers certain benefits, including health
insurance, vacation benefits, an employee discount purchase plan, holiday
premium pay, and a 401(k) plan to most of its employees as well as an
executive-deferred compensation plan for certain key management. Additionally,
almost all active hourly employees with six months tenure and all members of
management and the Board of Directors (other than David Gold, Eric Schiffer,
Jeff Gold, and Howard Gold) have been eligible for an annual grant of stock
options. With recent changes in accounting pronouncements affecting the
financial accounting of stock options, management has determined not to
distribute stock options to all employees and will evaluate additional or
alternative methods for maintaining employee loyalty in the future.
None
of
the Company’s employees are party to a collective bargaining agreement and none
are represented by a labor union.
Trademarks
and Service Marks
“99¢
Only
Stores,” “Rinso,” and “Halsa” are among the Company’s service marks and
trademarks, and are listed on the United States Patent and Trademark Office
Principal Register. “Bargain Wholesale” is among the fictitious business names
used by the Company. Management believes that the Company’s trademarks, service
marks, and fictitious business names are an important but not critical element
of the Company’s merchandising strategy. The Company is involved in litigation
against certain of those whom it believes are infringing upon its “99¢” family
of marks, although the Company believes that simultaneous litigation against
all
persons everywhere whom the Company believes to be infringing upon these marks
is not feasible.
Environmental
Matters
Under
various federal, state, and local environmental laws and regulations, current
or
previous owners or occupants of property may face liability associated with
hazardous substances. These laws and regulations often impose liability without
regard to fault. In the future the Company may be required to incur substantial
costs for preventive or remedial measures associated with hazardous materials.
The Company has several storage tanks at its warehouse facilities, including:
an
aboveground and an underground diesel storage tank at the main Southern
California warehouse; ammonia storage at the Southern California cold storage
facility and the Texas warehouse; aboveground diesel and propane storage tanks
at the Texas warehouse; an aboveground propane storage tank at the main Southern
California warehouse; and an aboveground propane tank located at the warehouse
the Company owns in Eagan, Minnesota. Although the Company has not been notified
of, and is not aware of, any material current environmental liability, claim
or
non-compliance, the Company could incur costs in the future related to its
owned
properties, leased properties, storage tanks, or other business properties
and/or activities. In the ordinary course of business, the Company handles
or
disposes of commonplace household products that are classified as hazardous
materials under various environmental laws and regulations.
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 are available on the same day that they are electronically filed
with or furnished to the Securities and Exchange Commission by the
Company.
Item
1A. Risk Factors
Inflation
may affect the Company’s ability to sell merchandise at the 99¢ price
point
The
Company’s ability to provide quality merchandise for profitable resale within
the 99¢ price point is subject to certain economic factors, which are beyond the
Company’s control. Inflation could have a material adverse effect on the
Company’s business and results of operations, especially given the constraints
on the Company’s ability to pass on incremental costs due to price increases or
other factors. A sustained trend of significantly increased inflationary
pressure could require the Company to abandon its 99¢ price point, which could
have a material adverse effect on its business and results of operations.
However, the Company can pass price increases on to customers to a degree,
such
as by selling smaller units for the same price and by selling fewer units for
$0.99 in the case of items sold at two or more for $0.99. See also “The Company
is vulnerable to uncertain economic factors, changes in the minimum wage, and
increased workers’ compensation and healthcare costs” for a discussion of
additional risks attendant to inflationary conditions.
The
Company has identified material weaknesses in internal control over financial
reporting
The
Company received an adverse opinion on the effectiveness of its internal control
over financial reporting as of March 31, 2006 because of material weaknesses
identified in management’s assessment of the effectiveness of such internal
control as of that date related to significant deficiencies in merchandise
inventory management and financial reporting. These material weaknesses, if
not
remediated, create an increased risk of misstatement of the Company’s financial
results, which, if material, may require future restatement thereof. A failure
to implement improved internal controls, or difficulties encountered in their
implementation or execution, could cause the Company future delays in its
reporting obligations and could have a negative effect on the Company and the
trading price of the Company’s common stock. See “Item 9A. Controls and
Procedures,” for more information on the status of the Company’s internal
control over financial reporting.
The
Company is dependent primarily on new store openings for future
growth
The
Company’s ability to generate growth in sales and operating income depends
largely on its ability to successfully open and operate new stores outside
of
its traditional core market of Southern California and to manage future growth
profitably. The Company’s strategy depends on many factors, including its
ability to identify suitable markets and sites for new stores, negotiate leases
or purchases with acceptable terms, refurbish stores, successfully compete
against local competition and the increasing presence of large and successful
companies entering or expanding into the markets that the Company operates
in,
upgrade its financial and management information systems and controls, gain
brand recognition and acceptance in new markets, and manage operating expenses
and product costs. In addition, the Company must be able to hire, train,
motivate, and retain competent managers and store personnel at increasing
distances from the Company’s headquarters. Many of these factors are beyond the
Company’s control or are difficult to manage. As a result, the Company cannot
assure that it will be able to achieve its goals with respect to growth. Any
failure by the Company to achieve these goals on a timely basis, differentiate
itself and obtain acceptance in markets in which it currently has limited or
no
presence, attract and retain management and other qualified personnel,
appropriately upgrade its financial and management information systems and
controls, and manage operating expenses could adversely affect its future
operating results and its ability to execute the Company’s business strategy.
A
variety
of factors, including store location, store size, local demographics, rental
terms, competition, the level of store sales, availability of locally sourced
as
well as intra-Company distribution of merchandise, locally prevailing wages
and
labor pools, distance and time from existing distribution centers, and the
level
of initial advertising influence if and when a store becomes profitable.
Assuming that planned expansion occurs as anticipated, the store base will
include a portion of stores with relatively short operating histories. New
stores may not achieve the sales per estimated saleable square foot and
store-level operating margins historically achieved at existing stores. If
new
stores on average fail to achieve these results, planned expansion could produce
a further decrease in overall sales per estimated 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 operating margins. New stores opened in existing
and
in new markets have in the past and may in the future be less profitable than
existing stores in the Company’s core Southern California market and/or may
reduce retail sales of existing stores, negatively affecting comparable store
sales.
The
Company’s operations are concentrated in California; Natural disaster risk in
all markets
As
of
March 31, 2006, all but 68 of our 232 stores were located in California (with
36
stores in Texas, 21 stores in Arizona and 11 stores in Nevada). The Company
expects that it will continue to open additional stores in California, as well
as in other states. For the foreseeable future, the Company’s results of
operations will depend significantly on trends in the California economy. If
retail spending declines due to an economic slow-down or recession in
California, the Company’s operations and profitability may be negatively
impacted. California has also historically enacted minimum wages that exceed
federal standards (and certain of its cities have enacted “living wage” laws
that exceed State minimum wage laws), it is widely believed that it will soon
do
so again, and it typically has other factors making compliance, litigation
and
workers’ compensation claims more prevalent and costly.
In
addition, the Company historically has been vulnerable to certain natural
disasters and other risks, such as earthquakes, fires, floods, tornados,
hurricanes, and civil disturbances. At times, these events have disrupted the
local economy. These events could also pose physical risks to the Company’s
properties. Furthermore, although the Company maintains standard property and
business interruption insurance, the Company does not maintain earthquake
insurance on its facilities and business or insure other risks which are not
normally insured such as acts of war and acts of terrorism.
The
Company could experience disruptions in receiving and
distribution
The
Company’s success depends upon whether receiving and shipments are organized and
well managed. As the Company continues to grow, it may face increased or
unexpected demands on warehouse operations, as well as unexpected demands on
its
transportation network, and new store locations receiving shipments from
distribution centers that are increasingly further from the new stores that
they
serve will increase transportation costs and may create transportation
scheduling strains. The very nature of the Company’s closeout business makes it
uniquely susceptible to periodic and difficult to foresee warehouse/distribution
center overcrowding caused by spikes in inventory resulting from opportunistic
closeout purchases. Such demands could cause delays in delivery of merchandise
to and from warehouses and/or to stores. The Company is also in the process
of
implementing new warehouse distribution and merchandising systems and has
experienced problems with the warehousing, distribution and merchandising
systems being replaced. A fire, earthquake, or other disaster at our warehouses
could also hurt our business, financial condition and results of operations,
particularly because much of the merchandise consists of closeouts and other
irreplaceable products. The Company also faces the possibility of future labor
unrest that could disrupt our receiving, processing, and shipment of
merchandise.
The
Company could be exposed to product liability or packaging violation
claims
The
Company purchases many products on a closeout basis, some of which are of an
unknown origin and/or are manufactured or distributed by overseas entities,
and
some of which are purchased through brokers as opposed to original manufacturing
and supply sources. The closeout nature of many of the products may limit the
Company’s opportunity to conduct product testing, label and ingredient analysis
and other diligence as to these products, including compliance with particular
State by State regulations. The Company is not listed as an additional insured
for certain products and/or by certain product vendors, and general insurance
may not provide full coverage in certain instances. This could result in
unanticipated future losses from product liability or packaging violation
claims. For example, the Environmental Protection Agency is investigating the
Company’s past purchase of a product that it claims was not properly labeled
and/or registered, and the California Air Resources Board is investigating
product compliance with State pollution regulations, which may result in future
action by the agencies, such as the imposition of penalties against the
Company.
The
Company depends upon its relationships with suppliers and the availability
of
closeout and special-situation merchandise
The
Company’s success depends in large part on its ability to locate and purchase
quality closeout and special-situation merchandise at attractive prices. This
results in a mix of name-brand and other merchandise within the 99¢ price point.
The Company cannot be certain that such merchandise will continue to be
available in the future at prices consistent with the Company business plan
and/or historical costs. Further, the Company may not be able to find and
purchase merchandise in necessary quantities. Additionally, suppliers sometimes
restrict the advertising, promotion and method of distribution of their
merchandise. These restrictions in turn may make it more difficult for the
Company to quickly sell these items from inventory. Although the Company
believes its relationships with suppliers are good, the Company typically does
not have long-term agreements or pricing commitments with any suppliers. As
a
result, the Company must continuously seek out buying opportunities from
existing suppliers and from new sources. There is increasing competition for
these opportunities with other wholesalers and retailers, discount and
deep-discount stores, mass merchandisers, food markets, drug chains, club
stores, and various other companies and individuals as the deep discount retail
segment continues to expand outside and within existing retail channels. There
is also a growth in consolidation among vendors and suppliers of merchandise
targeted by the Company. A disruption in the availability of merchandise at
attractive prices could impair our business.
The
Company purchases in large volumes and its inventory is highly
concentrated
To
obtain
inventory at attractive prices, the Company takes advantage of large volume
purchases, closeouts and other special situations. As a result, inventory levels
are generally higher than other discount retailers and from time to time this
can result in an over-capacity situation in the warehouses and place stress
on
the Company’s warehouse and distribution operations as well as the back rooms of
its retail stores. The Company’s short-term and long-term store and warehouse
inventory approximated $155.8 million, $136.6 million and $143.9 million at
December 31, 2004, March 31, 2005 and March 31, 2006, respectively. The Company
periodically reviews the net realizable value of its inventory and makes
adjustments to its carrying value when appropriate. The current carrying value
of inventory reflects the Company’s belief that it will realize the net values
recorded on the balance sheet. However, the Company may not do so, and if it
does, this may result in overcrowding and supply chain difficulties. If the
Company sells large portions of inventory at amounts less than their carrying
value or if it writes down or otherwise disposes of a significant part of
inventory, cost of sales, gross profit, operating income, and net income could
decline significantly during the period in which such event or events occur.
Margins could also be negatively affected should the grocery category sales
become a larger percentage of total sales in the future, and by increases in
shrinkage and spoilage from perishable products.
The
Company faces strong competition
The
Company competes in both the acquisition of inventory and sale of merchandise
with other wholesalers and retailers, discount and deep-discount stores, single
price point merchandisers, mass merchandisers, food markets, drug chains, club
stores and other retailers. It also competes for retail real estate sites.
In
the future, new companies may also enter the deep-discount retail industry.
It
is also becoming more common for superstores to sell products competitive with
our own. Additionally, the Company currently faces increasing competition for
the purchase of quality closeout and other special-situation merchandise, and
some of these competitors are entering or may enter the Company’s traditional
markets. In addition, as it expands, the Company will enter new markets where
its own brand is weaker and established brands are stronger, and where its
own
brand value may have been diluted by other retailers with similar names
appearances and/or business models. Some of the Company’s competitors have
substantially greater financial resources and buying power than the Company
does, as well as nationwide name-recognition and organization. The Company’s
capability to compete will depend on many factors including the ability to
successfully purchase and resell merchandise at lower prices than competitors
and the ability to differentiate itself from competitors that do not share
the
Company’s price and merchandise attributes, yet may appear similar to
prospective customers. The Company also faces competition from other retailers
with similar names and/or appearances. The Company cannot assure it will be
able
to compete successfully against current and future competitors in both the
acquisition of inventory and the sale of merchandise.
The
Company is vulnerable to uncertain economic factors, changes in the minimum
wage, and increased workers’ compensation and healthcare
costs
The
Company’s future results of operations and ability to provide quality
merchandise within the 99¢ price point could be hindered by certain economic
factors beyond its control, including but not limited to:
The
Company faces risks associated with international sales and
purchases
International
sales historically have not been important to the Company’s overall net sales.
Some of the Company’s inventory is manufactured outside the United States and
there are many risks associated with doing business internationally.
International transactions may be subject to risks such as:
The
United States and other countries have at times proposed various forms of
protectionist trade legislation. Any resulting changes in current tariff
structures or other trade policies could result in increases in the cost of
and/or reduction in the availability of certain merchandise and could adversely
affect the Company’s ability to purchase such merchandise.
The
Company could encounter risks related to transactions with
affiliates
The
Company leases 13 of its stores and a parking lot for one of those stores from
the Gold family and their affiliates, of which 11 stores are leased on a month
to month basis and are in negotiation for renewal. Under current policy, the
Company only enters into real estate transactions with affiliates for the
renewal or modification of existing leases and on occasions where it determines
that such transactions are in the Company’s best interests. Moreover, the
independent members of the Board of Directors must unanimously approve all
real
estate transactions between the Company and its affiliates. They must also
determine that such transactions are no less favorable to a negotiated
arm’s-length transaction with a third party. The Company cannot guarantee that
it will reach agreements with the Gold family on renewal terms for the
properties it currently leases from them. Also, even if the Company agrees
to
such terms, it cannot be certain that the independent directors will approve
them. If the Company fails to renew one or more of these leases, it would be
forced to relocate or close the leased stores. Any relocations or closures
could
potentially result in significant closure expense and could adversely affect
our
net sales and operating results.
The
Company relies heavily on its executive management team and is transitioning
to
new leadership
David
Gold, who served as the Company’s Chief Executive Officer since it commenced
operations, retired as CEO effective December 31, 2004. Although he remains
Chairman of its Board of Directors, this was nevertheless a substantial change
for the Company and its management team. Effective January 1, 2005, Eric
Schiffer, formerly the Company’s President, became Chief Executive Officer, and
he has established a new and different management style. Jeff Gold, formerly
Senior Vice President of Real Estate and Information Systems, assumed broader
duties as President and Chief Operating Officer, and in addition to Real Estate,
now also oversees the Company’s Retail operations, Logistics and Human Resources
functions. In addition, Howard Gold, who for many years had been in charge
of
the Company’s distribution operations, moved to the newly created position of
Executive Vice President of Special Projects and now also oversees our Bargain
Wholesale division. In November 2005, the Company hired Robert Kautz as its
new
Chief Financial Officer, responsible for the Finance, Information Systems and
Strategic Planning functions. In addition, the Company has added a number of
new
officer level positions in the areas of buying, real estate, information
technology, finance, store operations, loss prevention, distribution and
merchandise planning and allocation. The officers in these positions come from
many different companies and this team must be retained to develop a coordinated
management style.
These
are
very significant changes, implemented over a relatively short period of time.
These officers and executive officers are largely untested in their new
positions, and their success is not assured. The Company also relies on the
continued service of other officers and key managers. With the exception of
Robert Kautz, the Company has not entered into employment agreements with any
of
its executive officers. Also, the Company does not maintain key person life
insurance on any of its officers. The Company’s future success will depend on
its ability to identify, attract, hire, train, retain and motivate other highly
skilled management personnel. Competition for such personnel is intense, and
the
Company may not successfully attract, assimilate or sufficiently retain the
necessary number of qualified candidates.
The
Company’s operating results may fluctuate and may be affected by seasonal buying
patterns
Historically,
the Company’s highest net sales and operating income have occurred during the
quarter ended December 31, which includes the Christmas and Halloween selling
seasons. During fiscal 2004 and 2006, the Company generated approximately 27.4%
and 27.2%, respectively of its net sales during this quarter. If for any reason
the Company’s net sales were to fall below norms during this quarter, it could
have an adverse impact on profitability and impair the results of operations
for
the entire fiscal year. Transportation scheduling, warehouse capacity
constraints, supply chain disruptions, adverse weather conditions, labor
disruptions or other disruptions during the peak holiday season could also
affect net sales and profitability for the fiscal year.
In
addition to seasonality, many other factors may cause the results of operations
to vary significantly from quarter to quarter. These factors, some beyond the
Company’s control, include the following:
The
Company is subject to environmental regulations
Under
various federal, state and local environmental laws and regulations, current
or
previous owners or occupants of property may face liability associated with
hazardous substances. These laws and regulations often impose liability without
regard to fault. In the future the Company may be required to incur substantial
costs for preventive or remedial measures associated with hazardous materials.
The Company has several storage tanks at its warehouse facilities, including:
an
aboveground and an underground diesel storage tank at the main Southern
California warehouse; ammonia storage tanks at the Southern California cold
storage facility and the Texas warehouse; aboveground diesel and propane storage
tanks at the Texas warehouse; an aboveground propane storage tank at the main
Southern California warehouse; and an aboveground propane tank located at the
warehouse the Company owns in Eagan, Minnesota. Although the Company has not
been notified of, and is not aware of, any material current environmental
liability, claim or non-compliance, it could incur costs in the future related
to owned properties, leased properties, storage tanks, or other business
properties and/or activities. In the ordinary course of business, the Company
handles or disposes of commonplace household products that are classified as
hazardous materials under various environmental laws and regulations. The
Company has adopted policies regarding the handling and disposal of these
products, but the Company cannot be assured that its policies and training
are
comprehensive and/or are consistently followed, nor that they will successfully
help the Company avoid potential liability or violations of these environmental
laws and regulations in the future even if consistently followed.
Anti-takeover
effect; Concentration of ownership by existing officers and principal
stockholders
In
addition to some governing provisions in the Company’s Articles of Incorporation
and Bylaws, the Company is also subject to certain California laws and
regulations which could delay, discourage or prevent others from initiating
a
potential merger, takeover or other change in control, even if such actions
would benefit both the Company and its shareholders. Moreover, David Gold,
the
Chairman of the Board of Directors and members of his family (including Eric
Schiffer, Chief Executive Officer, Jeff Gold, President and Chief Operating
Officer and Howard Gold, Executive Vice President of Special Projects) and
certain of their affiliates and the Company’s other directors and executive
officers beneficially own as of February 28, 2007, an aggregate of 23,206,101,
or 33.1%, of the Company’s outstanding common shares. As a result, they have the
ability to influence the Company’s policies and matters requiring a shareholder
vote, including the election of directors and other corporate action, and
potentially to prevent a change in control. This could adversely affect the
voting and other rights of other shareholders and could depress the market
price
of the Company’s common stock.
The
Company’s common stock price could decrease and fluctuate
widely
Trading
prices for the Company’s common stock could decrease and fluctuate significantly
due to many factors, including:
Item
1B. Unresolved Staff Comments
None.
Item
2. Properties
As
of
March 31, 2006, the Company owned 37 stores and leased 195 of its 232 store
locations. Additionally, as of March 31, 2006, the Company owns three parcels
of
land for potential store sites. The Company has an interest in a variable
interest entity that developed a shopping center in La Quinta, California,
in
which it leases a store that opened in December 2005. The Company also has
a 50%
interest in another property which includes a leased store site.
The
Company’s leases generally provide for a fixed minimum rental, and some leases
require additional rental based on a percentage of sales once a minimum sales
level has been reached. Management believes that the Company’s stable operating
history, excellent credit record, and ability to generate substantial customer
traffic give the Company leverage when negotiating lease terms. Certain leases
include cash reimbursements from landlords for leasehold improvements and other
cash payments received from landlords as lease incentives. The Company currently
leases 13 store locations and a parking lot associated with one of these stores
from the Gold family and their affiliates, of which 11 stores are leased on
a
month to month basis and are in negotiation for renewal. The Company enters
into
real estate transactions with affiliates only for the renewal or modification
of
existing leases, and on occasions where it determines that such transactions
are
in the Company’s best interests. Moreover, the independent members of the Board
of Directors must unanimously approve all real estate transactions between
the
Company and its affiliates. They must also determine that such transactions
are
not less favorable to the Company than a negotiated arm’s-length transaction
with a third party. The Company cannot guarantee that it will reach agreements
with the Gold family on renewal terms for the properties the Company currently
leases from them. In addition, even if the Company reaches agreement on such
terms, it cannot be certain that the independent directors will approve them.
If
the Company fails to renew one of these leases, it would be forced to relocate
or close the leased store.
Prior
to
the sale of Universal in 2000, the Company signed documents purporting to
guarantee certain obligations under leases in which Universal, or a
subsidiary, was the lessee. Subsequent to the sale, Universal may have
defaulted on these lease agreements. The Company was potentially
contingently liable for lease payments totaling up to $1.1 million as of
March 31, 2006, as well as additional costs for attorney fees, rent increases
and common area maintenance charges, in connection with three lawsuits brought
by the lessors under these leases. As of June 2006 one of the matters settled,
and the Company has been fully reimbursed for the settlement pursuant to the
guarantees by David and Sherry Gold. The Company and the plaintiffs in the
two
remaining cases have agreed on a tentative settlement of the cases, pursuant
to
which the Company would be responsible for an aggregate payment of $150,000.
This settlement has not yet been reduced to writing or approved by the Court.
The Company anticipates full reimbursement of any such settlement payment or
other obligation in connection with these cases under the guarantees of David
and Sherry Gold. As part of the Universal sale in 2000, David and Sherry Gold
agreed to indemnify the Company for any and all attorney fees, costs, judgments,
settlements or other payments that the Company may make under its guarantees
of
these leases, which indemnity David and Sherry Gold confirmed in writing in
April 2004 and re-executed on August 5, 2005. For further information see
Note 8 “Related Party Transactions” under notes to Consolidated Financial
Statements, included in “Item 8. Financial Statements and Supplementary Data.”
of this Form 10-K.
The
following table sets forth, as of March 31, 2006, information relating to the
calendar year expiration dates of the Company’s current stores leases:
The
large
majority of the Company’s store leases were entered into with multiple renewal
options of typically five-years per option. Historically, the Company has
exercised the large majority of the lease renewal options as they arise, and
anticipates continuing to do so for the majority of leases for the foreseeable
future.
The
Company owns its main warehouse, distribution and executive office facility,
located in the City of Commerce, California. The Company purchased an additional
warehouse storage space nearly adjacent to its main distribution facility for
$9.7 million in July 2005.
The
Company owns a warehouse/distribution center in the Houston area to service
its
Texas operation. See “Growth Strategy - Continued Expansion into
Texas.”
The
Company also owns a cold storage warehouse/distribution center and leases
additional warehouse facilities from time to time located near the City of
Commerce, California.
The
Company also owns a warehouse in Eagan, Minnesota.
Item
3. Legal Proceedings
Gillette
Company vs. 99¢ Only Stores (Los Angeles Superior Court).
The
lawsuit arose out of a dispute over the interpretation of an alleged contract
between the parties, with Gillette alleging that the Company owed Gillette
an
additional amount of approximately $2.0 million (apart from approximately $1.0
million already paid to Gillette for product purchases), together with
pre-judgment interest at ten-percent per annum from the December 1998 date
of
the agreement. On August 9, 2006, the parties agreed upon a settlement under
which the Company would pay Gillette the sum of $540,000 in full settlement
of
this lawsuit and dispute. The parties subsequently entered into a written
settlement agreement and the Company has paid the $540,000 settlement amount
to
Gillette. This amount had been accrued as of March 31, 2006.
Ortiz
and Perez vs. 99¢ Only Stores (U.S. District Court, Southern District of
Texas).
On July
23, 2004, the plaintiffs filed a putative collective action under the federal
Fair Labor Standards Act alleging that Store Managers and Assistant Managers
in
the Company’s Arizona, California, Nevada and Texas stores were misclassified as
exempt employees under federal law and seeking to recover allegedly unpaid
overtime wages as well as penalties, interest and attorney fees for these
employees. The Company entered into a settlement with the plaintiffs in this
matter, and the Court granted final approval of the settlement on March 17,
2006
and entered final judgment. The Company has paid out an aggregate sum of
approximately $100,000 in settlement of this action. This sum includes the
settlement payments to the named plaintiffs and plaintiffs who have opted into
the settlement as well as the payments for costs and fees to plaintiffs’
counsel.
Securities
Class Action and Shareholder Derivative Lawsuits.
On June
15, 2004, David Harkness filed a class action suit against the Company and
certain of its executive officers in the United States District Court for the
Central District of California. Harkness, who sought to represent all who
purchased shares of the Company's common stock between March 11 and June 10,
2004, alleged that the Company's public statements during the class period
violated the Securities Exchange Act of 1934 by failing to adequately describe
various aspects of the Company's operations and prospects. Soon thereafter,
several other alleged shareholders filed complaints in the same court, making
substantially the same allegations against the same defendants and seeking
to
represent the same putative class. Three such plaintiffs, Joseph Boodaie, Morgan
Boodaie and Samuel Toovy, were designated “lead plaintiffs” pursuant to the
Private Securities Class Action Reform Act (“PSLRA”), and filed a consolidated
amended complaint that superseded the various complaints originally filed and
contained an expanded class period. The defendants moved to dismiss the
consolidated amended complaint for failure to state a claim upon which relief
can be granted, in particular by failing to satisfy the pleading standards
of
PSLRA. By order dated March 30, 2005, the Court granted the defendants’ motion
to dismiss, and granted the plaintiffs leave to amend the complaint. The
plaintiffs filed a second amended complaint on April 29, 2005. The defendants
moved to dismiss the second amended complaint as well. On June 16, 2004, another
alleged shareholder, Paul Doherty, filed a shareholder derivative suit in Los
Angeles County Superior Court, repeating the allegations of the Harkness
complaint and demanding, purportedly on behalf of the Company, damages and
other
relief against certain of the Company's executive officers and directors for
alleged breaches of fiduciary and other duties. On or about January 24, 2006,
the Company, the Company’s insurer and plaintiffs’ counsel in both the federal
securities class action and in the state derivative action agreed to settle
these matters. Pursuant to the settlement agreement the Company’s insurer and
the Company each paid $2,062,500 in settlement of the putative class action
and
$87,500 in settlement of the state derivative action. The parties also agreed
that the class action period would be extended through and including September
21, 2005. Both the federal court and the state court approved the settlement
and
dismissed the actions with prejudice. The time for any appeal has expired.
The
Company had reserves for this matter at March 31, 2006 of $2.2
million.
Jasmine
Minesaki v. 99¢ Only Stores (Los Angeles Superior Court). Plaintiff
Jasmine Minesaki filed this action on behalf of herself and her daughter for
personal injuries suffered at a facility previously owned by the Company. The
Court approved a settlement of this matter in October 2006, pursuant to which
the Company's insurance carriers are obligated to satisfy the amounts owed
to
the plaintiff thereunder,
which
totaled approximately $35.0 million.
Employment
Class Actions.
Vargas
vs. 99¢ Only Stores (Ventura County Superior Court). On
June
19, 2006, the plaintiff, Joanna Vargas, filed this putative class action suit
against the Company seeking to represent its California retail non-exempt
employees. The lawsuit alleges non-payment of wages, non-payment of overtime
wages, failure to provide or pay for meal or rest breaks, unlawful deduction
of
wages, non-payment of wages to employees who quit or were terminated, and
similar claims. The lawsuit seeks compensatory, special and punitive damages
in
unspecified amounts, as well as injunctive relief. The Company has responded
to
the complaint and denied all material allegations therein. The parties are
currently litigating whether this matter and the Washington matter described
below should be coordinated. Based on discussions during recent settlement
negotiations, the Company has reserved $1.5 million at March 31, 2006 for
potential liability in this case and the Washington matter described below.
As
the parties in this matter and the Washington matter have not entered into
a
settlement agreement, and any settlement would be subject to court approval,
a
settlement in this matter and the Washington matter cannot be
assured.
Washington
v. 99¢ Only Stores (Los Angeles County Superior Court). On
October 31, 2006, the plaintiff, Chantelle Washington, filed this putative
class
action suit against the Company seeking to represent its California retail
non-exempt cashier employees. The lawsuit alleges non-payment of failure to
provide or pay for meal or rest breaks and associated claims. The lawsuit seeks
compensatory damages and/or penalties in unspecified amounts, as well as
equitable relief, attorney fees and interest. The Company has responded to
the
complaint and filed a demurrer asserting that this action should be stayed
pending the resolution of the Vargas action described above. The parties are
currently litigating whether this matter and the Vargas action should be
coordinated. See the Vargas matter described above for reserves pertaining
to
this matter and a description of the settlement status.
Environmental
Protection Agency.
Region
IX of the U.S. Environmental Protection Agency (the "EPA") notified the Company
on May 4, 2005 that it intended to commence an action seeking civil penalties
for an alleged sale of an unregistered pesticide product. The EPA has not
yet filed a complaint in this matter, nor has it made any demands for a specific
penalty amount. The Company is unable to predict the likely outcome of
this matter, but does not expect such outcome to have a material adverse effect
on the Company's financial condition, results of operations, or overall
liquidity.
Others. The
Company is named as a defendant in numerous other legal matters arising in
the
normal course of business. In management’s opinion, none of these
matters are expected to have a material adverse effect on either the
Company’s financial position, results of operations, or overall
liquidity.
Item
4. Submission of Matters to a Vote of Security
Holders
None.
Item
5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities
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.
As
of
March 12, 2007, the Company had 418 shareholders of record and approximately
15,282 beneficial holders of its Common Stock.
The
Company has never paid any cash dividends with respect to its Common Stock
since
it became a pubic Company in 1996. The Company presently intends to retain
future earnings to finance continued system improvements, store development,
and
other expansion and therefore does not anticipate the payment of any cash
dividends for 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
5,035,000 are available as of March 31, 2006 for future option grants. Options
may be granted to officers, employees, non-employee directors and consultants.
All grants are made at fair market value at the date of grant or at a price
determined by the compensation committee, which consists of independent members
of the Board of Directors. Options typically vest over a three-year period,
one-third one year from the date of grant and one-third per year thereafter,
though an exception was made by the Company’s Compensation Committee on June 6,
2006, when it granted options that vested in equal halves over a two year
period. Options typically 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 2003, 2004, three months ended
March 31, 2005. The Company recognized $0.2 million in option related
compensation cost during fiscal 2006 (see Note 10 to Consolidated Financial
Statements for detailed discussion). In fiscal 2007, the Company adopted SFAS
No. 123(R), “Share-Based Payment” and expects to report approximately $5.2
million in option related compensation cost in fiscal 2007. The plan will expire
in 2011.
Securities
Authorized for Issuance Under Equity Compensation Plans
The
following table provides information as of March 31, 2006 about the Company’s
Common Stock that may be issued upon the exercise of options granted to
employees or members of our Board of Directors under the Company’s existing 1996
Stock Option Plan.
Item
6. Selected Financial Data
The
following table sets forth selected financial and operating data of the Company
for the periods indicated. The data set forth below should be read in
conjunction with the consolidated financial statements and notes thereto.
The
following table sets forth selected financial data for the transition three
months ended March 31, 2005 and comparable three month period ended March 31,
2004 (amounts in thousands, except for per share data):
Item
7. Management’s Discussion and Analysis of Financial Condition
and Results of Operations.
This
Management’s Discussion and Analysis of Financial Condition and Results of
Operations should be read in connection with “Item 6. Selected Financial Data”
and “Item 8. Financial Statements and Supplementary Data” of this Form
10-K.
General
In
fiscal
2006, 99¢ Only Stores had net sales of $1,023.6 million, operating income of
$11.7 million and net income of $11.4 million. Sales increased 5.3% over fiscal
2004 primarily due to the 15 new store openings since the end of fiscal 2004.
Operating income and net income decreased 70.2% and 59.0%, respectively, from
fiscal 2004. Average sales per store open the full year declined from $4.6
million in fiscal 2004 to $4.3 million, in fiscal 2006. Average net sales per
estimated saleable square foot (computed for 99¢ Only Stores open for the full
year) declined from $270 per square foot at December 31, 2004 to $250 per square
foot at March 31, 2006. This trend reflects the Company’s opening of larger
locations for new store development and the under-performance of the Texas
stores. Existing stores at March 31, 2006 average approximately 22,204 gross
square feet. From January 1, 2003 through March 31, 2006, the Company opened
new
99¢ Only Stores that average approximately 24,805 gross square feet. The Company
had targeted new store locations between 15,000 and 36,000 gross square feet
during this period. In addition to the decline in average store sales and
average net sales per estimated saleable square foot, operating income and
net
income were negatively impacted by certain operating expenses increasing
proportionately more than revenues in fiscal 2006, as well as a decline in
the
gross profit margin.
The
rate
of annual sales growth has declined each year since 2001. As previously
announced, the Company had significantly reduced its planned store opening
growth rate in 2005 to approximately five percent to allow the Company to focus
on implementing improvements in its systems infrastructure, business processes,
and internal controls in order to help the Company to better support its
existing stores and to establish a foundation for future profitable growth.
In
fiscal
2007 the Company continued to expand its store base with 19 store openings
in
California, Texas, Nevada and Arizona. In fiscal 2008, the Company intends
to
increase its store opening growth rate and believes that near term growth in
2007 and 2008 will primarily result from new store openings in its existing
territories and increases in same store sales. The Company is now targeting
locations between 15,000 and 19,000 gross square feet.
On
December 30, 2005 the Company changed its fiscal year-end from December 31
to
March 31 (see “Notes to Consolidated Financial Statements”). Unless specifically
indicated otherwise, any reference to “2006” or “fiscal 2006” relates to as of,
or for the year ended, March 31, 2006 and any reference to “2004” and “2003” or
“fiscal 2004”and “fiscal 2003” relate to as of, or for the years ended, December
31, 2004 and 2003, respectively. References to “fiscal 2007” refer to a period
from April 1, 2006 to March 31, 2007 and “fiscal 2008” refer to a period from
April 1, 2007 to March 31, 2008, and so forth.
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 other
factors that management believes are reasonable. Estimates and assumptions
include, but are not limited to, the areas of inventories, long-lived asset
impairment, legal reserves, self-insurance reserves, leases, and
taxes.
The
Company believes that the following represent the areas where more critical
estimates and assumptions are used in the preparation of the financial
statements:
Inventory
valuation: Inventories
are valued at the lower of cost (first in, first out) or market. Valuation
allowances for obsolete and excess inventory, shrinkage, spoilage, and scrap
are
also recorded. Shrinkage/scrap is estimated as a percentage of sales for the
period from the last physical inventory date to the end of the applicable
period. Such estimates are based on experience and the most recent physical
inventory results. The valuation allowances such as the amount of obsolete
inventory, shrinkage and scrap in many locations (including various warehouses,
store backrooms, and sales floors of all its stores), require management
judgment and estimates that may impact the ending inventory valuation as well
as
gross margins. Additions to the inventory obsolescence reserve as a percentage
of cost of sales have averaged approximately 0.3% for the fiscal years ended
December 31, 2003, December 31, 2004 and March 31, 2006.
Long-lived
asset impairment:
In
accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144,
“Accounting for the Impairment or Disposal of Long-lived Assets”, the Company
assesses the impairment of long-lived assets when events or changes in
circumstances indicate that the carrying value may not be recoverable.
Recoverability is measured by comparing the carrying amount of an asset to
expected future net cash flows generated by the asset. If the carrying amount
of
an asset exceeds its estimated undiscounted future cash flows, the carrying
amount is compared to its fair value and an impairment charge is recognized
to
the extent of the difference. Factors that the Company considers important
which
could individually or in combination trigger an impairment review include the
following: (1) significant underperformance relative to expected historical
or
projected future operating results; (2) significant changes in the manner of
the
Company’s use of the acquired assets or the strategy for the Company’s overall
business; and (3) significant changes in our business strategies and/or negative
industry or economic trends. On a quarterly basis, the Company assesses whether
events or changes in circumstances occur that potentially indicate that the
carrying value of long-lived assets may not be recoverable. Considerable
management judgment is necessary to estimate projected future operating cash
flows. Accordingly, if actual results fall short of such estimates,
significant future impairments could result. The Company concluded that there
were no such events or changes in circumstances during fiscal 2003, 2004 and
three months ended March 31, 2005. However, in the third quarter of fiscal
2006,
the Company recorded an asset impairment charge of $0.8 million related to
one
underperforming store in Texas.
Legal
reserves: In
the
ordinary course of its business, the Company is subject to various legal actions
and claims. In connection with such actions and claims, the Company must make
estimates of potential future legal obligations and liabilities, which requires
management’s judgment on the outcome of various issues. Management also relies
on outside legal counsel in this process. The ultimate outcome of various legal
issues could be materially different from management’s estimates and adjustments
to income could be required. The assumptions used by management are based on
the
requirements of SFAS No. 5, “Accounting for Contingencies”. The Company will
record, if material, a liability when it has determined that the occurrence
of a
loss contingency is probable and the loss amount can be reasonably estimated,
and it will disclose the related facts in the notes to its financial statements.
If the Company determines that the occurrence of a loss contingency is
reasonably possible or that it is probable but the loss cannot be reasonably
estimated, the Company will, if material, disclose the nature of the loss
contingency and the estimated range of possible loss, or include a statement
that no estimate of loss can be made.
Self-insured
workers’ compensation liability:
The
Company self-insures for workers’ compensation claims in California and Texas.
The Company establishes a liability for losses of both estimated known and
incurred but not reported insurance claims based on reported claims and
actuarial valuations of estimated future costs of reported and incurred but
not
yet reported claims. Should an amount of claims greater than anticipated occur,
the liability recorded may not be sufficient and additional workers’
compensation costs, which may be significant, could be incurred. The Company
has
not discounted the projected future cash outlays for the time value of money
for
claims and claim related costs when establishing its workers’ compensation
liability as of December 31, 2003, 2004, March 31, 2005, and March 31, 2006
due
to the volatility and unpredictability of its workers’ compensation experience
over the past several years.
Operating
leases: The
Company recognizes rent expense for operating leases on a straight-line basis
(including the effect of reduced or free rent and rent escalations) over the
applicable lease term. The difference between the cash paid to the landlord
and
the amount recognized as rent expense on a straight-line basis is included
in
deferred rent. Cash reimbursements received from landlords for leasehold
improvements and other cash payments received from landlords as lease incentives
are recorded as deferred rent. Deferred rent related to landlord incentives
is
amortized as an offset to rent expense using the straight-line method over
the
applicable lease term. The closing of stores in the future may result in the
immediate write-off of associated deferred rent balances, if any.
Tax
Valuation Allowances: The
Company accounts for income taxes in accordance with SFAS No. 109, “Accounting
for Income Taxes” (“SFAS
No. 109”), which requires that deferred tax assets and liabilities be recognized
using enacted tax rates for the effect of temporary differences between the
book
and tax bases of recorded assets and liabilities. SFAS No. 109 also requires
that deferred tax assets be reduced by a valuation allowance if it is more
likely than not that some portion or all of the net deferred tax asset will
not
be realized. The Company had approximately $32.4 million, $34.4 million and
$40.3 million in net deferred tax assets that are net of tax valuation
allowances of $4.6 million, $4.7 million and $5.5 million at December 31, 2004,
March 31, 2005 and March 31, 2006, respectively. Management evaluated the
available positive and negative evidence in assessing the Company’s ability to
realize the benefits of the net deferred tax assets at March 31, 2006 and
concluded it is more likely than not that the Company will not realize a portion
of its net deferred tax assets. The remaining balance of the net deferred tax
assets should be realized through future operating results and the reversal
of
taxable temporary differences.
Results
of Operations
The
following discussion defines the components of the statement of income and
should be read in conjunction with “Item 6. Selected Financial Data”.
Net
Sales:
Revenue
is recognized at the point of sale for retail sales. Bargain Wholesale sales
revenue is recognized on the date merchandise is shipped. Bargain Wholesale
sales are shipped free on board shipping point.
Cost
of Goods Sold:
Cost of
goods sold includes the cost of inventory sold, net of discounts and allowances,
freight in, inter-state warehouse transportation costs, obsolescence, spoilage
and inventory shrinkage. The Company receives various cash discounts, allowances
and rebates from its vendors. Such items are included as a reduction of cost
of
sales as merchandise is sold. The Company does not include purchasing, receiving
and distribution warehouse costs in its cost of goods sold, which totaled $35.9
million, $48.5 million and $47.4 million as of fiscal 2003, 2004 and 2006,
respectively. Purchasing, receiving and distribution warehouse costs totaled
$11.1 million and $13.0 million for three months ended March 31, 2004 and 2005,
respectively. Due to this classification, the Company's gross profit rates
may
not be comparable to those of other retailers that include costs related to
their distribution network in cost of sales.
Selling,
General, and Administrative Expenses:
Selling, general, and administrative expenses include purchasing, receiving,
inspection and warehouse costs, the costs of selling merchandise in stores
(payroll and associated costs, occupancy and other store level costs),
distribution costs (payroll and associated costs, occupancy, transportation
to
and from stores, and other distribution related costs), and corporate costs
(payroll and associated costs, occupancy, advertising, professional fees, and
other corporate administrative costs). Selling, general, and administrative
expenses also include depreciation and amortization expense.
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 and construction loan.
The
following table sets forth for the periods indicated, certain selected income
statement data, including such data as a percentage of net sales:
Fiscal
Year Ended March 31, 2006 Compared to Fiscal Year Ended December 31, 2004
Net
sales.
Total
net sales increased $51.4 million, or 5.3%, from $972.2 million in fiscal 2004
to $1,023.6 million in fiscal 2006. 99¢ Only Stores’ net retail sales increased
$54.4 million, or 5.8%, from $929.9 million in fiscal 2004 to $984.3 million
in
fiscal 2006. Bargain Wholesale net sales decreased $3.0 million, or 7.1%, from
$42.3 million in fiscal 2004 to $39.3 million in fiscal 2006. The effect of
15
new stores opened since the end of fiscal 2004 increased 99¢ Only Stores net
retail sales by $18.5 million and the full year fiscal 2006 effect of 30 net
stores opened in fiscal 2004 increased sales by $50.7 million. However,
comparable stores net sales for all stores open at least 18 months in fiscal
2004 and 2006 decreased 0.6% in 2006 which management believes was due to
operational issues in early to mid-year including lack of execution in the
supply chain and shelf in-stock issues as well as the effects of higher gasoline
prices. As has been announced, comparable stores net sales have increased in
the
first, second and third quarters of fiscal 2007. To account for the change
in
year end that affects the comparable stores sales comparison between fiscal
2006
and fiscal 2004, the Company used stores open at least 18 months instead of
15
months. Since the end of fiscal 2004, the Company added 15 stores and closed
two
stores; three stores were opened in Texas, three in Arizona and nine in
California. At the end of fiscal 2006, the Company had 232 stores compared
to
219 as of fiscal 2004. Gross retail square footage at the end of fiscal 2006
and
fiscal 2004 was 5.2 million and 4.8 million, respectively. For 99¢ Only Stores
open all of fiscal 2006, the average net sales per estimated saleable square
foot was $250 and the average annual net sales per store were $4.3 million,
including the Texas stores open for the full year. Non-Texas stores net sales
averaged $4.7 million per store and $283 per square foot. Texas stores open
for
a full year averaged net sales of $2.3 million per store and $111 per square
foot.
Gross
profit.
Gross
profit increased $3.8 million, or 1.0%, from $379.6 million in fiscal 2004
to
$383.4 million in fiscal 2006. The increase in gross profit dollars was due
to
higher retail net sales. As a percentage of net sales, overall gross margin
decreased to 37.5% in fiscal 2006 from 39.0% in fiscal 2004. As a percentage
of
retail sales, retail gross margin decreased to 38.2% in fiscal 2006 from 39.9%
in fiscal 2004. The increase in gross profit dollars was partially offset by
a
reserve of $1.2 million or 0.2% which was recorded in cost of sales in fiscal
2006 to account for a change in the net realizable value of certain retail
sales
floor inventory due to strategic changes in management’s plans for certain
products. This additional expense increased the reserve which is included in
inventory to $2.3 million. There was also an increase in product cost for retail
from 56.4% for fiscal 2004 to 57.6% for fiscal 2006, primarily due to product
cost changes and a shift in the sales mix to more grocery items. The increase
in
gross profit dollars was further offset by an increase in spoilage/shrink from
3.5% for fiscal 2004 to 3.7% for fiscal 2006 as a result of higher shrink
recorded based on physical inventories. The Bargain Wholesale margin decreased
to 19.6% in fiscal 2006 versus 19.9% in fiscal 2004. The remaining change was
made up of increases and decreases in other less significant items included
in
cost of sales.
Operating
expenses.
Operating expenses increased $28.1 million, or 9.0%, from $312.3 million in
fiscal 2004 to $340.4 million in 2006. As a percentage of net sales, operating
expenses increased to 33.3% for the year ended March 31, 2006 from 32.1% for
the
year ended December 31, 2004. The increase was primarily due to higher retail
store operating expenses of $36.5 million between fiscal 2004 and fiscal 2006,
including an increase in retail store labor and benefits costs of $27.2 million
and an increase in rent costs of $3.2 million. The increases in labor, benefits,
and rent expenses generally reflect the opening of 15 new stores since the
end
of fiscal 2004, the full year effect of fiscal 2004 store additions and cost
increases in existing stores. In addition, retail store operating expenses
increased disproportionately compared to retail sales increases due to the
underperformance of Texas stores. The increase in operating expenses was due
to
an increase in transportation costs of $5.3 million, as a result of higher
fuel
costs and increased delivery costs, due to additional store locations. In
addition, there was a $6.8 million increase in accounting and consulting fees
associated with various systems initiatives and Sarbanes-Oxley compliance.
Finally, the Company recorded an asset impairment charge of $0.8 million
relating to one underperforming store in Texas. The increase in operating
expenses was partially offset by a decrease in workers’ compensation expenses of
$11.4 million due to stabilization of the reserves necessary for claims
liability and improvements in claims handling and accident reporting. The
increase in operating expenses was also partially offset by a decrease in legal
costs of $4.4 million primarily due to reduced outside legal costs stemming
from
less litigation and settlement payments in fiscal 2006. The remaining change
was
made up of increases and decreases in other less significant items included
in
operating expenses.
Depreciation
and amortization. Depreciation
increased $3.2 million, or 11.3%, from $28.2 million in fiscal 2004 to $31.4
million in fiscal 2006 as a result of the net 13 new stores operating since
the
end of the fiscal 2004, the full year effect of fiscal 2004 store additions,
and
the purchase of an additional distribution center in July 2005. The increase
was
partially offset due to the disposal of certain store fixed assets and fully
depreciated assets.
Operating
income.
Operating income decreased $27.4 million, or 70.2%, from $39.1 million in fiscal
2004 to $11.7 million in fiscal 2006. Operating income as a percentage of net
sales decreased from 4.0% in fiscal 2004 to 1.1% in fiscal 2006 primarily due
to
the decrease in the gross margin percentage on sales and increases in operating
expenses discussed above. Operating income in 2006 also benefited from a net
gain of $4.2 million for a forced store closure due a local government eminent
domain action, which is included in selling, general, and administrative
expenses.
Other
income, net.
Other
income increased $1.8 million to $5.1 million in fiscal 2006 compared to $3.3
million in fiscal 2004. Interest income earned on the Company’s investments
increased from $3.3 million in fiscal 2004 to $5.1 million in fiscal 2006 as
a
result of increasing interest rates enhanced by a $12.6 million increase in
cash
and investments since the end of fiscal 2004, and the net effect of market
interest rate fluctuations during both periods on interest income. Interest
expense related to the capital lease and a consolidated partnership line of
credit with a bank was $0.1 million in fiscal 2006. Interest expense related
to
the capital lease was $0.1 million in fiscal 2004. The Company had no
outstanding bank debt during fiscal 2004.
Provision
for income taxes.
The
provision for income taxes in fiscal 2006 was $5.3 million compared to $14.5
million in fiscal 2004. The provision for income taxes had effective combined
federal and state income rates of 31.8% and 34.3% in fiscal 2006 and 2004,
respectively. The effective combined federal and state tax income rates are
less
than the statutory rates in each period and were calculated to reflect estimated
income tax rates after giving effect for tax credits and the effect of certain
revenues and/or expenses that are not subject to taxation.
Net
income. As
a
result of the items discussed above, net income decreased $16.4 million, or
59.0%, from $27.8 million in fiscal 2004 to $11.4 million in fiscal 2006. Net
income as a percentage of net sales declined from 2.9% in fiscal 2004 to 1.1%
in
fiscal 2006.
Three
Months Ended March 31, 2005 (Audited) Compared to Three Months ended March
31,
2004 (Unaudited)
Net
Sales.
Net
sales increased $12.6 million, or 5.5%, to $242.6 million for the three months
ended March 31, 2005 compared to $230.1 million for the three months ended
March
31, 2004. Retail sales increased $13.1 million, or 6.0%, to $231.9 million
for
the three months ended March 31, 2005 compared to $218.8 million for the three
months ended March 31, 2004. The effect of five new stores opened in the first
three months of calendar 2005 increased retail sales by $3.2 million and the
full quarter effect of 33 new stores opened in fiscal 2004 increased sales
by
$19.0 million for the three months ended March 31, 2005. However,
same-store-sales decreased 2.8% for the three months ended March 31, 2005
compared to a slight increase of 0.2% for the three months ended March 31,
2004
primarily due to the extra sales day due to the Leap Year in 2004 and other
external factors negatively affecting the three months ended March 31, 2005
same-store-sales which included severe inclement weather in California, the
ending of the Southern California grocery strike in late February 2004, and
the
effects of higher gasoline prices. However, the decrease in same-store-sales
was
partially offset due to the Easter selling season occurring in the three months
ended March 31, 2005 versus in the quarter ended June 30, 2004. Bargain
Wholesale net sales decreased $0.5 million, or 4.5%, to $10.7 million for the
three months ended March 31, 2005 compared to $11.2 million for the three months
ended March 31, 2004.
Gross
Profit.
Gross
profit decreased $1.9 million, or 2.1%, to $90.3 million for the three months
ended March 31, 2005 compared to $92.2 million for the three months ended March
31, 2004. As a percentage of net sales, overall gross margin decreased to 37.2%
for the three months ended March 31, 2005 compared to 40.1% for the three months
ended March 31, 2004. As a percentage of retail sales, retail gross margin
decreased to 38.0% for the three months ended March 31, 2005 compared to 41.1%
for the three months ended March 31, 2004 in part due to the increase in product
cost for retail from 56.0% in the quarter ended March 31, 2004 to 57.4% for
the
three months ended March 31, 2005 primarily due to product cost changes and
a
shift in the sales mix to more grocery items. Gross margin also decreased due
to
an increase in spoilage, scrap, and shrink from 3.1% in the quarter ended March
31, 2004 to 3.6 % in the three months ended March 31, 2005. The Company also
recorded additional reserves of 1.1% based on the results of complete
physical counts taken at all stores and warehouses subsequent to the end of
the
quarter and refined estimates with the benefit of hindsight from May 2006 to
account for a change in net realizable value of certain retail sales floor
inventory due to strategic changes in management plans for certain
products.
The
Bargain Wholesale margin increased slightly to 21.1% for the three months ended
March 31, 2005 compared to 19.8% for the three months ended March 31, 2004.
The
remaining change was made up of increases and decreases in other less
significant items included in cost of sales.
Operating
Expenses.
Operating expenses increased $10.7 million, or 15.1%, to $81.8 million for
the
three months ended March 31, 2005 compared to $71.0 million for the three months
ended March 31, 2004. As a percentage of net sales, operating expenses increased
to 33.7% for the three months ended March 31, 2005 from 30.9% for the three
months ended March 31, 2004. The dollar increase was primarily due to higher
retail store operating expenses of $6.8 million between the three months ended
March 31, 2005 and 2004, primarily as a result of an increase in retail store
labor and benefit costs of $4.5 million, an increase in rent costs of $1.9
million due to the opening of five new stores in the three months ended March
31, 2005, the full quarter effect of 33 new stores opened in 2004 and costs
increases in existing stores. In addition, retail store operating expenses
increased disproportionately compared to retail sales increases due to the
underperformance of Texas stores. The increase in operating expenses was also
due to an increase in distribution and transportation costs of $1.9 million,
primarily as a result of higher fuel costs and increased delivery costs due
to
new store locations. Operating expenses also increased by $1.1 million as a
result of higher accounting and consulting fees due primarily to Sarbanes-Oxley
compliance efforts. Finally, operating expenses increased due to an increase
in
workers’ compensation expenses of $2.8 million, which was primarily driven by an
increase in the number of claims. The increase in operating expenses was
partially offset by a decrease in legal costs of $3.3 million between the three
months ended March 31 2005, and 2004 primarily due to lower legal settlements
of
$2.1 million in the three months ended March 31, 2005 compared to $6.1 million
(including a $4.7 million legal settlement) in the quarter ended March 31,
2004.
The remaining change was made up of increases and decreases in other less
significant items included in operating expenses.
Depreciation
and Amortization.
Depreciation and amortization increased $1.8 million, or 29.2%, to $7.8 million
for the three months ended March 31, 2005 compared to $6.0 million for the
three
months ended March 31, 2004 as a result of five new stores opened through March
31, 2005, the full quarter effect of 33 new stores opened in 2004, and additions
to existing stores and distribution centers. This resulted in an increase as
a
percentage of sales to 3.2% from 2.6% due to the performance of the new stores
in Texas that operated at significantly lower sales per square foot than the
existing store base.
Operating
Income.
Operating income decreased $14.4 million, or 94.7%, to $0.8 million for the
three months ended March 31, 2005 compared to $15.2 million for the three months
ended March 31, 2004. Operating income as a percentage of net sales decreased
from 6.6% for the three months ended March 31, 2004 to 0.3% for the three months
ended March 31, 2005 primarily due to the decrease in the gross margin
percentage on sales and increases in operating expenses discussed
above.
Other
Income, net.
Other
income decreased $1.3 million, or 81.1%, to $0.3 million for the three months
ended March 31, 2005 compared to $1.6 million for the three months ended March
31, 2004. Interest income earned on the Company’s investments decreased $1.0
million, or 62.1% to $0.6 million for the three months ended March 31, 2005
compared to $1.6 million for the three months ended March 31, 2004 due primarily
to the valuation losses recognized on certain of its bonds as a result of
interest rate fluctuations and the corresponding decrease in bond values in
2005
and due to the repurchase of 2.6 million shares of the Company’s common stock
for $38.2 million in the second and third quarters of 2004, which reduced the
total investment portfolio in the three months ended March 31, 2005. The Company
had no outstanding bank debt during the three months ended March 31, 2005 and
2004.
Provision
for Income Taxes.
The
provision for income taxes was $0.3 million for the three months ended March
31,
2005 compared to $6.6 million for the three months ended March 31, 2004. The
effective rate of the provision for income taxes was approximately 27.7% and
39.1% for the three months ended March 31, 2005 and 2004, respectively. The
provision rate decreased primarily due to the impact that certain permanent
tax
differences had on lower pre-tax income for the three months ended March 31,
2005.
Net
Income.
As a
result of the items discussed above, net income decreased $9.4 million, or
92.2%, to $0.8 million for the three months ended March 31, 2005 compared to
$10.2 million for the three months ended March 31, 2004. Net income as a
percentage of net sales was 0.3% and 4.4% for the three months ended March
31,
2005 and 2004, respectively.
Year
Ended December 31, 2004 Compared to Year Ended December 31,
2003
Net
sales.
Total
net sales increased $109.7 million, or 12.7%, from $862.5 million in 2003 to
$972.2 million in 2004. 99¢ Only Stores’ net retail sales increased $113.5
million, or 13.9%, from $816.3 million in 2003 to $929.9 million in 2004.
Bargain Wholesale net sales decreased $3.8 million, or 8.3%, from $46.1 million
in 2003 to $42.3 million in 2004. The effect of 33 new stores opened in 2004
increased 99¢ Only Stores net retail sales by $70.9 million and the full year
2004 effect of 38 net stores opened in 2003 increased sales by $67.7 million.
However, comparable stores net sales for all stores open at least 15 months
in
2003 and 2004 decreased 1.8% in 2004 due to the underperformance of the Texas
stores. In 2004, the Company added 33 stores and closed three stores; 16 stores
were opened in Texas, five in Arizona, one in Nevada and 11 in California.
As of
year-end 2004, the Company had 219 stores compared to 189 as of year-end 2003.
Gross retail square footage and estimated saleable square footage at the
year-end 2004 were 4.8 million and 3.8 million, respectively. For 99¢ Only
Stores open all of 2004, the average net sales per estimated saleable square
foot was $270 and the average annual net sales per store were $4.6 million,
including the Texas stores open for the full year. Non-Texas stores net sales
averaged $4.8 million per store and $293 per square foot. Texas stores open
for
a full year averaged net sales of $2.2 million per store and $101 per square
foot.
Gross
profit.
Gross
profit increased $33.8 million, or 9.8%, from $345.8 million in 2003 to $379.6
million in 2004. The increase in gross profit dollars was primarily due to
higher retail net sales. As a percentage of net sales, overall gross profit
decreased to 39.0% in 2004 from 40.1% in 2003. As a percentage of retail sales,
gross profit for retail decreased to 39.9% in 2004 from 41.2% in 2003 in part
due to the increase in product cost for retail from 55.5% in 2003 to 56.4%
in
2004, and in part due to product mix and increase in spoilage/shrink from 3.0%
in 2003 to 3.5% in 2004 (which the Company believes was caused by a variety
of
factors including an overcapacity situation in its Los Angeles distribution
center and spoilage resulting from the initial introduction of its fresh produce
offerings). The Bargain Wholesale margin remained relatively constant at 19.9%
in 2004 versus 19.8% in 2003. The remaining change was made up of increases
and
decreases in other less significant items included in cost of sales.
Operating
expenses.
Operating expenses increased $76.8 million, or 32.6%, from $235.4 million in
2003 to $312.3 million in 2004. The increase was primarily due to higher retail
store operating expenses of $40.5 million between 2003 and 2004, primarily
as a
result of an increase in retail store labor costs of $22.6 million and an
increase in rent costs of $11.3 million due to the opening of 33 new stores
in
2004 and the full year effect of 2003 store additions. The increase in operating
expenses was also due to an increase in distribution and transportation costs
of
$12.6 million, primarily as a result of higher fuel costs, increased delivery
costs, and additional handling of product due to added warehousing facilities
(which were leased to support our store growth). Operating expenses also
increased due to an increase in legal costs of $8.3 million due to payments
of
$6.2 million for legal settlements and outside legal counsel fees of $2.1
million, primarily as a result of a greater number of personal injury lawsuits,
class action lawsuits, and other employee related matters. Operating expenses
also increased due to higher accounting and consulting fees of $1.8 million,
primarily as a result of Sarbanes Oxley work for 2004. Finally, operating
expenses increased due to an increase in workers compensation expenses of $11.2
million, which was primarily driven by an increase in the number of claims
and
an increase in average costs per claim. The remaining change was made up of
increases and decreases in other less significant items included in operating
expenses.
Depreciation
and amortization. Depreciation
increased $8.9 million, or 45.7%, from $19.4 million in 2003 to $28.2 million
in
2004 as a result of the net 30 new stores opened in 2004, the full year effect
of 2003 store additions, and the purchase of the Commerce cold storage and
Texas
distribution centers in 2003.
Operating
income.
Operating income decreased $51.9 million, or 57.0%, from $91.0 million in 2003
to $39.1 million in 2004. Operating income as a percentage of net sales
decreased from 10.6% in 2003 to 4.0 % in 2004 primarily due to the decrease
in
the gross margin percentage on sales and increases in operating expenses
discussed above.
Other
income, net.
Other
income decreased $1.2 million, or 26.8%, from $4.5 million in 2003 to $3.3
million in 2004. The decrease was primarily due to the expiration of a service
and lease agreement with a related party in 2003, which eliminated the
management fee and rent that the Company earned from the related party of $1.4
million in 2003. Interest income earned on the Company’s investments was $3.3
million in 2004 and $3.1 million in 2003. At December 31, 2004, the Company
held
$92.6 million in short-term investments and $50.8 million in long-term
investments. Interest expense related to the capital lease was $0.1 million
in
both 2004 and 2003. The Company had no outstanding bank debt during 2004 or
2003.
Provision
for income taxes.
The
provision for income taxes in 2004 was $14.5 million compared to $36.7 million
in 2003. The provision for income taxes had effective combined federal and
state
income rates of 34.3% and 38.5% in 2004 and 2003, respectively. The effective
combined federal and state tax income rates are less than the statutory rates
in
each period and were calculated to reflect estimated income tax rates after
giving effect for tax credits and the effect of certain revenues and/or expenses
that are not subject to taxation.
Net
income. As
a
result of the items discussed above, net income decreased $30.9 million, or
52.6%, from $58.7 million in 2003 to $27.8 million in 2004. Net income as a
percentage of net sales declined from 6.8% in 2003 to 2.9% in 2004.
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 closeout 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 operating activities in fiscal 2003, 2004 and 2006 was $65.3
million, $94.4 million, and $82.5 million, respectively, consisting primarily
of
$86.6 million, $45.8 million and $38.5 million of net income, respectively,
adjusted for depreciation and other non-cash items. The Company used $7.2
million and $5.8 million in working capital in fiscal 2003 and 2004,
respectively. Net cash provided by working capital activities was $6.1 million
in fiscal 2006. Net cash used in working capital activities primarily reflects
the increases in inventories, net of increases in accounts payable and workers’
compensation for fiscal 2003 and 2004. Net cash provided by working capital
activities primarily reflects increases in accounts payable and workers’
compensation partially offset by increases in inventories and a decrease in
income tax payable in fiscal 2006. Cash used for growth in inventories was
$24.2
million, $48.4 million and $7.2 million in fiscal 2003, 2004 and 2006,
respectively. Cash provided by other working capital activities included
increases in workers’ compensation of $8.6 million, $20.1 million and $5.9
million in fiscal 2003, 2004, and 2006, respectively. In fiscal 2003, the
Company invested $14.4 million in trading securities. In fiscal 2004 and 2006,
the Company sold $55.1 million and $36.0 million of its trading securities,
respectively.
Net
cash
used in investing activities during fiscal 2003, 2004 and 2006 was $98.6
million, $57.2 million, and $85.6 million, respectively. In fiscal 2003, 2004,
and 2006 the Company used $98.8 million, $57.2 million and $47.6 million for
the
purchase of property and equipment due to the opening of 38, 33, and 10 new
stores during the respective fiscal years and the purchase of a warehouse in
Commerce, California for $9.7 million in fiscal 2006. In fiscal 2006, the
Company used $135.0 million for the purchase of investments, which was offset
by
$96.9 million of cash inflow from the sale and maturity of available for sale
securities. There was no purchase of investments and sale of available for
sale
securities in fiscal 2003 and 2004.
Net
cash
provided by financing activities during 2003 was $25.7 million, which primarily
represents the proceeds from the exercise of non-qualified stock options in
that
fiscal year compared to cash used in financing activities of $36.6 million
in
2004. Cash used in financing activities increased significantly in 2004 due
to
the repurchase of 2.6 million shares of the Company’s common stock (valued at
$38.2 million) under its stock repurchase program. Net cash provided by
financing activities during 2006 was $6.0 million, which is composed primarily
of the proceeds of a consolidated partnership’s construction loan.
The
Company estimates that total capital expenditures in fiscal year 2007 will
be
approximately $55.0 million to $60.0 million and relate principally to property
acquisitions and new store openings described in this report. The Company
intends to fund its liquidity requirements in fiscal 2007 out of net cash
provided by operations, short-term investments, and cash on hand.
Review
of Equity Grants and Procedures
The
Company’s management also recently conducted a voluntary, self-initiated review
of the measurement dates for the Company’s stock option grants accounted for
under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued
to Employees”, and SFAS 123(R), “Share-based Payment”, from its initial public
offering in 1996 to December 31, 2006. Management found that certain measurement
date errors occurred during the period 1996-2004. These errors resulted in
adjustments that would have increased non-cash compensation expense in these
periods. These non-material adjustments accumulated over eight years to
approximately $2.4 million in unrecorded non-cash compensation expense. In
addition, the Company recorded $0.2 million of non-cash compensation expense
in
fiscal 2006 related to the review. The Company evaluated these adjustments
using
its historical method of evaluating adjustments, the "roll-over" method. The
rollover method focuses primarily on the impact of any misstatement, including
the reversal of prior-year misstatements, on the current-year consolidated
income statement. Under this method, the Company believes that these adjustments
are not material to its financial statements in any of the periods to which
the
adjustments were related, and, therefore, does not believe that it is necessary
to amend or revise its historical financial statements.
Management
believes that the stock option errors were due to misunderstandings of how
to
establish the measurement date for accounting purposes and did not involve
any
intentional wrongdoing. Based on its review, management believes that there
was
no preferential treatment for officers and directors who participated in these
annual grants, because they always received options on the same date and with
the same price as other employees, and that although certain officers and
directors did receive a benefit from the measurement date errors along with
the
rest of the employees, this benefit was de minimis in each instance. The
Chairman and CEO, and the then President, who oversaw the grant process, did
not
receive any option grants during this period.
The
transition provisions of SEC Staff Accounting Bulletin (“SAB”) No. 108,
“Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in the Current Year Financial Statements”, permits the Company to
adjust for the cumulative effect of the uncorrected prior year misstatements
that were not material to any prior periods under the Company’s historical
income statement approach but that were material under the guidance in SAB
108
through retained earnings at the beginning of fiscal 2006. The Company has,
in
accordance with the transition provisions of SAB108, recorded a
reclassification, within the equity section of the consolidated balance sheet
included on this Form 10-K for the fiscal year ending March 31, 2006, of
approximately $2.1 million, net of the related tax effect. See Note 3 to
Consolidated Financial Statements for detailed discussion.
The
Company is currently evaluating the steps it will take with respect to
outstanding options that were affected by these errors and has assessed
costs it may incur in connection therewith, including with respect to Internal
Revenue Code § 409A, and the Company believes any such costs would be
immaterial. In light of the compensation level of the Company's option
recipients the Company does not anticipate incurring any negative tax
consequences under Internal Revenue Code § 162(m) in connection with these
errors.
Contractual
Obligations
The
following table summarizes the Company’s consolidated contractual obligations
(in thousands) as of March 31, 2006.
Lease
Commitments
The
Company leases various facilities under operating leases (except for one
location that is classified as a capital lease), which will expire at various
dates through 2019. Most of the lease agreements contain renewal options and/or
provide for rent escalations 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
term of each respective lease. Most leases require the Company to pay property
taxes, maintenance and insurance. Rental expense charged to operations in fiscal
2003, 2004 and fiscal 2006 was approximately $32.9 million $43.4 million and
$45.7 million, respectively. Rental expense charged for three months ended
March
31, 2005 was $11.4 million. The Company typically seeks leases with a five-year
to ten-year term and with multiple five-year renewal options. See “Item 2.
Properties” The large majority of the Company’s store leases were entered into
with multiple renewal periods, which are typically five years and occasionally
longer.
Off-Balance
Sheet Arrangements
At
December 31, 2004, the Company was the primary beneficiary of a variable
interest entity to develop a shopping center in La Quinta, California, in which
the Company committed to lease a store. The construction of this shopping center
was completed and the store opened in the third quarter of fiscal 2006. As
of
March 31, 2006, this entity has $8.2 million in assets and $6.2 million in
liabilities, including a bank construction loan for $6.2 million, which is
shown
on the Company’s fiscal 2006 year-end consolidated balance sheet.
The
Company had an interest in two partnerships which the Company consolidated
at
December 31, 2004, March 31, 2005 and March 31, 2006 as a result of Financial
Accounting Standards Board (“FASB”) Interpretation No. 46(R), “Consolidation of
Variable Interest Entities - an Interpretation of ARB No. 51, Consolidated
Financial Statements”.
The
assets of the partnerships consist of real estate with a carrying value of
approximately $3.0 million and there is no mortgage debt or other significant
liabilities associated with the entities, other than notes payable to the
Company. The balance sheet effect of consolidating these entities at December
31, 2004, March 31, 2005 and March 31, 2006 is a reclassification of
approximately $3.0 million, $2.9 million and $2.8 million, respectively, from
investments to property and equipment with no corresponding impact on the
Company’s recorded liabilities.
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, Easter, and Halloween
seasons. A proportionately greater amount of the Company’s net sales and
operating and net income is generally realized during the quarter ended December
31. 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 such as Easter, the timing of new store openings and the
merchandise mix.
New
Authoritative Pronouncements
In
January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB
Interpretation No. 46, “Consolidation of Variable Interest Entities - an
Interpretation of ARB No. 51, Consolidated Financial Statements” (“FIN 46”).
This interpretation addresses consolidation by business enterprises of entities
in which equity investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity
to
finance its activities without additional subordinated financial support from
other parties. Variable interest entities are required to be consolidated by
their primary beneficiaries if they do not effectively disperse risks among
the
parties involved. The primary beneficiary of a variable interest entity is
the
party that absorbs a majority of the entity’s expected losses or receives a
majority of its expected residual returns. In December 2003, the FASB amended
FIN 46 (“FIN 46(R)”). The requirements of FIN 46(R) were effective no later than
the end of the first reporting period that ended after March 15, 2004.
Additionally, certain new disclosure requirements applied to all financial
statements issued after December 31, 2003. The Company is involved with certain
variable interest entities (see Note 5 to Consolidated Financial Statements).
The Company adopted the provisions of this Interpretation in fiscal 2004, which
resulted in the consolidation of two partnership investments and an additional
partnership that was consolidated beginning March 31, 2005 (see Note 5 to
Consolidated Financial Statements). In April 2006, the FASB issued FASB Staff
Position (“FSP”) FIN 46(R)-6, “Determining the Variability to Be Considered in
Applying FASB Interpretation No. 46(R)” (FSP FIN 46(R)-6”), that became
effective beginning July 2006. FSP FIN 46(R)-6 clarifies that the variability
to
be considered in applying FIN 46(R) shall be based on an analysis of the design
of the variable interest entity. The adoption did not have a material impact
on
the Company’s consolidated financial position or results of
operations.
In
November 2004, the FASB issued Statement of Financial Accounting Standard
(“SFAS”) No. 151, “Inventory Costs, an Amendment of ARB No. 43, Chapter 4,”
(“SFAS No. 151”) which amends the guidance in ARB No. 43, Chapter 4, “Inventory
Pricing” to clarify the accounting for abnormal amounts of idle facility
expense, freight, handling costs and spoilage. SFAS No. 151 requires that these
costs be expensed as current period charges. In addition, SFAS No. 151 requires
that the allocation of fixed production overhead to the costs of conversion
be
based on normal capacity of the production facilities. The provisions of SFAS
No. 151 are effective for inventory costs incurred during fiscal years beginning
after June 15, 2005. The Company adopted SFAS No. 151 at the beginning of fiscal
2007. The adoption did not have a material impact on the Company’s consolidated
financial position or results of operations.
In
December 2004, the FASB issued SFAS No. 123(R), “Share-Based
Payment,” (“SFAS No. 123(R)”) a revision to SFAS No. 123, “Accounting
for Stock-Based Compensation.” This statement supersedes Accounting Principles
Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS
No. 123(R) establishes standards for the accounting for transactions in which
an
entity exchanges its equity instruments for goods or services. Examples
include stock options and awards of restricted stock in which an employer
receives employee services in exchange for equity securities of the company
or
liabilities that are based on the fair value of the company’s equity
securities. SFAS No. 123(R) requires that the cost of share-based payment
transactions be recorded as an expense at their fair value determined by
applying a fair value measurement method at the date of the grant, with limited
exceptions. Costs will be recognized over the period in which the goods or
services are received. The provisions of SFAS No. 123(R) are effective as
of the first annual reporting period beginning after June 15, 2005. The
Company will
adopt the new requirements using the modified prospective transition method
in
the first quarter of fiscal 2007, and as a result, will not retroactively adjust
results from prior periods. Under this transition method, compensation expense
associated with stock options recognized in the first quarter of fiscal 2007
will include: 1) expense related to the remaining unvested portion of all stock
option awards granted prior to March 31, 2006, based on the grant date fair
value estimated in accordance with the original provisions of SFAS No. 123;
and 2) expense related to all stock option awards granted or modified subsequent
to March 31, 2006, based on the grant date fair value estimated in accordance
with the provisions of SFAS No. 123(R). The Company will apply the
Black-Scholes valuation model in determining the fair value of share-based
payments to employees, which will then be amortized on a straight-line basis
over the requisite service period. Based on current analysis, information and
excluding future option grants, the Company has determined that the adoption
of
SFAS No. 123(R) will reduce our pretax earnings by approximately $5.2
million in fiscal 2007. The Company adopted this pronouncement beginning with
its fiscal year which starts April 1, 2006.
In
December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets”
(“SFAS No. 153”), which is an amendment of APB Opinion No. 29, “Accounting for
Nonmonetary Transactions,” (“APB No. 29”). This statement addresses the
measurement of exchanges of nonmonetary assets, and eliminates the exception
from fair value measurement for nonmonetary exchanges of similar productive
assets as defined in paragraph 21(b) of APB No. 29, and replaces it with an
exception for exchanges that do not have commercial substance. This statement
specifies that a nonmonetary exchange has commercial substance if the future
cash flows of the entity are expected to change significantly as a result of
the
exchange. SFAS No. 153 is effective for nonmonetary asset exchanges occurring
in
fiscal periods beginning after June 15, 2005. The Company adopted SFAS No.
153
at the beginning of fiscal 2007. The adoption of SFAS No.153 did not have a
material impact on the Company’s consolidated financial position or results of
operations.
In
March
2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset
Retirement Obligations—an interpretation of FASB Statement No. 143” (“FIN 47”).
FIN 47 requires an entity to recognize a liability for the fair value of a
conditional asset retirement obligation if the fair value can be reasonably
estimated. A conditional asset retirement obligation is a legal obligation
to
perform an asset retirement activity in which the timing or method of settlement
are conditional upon a future event that may or may not be within the control
of
the entity. The Company adopted FIN 47 for the fiscal year ended March 31,
2006
and the adoption did not have a material impact on the Company’s consolidated
financial statements.
In
May
2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections”
(“SFAS No. 154”). SFAS No. 154 is a replacement of APB No. 20 and FASB Statement
No. 3. SFAS No. 154 provides guidance on the accounting for and reporting of
accounting changes and error corrections. It establishes retrospective
application as the required method for reporting a voluntary change in
accounting principle. SFAS No. 154 provides guidance for determining whether
retrospective application of a change in accounting principle is impracticable
and for reporting a change when retrospective application is impracticable.
SFAS
No. 154 also addresses the reporting of a correction of an error by restating
previously issued financial statements. SFAS No. 154 is effective for accounting
changes and corrections of errors made in fiscal years beginning after December
15, 2005. The Company adopted this pronouncement beginning with its 2007 fiscal
year. The adoption of the provisions of SFAS No. 154 did not have a
material impact on the Company’s consolidated financial statements.
In
October 2005, the FASB issued FASB Staff Position (“FSP”) FAS 13-1, “Accounting
for Rental Costs Incurred during a Construction Period” The FASB has concluded
that rental costs incurred during and after a construction period are for the
right to control the use of a leased asset and must be recognized as rental
expense. Such costs were previously capitalized as construction costs if a
company had a policy to do so. The Company adopted FSP No. FAS 13-1 in the
fourth quarter of 2006 and the adoption did not have a material impact on the
Company’s consolidated financial statements.
In
November 2005, the FASB issued FSP FAS 115-1, “The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments.”
This addresses the determination as to when an investment is considered
impaired, whether that impairment is other than temporary, and the measurement
of an impairment loss. The FSP also includes accounting considerations
subsequent to the recognition of an other-than-temporary impairment and requires
certain disclosures about unrealized losses that have not been recognized as
other-than-temporary impairments. The guidance in the FSP is effective for
reporting periods beginning after December 15, 2005. The Company adopted
FSP FAS 115-1 on January 1, 2006. The adoption of this FSP will not impact
the Company’s consolidated financial statements.
In
February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid
Financial Instruments—an amendment of FASB Statement No. 133 and 140,” to permit
fair value remeasurement for any hybrid financial instrument that contains
an
embedded derivative that otherwise would require bifurcation in accordance
with
the provisions of SFAS No. 133, “Accounting for Derivative Instruments and
Hedging Activities.” SFAS No. 155 is effective for all financial instruments
acquired, issued, or subject to a remeasurement event occurring after the
beginning of an entity’s fiscal year that begins after September 15, 2006. The
Company will adopt SFAS No. 155 in the fiscal year beginning April 1, 2007.
The
Company does not believe that the adoption of this Statement will have a
material impact on the Company’s consolidated financial statements.
In
March
2006, the FASB’s Emerging Issues Task Force (“EITF”) issued Issue 06-3, “How
Sales Taxes Collected From Customers and Remitted to Governmental Authorities
Should Be Presented in the Income Statement (That Is, Gross versus Net
Presentation).” (“EITF 06-3”). A consensus was reached that entities may adopt a
policy of presenting sales taxes in the income statement on either a gross
or
net basis. If taxes are significant, an entity should disclose its policy of
presenting taxes and the amount of taxes. The guidance is effective for periods
beginning after December 15, 2006. The Company presents sales net of sales
taxes. The Company does not believe that the adoption of EITF 06-3 will impact
the method for recording these sales taxes in the Company’s consolidated
financial statements.
In
July
2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes—an interpretation of FASB Statement No. 109” (“FIN 48”), which
clarifies the accounting for uncertainty in income tax positions. This
Interpretation requires the Company to recognize in the consolidated financial
statements the impact of a tax position that is more likely than not to be
sustained upon examination based on the technical merits of the position. The
provisions of FIN 48 are effective for fiscal years beginning after December
15,
2006. The Company is currently evaluating the impact of adopting FIN 48 on
the
consolidated financial statements and plans to adopt FIN 48 at the beginning
of
fiscal year 2008.
In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.”
This statement clarifies the definition of fair value, establishes a framework
for measuring fair value, and expands the disclosures on fair value
measurements. SFAS No. 157 is effective for fiscal years beginning after
November 15, 2007. The Company has not determined the effect, if any, the
adoption of this statement will have on the Company’s consolidated financial
statements.
In
September 2006, the Securities
and Exchange Commission SEC
staff
issued Staff Accounting Bulletin No. 108, "Considering the Effects of Prior
Year
Misstatements when Quantifying Misstatements in Current Year Financial
Statements." (“SAB 108”).
SAB 108 addresses how the effects of prior-year uncorrected misstatements should
be considered when quantifying misstatements in current-year financial
statements. SAB 108 requires an entity to quantify misstatements using a balance
sheet and income-statement approach and to evaluate whether either approach
results in quantifying an error that is material in light of relevant
quantitative and qualitative factors. The
Company early-adopted
SAB 108 as of April 1, 2005, the beginning of fiscal 2006.
See Note
3 to Consolidated Financial Statements for further discussion.
In
February 2007, the FASB issued SFAS No. 159, "The Fair Value Option
for Financial Assets and Financial Liabilities--Including an amendment of FASB
Statement No. 115." SFAS No. 159 permits companies to choose to
measure many financial instruments and certain other items at fair value at
specified election dates. Upon adoption, an entity shall report unrealized
gains
and losses on items for which the fair value option has been elected in earnings
at each subsequent reporting date. Most of the provisions apply only to entities
that elect the fair value option. However, the amendment to SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," applies
to
all entities with available for sale and trading securities. SFAS No. 159
is effective as of the beginning of an entity's first fiscal year that begins
after November 15, 2007. The Company has not determined the effect, if any,
the adoption of this statement will have on the Company’s consolidated financial
statements.
Item
7A. Quantitative and Qualitative Disclosures About Market
Risk
The
Company is exposed to interest rate risk for its investments in marketable
securities but management believes the risk is not material. At March 31, 2006,
the Company had $151.9 million in securities maturing at various dates through
November 2038, with approximately 77.4% maturing within one year. The Company’s
investments are comprised primarily of marketable investment grade federal
and
municipal bonds, corporate bonds and equity securities, auction rate securities,
asset-backed securities, commercial paper and money market funds. Because the
Company generally invests in securities with terms of two years or less, the
Company generally holds investments until maturity, and therefore should not
bear any interest risk due to early disposition. The Company does not enter
into
any derivative or interest rate hedging transactions. At March 31, 2006, the
fair value of investments approximated the carrying value. Based on the
investments outstanding at March 31, 2006 a 1.0% increase in interest rates
would reduce the fair value of the Company’s total investment portfolio by $0.6
million or 0.4%.
Item
8. Financial Statements and Supplementary
Data
INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT
SCHEDULE
99¢
Only Stores
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board
of
Directors and Shareholders
99¢
Only
Stores
City
of
Commerce, California
We
have
audited the accompanying consolidated balance sheets of the 99¢ Only Stores and
consolidated entities (the “Company”) as of March 31, 2005 and 2006 and the
related consolidated statements of income, shareholders’ equity, and cash
flows for the three months ended March 31, 2005 and for the year ended March
31,
2006. We also have audited the schedule as listed in the accompanying index.
These consolidated financial statements and schedule are the responsibility
of
the Company’s management. Our responsibility is to express an opinion on these
consolidated financial statements and schedule based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether the financial
statements and schedule are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in
the financial statements and schedule, assessing the accounting principles
used
and significant estimates made by management, as well as evaluating the overall
presentation of the financial statements and schedule. We believe that our
audits provide a reasonable basis for our opinion.
In
our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of the Company at March 31,
2005 and 2006, and the results of its operations and its cash flows for the
three months ended March 31, 2005 and for the year ended March 31, 2006, in
conformity with accounting principles generally accepted in the United States
of
America.
Also,
in
our opinion, the schedule presents fairly, in all material respects, the
information set forth therein for three months ended March 31, 2005 and the
year
ended March 31, 2006.
As
discussed in Note 3 to the financial statements, effective April 1, 2005, the
Company changed its method of quantifying misstatements of prior year financial
statements. The Company adopted the dual method, as required by SEC Staff
Accounting Bulletin No. 108, “Considering
the Effects of Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements.”
We
also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of the Company’s internal
control over financial reporting as of March 31, 2006, based on criteria
established in Internal
Control - Integrated Framework
issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)
and our report dated April 2, 2007 expressed an unqualified opinion on
management’s assessment and an adverse opinion on the effectiveness of the
Company’s internal control over financial reporting.
/s/
BDO
Seidman, LLP
BDO
Seidman, LLP
Los
Angeles, California
April
2,
2007
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To
the
Board of Directors and Shareholders of 99¢ Only Stores
City
of
Commerce, California
We
have
audited the accompanying consolidated balance sheet of 99¢ Only Stores (the
“Company”) as of December 31, 2004, and the related consolidated statements of
income, shareholders’ equity, and cash flows for the year then ended. Our audit
also included the financial statement schedule listed in the Index to
Consolidated Financial Statements and Financial Statement Schedule. These
financial statements and the financial statement schedule are the responsibility
of the Company’s management. Our responsibility is to express an opinion on
these financial statements and the financial statement schedule based on our
audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining,
on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In
our
opinion, such 2004 consolidated financial statements present fairly, in all
material respects, the financial position of the Company as of December 31,
2004, and the results of its operations and its cash flows for the year then
ended in conformity with accounting principles generally accepted in the United
States of America. Also in our opinion, such financial statement schedule,
when
considered in relation to the basic consolidated financial statements taken
as a
whole, presents fairly, in all material respects, the information set forth
therein.
/s/
Deloitte & Touche LLP
Deloitte
& Touche LLP
Los
Angeles, California
August
30, 2005
Report
of Independent Registered Public Accounting Firm
To
the
Board of Directors and Shareholders of 99¢ Only Stores
In
our
opinion, the accompanying consolidated statements of income, shareholders’
equity and cash flows present fairly, in all material respects, the results
of
operations and cash flows of 99¢ Only Stores and its subsidiary for the year
ended December 31, 2003, in conformity with accounting principles generally
accepted in the United States of America. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an
opinion on these financial statements based on our audit. We conducted our
audit
of these statements in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining,
on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
/s/
PricewaterhouseCoopers LLP
PricewaterhouseCoopers
LLP
Los
Angeles, California
February
27, 2004, except for the restatement discussed in Note 2 (not presented herein)
to the consolidated financial statements appearing under Item 8 of the Company’s
2004 Annual Report on Form 10-K, as to which the date is July 18,
2005.
Report
of Independent Registered Public Accounting Firm
On
Financial
Statement Schedule
To
the
Board of Directors of 99¢ Only Stores
Our
audit
of the consolidated financial statements referred to in our report dated
February 27, 2004, except for the restatement discussed in Note 2 (not presented
herein) to the consolidated financial statements appearing under Item 8 of
the
Company’s 2004 Annual Report on Form 10-K, as to which the date is July 18,
2005, also included an audit of the financial statement schedule appearing
under
Item 15(b) of this Form 10-K. In our opinion, this financial statement schedule
presents fairly, in all material respects, the information set forth therein
when read in conjunction with the related consolidated financial
statements.
/s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers
LLP
Los
Angeles, California
February
27, 2004
99¢
Only Stores
CONSOLIDATED
BALANCE SHEETS
(Amounts
In Thousands, Except Share Data)
ASSETS
The
accompanying notes are an integral part of these financial
statements.
99¢
Only Stores
CONSOLIDATED
BALANCE SHEETS
(Amounts
In Thousands, Except Share Data)
LIABILITIES
AND SHAREHOLDERS’ EQUITY
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