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99 CENTS ONLY STORES 10-K 2010
form10k.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K
 
x    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended March 27, 2010
OR
 
o    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission file number 1-11735

99¢ Only Stores

(Exact name of registrant as specified in its charter)

California
95-2411605
(State or other Jurisdiction of Incorporation or Organization)
(I.R.S. Employer Identification No.)
   
4000 Union Pacific Avenue,
90023
City of Commerce, California
(zip code)
(Address of Principal Executive Offices)
 

Registrant's telephone number, including area code: (323) 980-8145
Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class
Name of Each Exchange On Which Registered
Common Stock, no par value
New York Stock Exchange

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 o  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 o  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 past 90 days. Yes x  No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter)  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. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  o
Accelerated filer x
Non-accelerated filer o
Smaller reporting company o

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 25, 2009 was $608,747,612 based on a $13.38 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 registrant’s classes of common stock as of the latest practicable date.
Common Stock, No Par Value, 69,635,381 Shares as of May 21, 2010
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the Registrant’s Proxy Statement for its 2010 Annual Meeting of Shareholders are incorporated by reference into Part III of this Annual Report on Form 10-K.
 


 
 

 

Table of Contents

   
Part I
Page
Item 1.
  3
Item 1A.   
  11
Item 1B.
  18
Item 2.
  18
Item 3.
  19
Item 4.
  19
   
Part II
 
Item 5.
  20
Item 6.
  23
Item 7.
  25
Item 7A.
  37
Item 8.
  38
Item 9.
  69
Item 9A.
  69
Item 9B.
  70
   
Part III
 
Item 10.
  72
Item 11.
  72
Item 12.
  72
Item 13.
  72
Item 14.
  72
   
Part IV
 
Item 15.
  73
    76
     


SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION
 
This Report contains statements that constitute “forward-looking statements” within the meaning of Section 21E of the Securities 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”) and 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 (including the Company’s store opening growth rate). Readers 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 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors.” sections. 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 on Form 10-K 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.

Fiscal Periods

On February 1, 2008, the Company changed its fiscal year end from March 31 to the Saturday nearest March 31 of each year. The Company now follows a fiscal calendar consisting of four quarters with 91 days, each ending on the Saturday closest to the calendar quarter-end and a 52-week fiscal year with 364 days, with a 53-week year every five to six years. The Company’s fiscal year 2011 (“fiscal 2011”) which began on March 28, 2010 and will end on April 2, 2011, will consist of 53 weeks.  The Company’s fiscal year 2010 (“fiscal 2010”) began on March 29, 2009 and ended March 27, 2010, its fiscal year 2009 (“fiscal 2009”) began on March 30, 2008 and ended on March 28, 2009, and its fiscal year 2008 (“fiscal 2008”) began on April 1, 2007 and ended on March 29, 2008.

PART I
 
Item 1. Business
 
99¢ Only Stores (the “Company”) is an extreme value retailer of primarily 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 first-quality closeout merchandise.  As of March 27, 2010, the Company operated 275 retail stores with 206 in California, 32 in Texas, 25 in Arizona, and 12 in Nevada.  These stores averaged approximately 21,300 gross square feet.  In fiscal 2010, the Company’s stores open for the full year averaged net sales of $4.8 million per store and $289 per estimated saleable square foot, which the Company believes is the highest among all dollar store chains.  In fiscal 2010, 235 non-Texas stores open for the full year averaged net sales of $5.0 million per store and $305 per estimated saleable square foot and the 31 Texas stores open for the full year averaged net sales of $3.4 million per store and $180 per estimated saleable square foot.
 
The Company opened its first 99¢ Only Stores location in 1982 and believes that it operates the nation’s oldest existing general merchandise chain where items are primarily priced at 99.99¢ or less.  For fiscal 2010, the Company opened nine new stores. Of these newly opened stores, eight stores are located in California, and one Texas store re-opened which was closed due to a hurricane. The Company closed 12 stores in Texas and one store in California during fiscal 2010.  In fiscal 2011, the Company plans to increase its store count by approximately 5%, with the majority of new stores expected to be opened in California during the second half of fiscal 2011.

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 and sometimes at prices higher than those customary at the Company’s retail stores.  Bargain Wholesale represented 3.0% of the Company’s total sales in fiscal 2010.


Industry
 
The Company participates primarily in the extreme value retail industry, with its 99¢ Only Stores. Extreme value 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. Extreme value 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, 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 extreme value 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. Extreme value 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 merchandise through its Bargain Wholesale division, which is generally obtained through the same or shared purchases of the retail operations.  The Company maintains showrooms at its main distribution facility in the City of Commerce, California and at the Company’s distribution facility in the Houston, Texas area. Additionally, the Company has a showroom located in Chicago, Illinois. 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 retailers, as well as smaller retailers, distributors, and wholesalers.

Business Strategy
 
The Company’s business strategy 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 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, primarily at a price point of 99.99¢ or less, in attractively merchandised, clean and convenient stores.  The Company’s strategies to accomplish this 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 are in most cases priced at 99.99¢ or less. During fiscal 2010, the Company purchased merchandise from more than 999 suppliers, including 3M, Colgate-Palmolive, Con Agra, Dole, Energizer Battery, Frito-Lay, General Mills, Georgia Pacific, Hasbro, Heinz, Hershey Foods, Johnson & Johnson, Kellogg’s, Kraft, Nestle, Procter & Gamble, Quaker, 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.  The Company’s total retail sales by product category for fiscal years 2010, 2009 and 2008 are set forth below:


   
Years Ended
 
   
March 27, 2010
   
March 28, 2009
   
March 29, 2008
 
Product Category:
                 
Food and grocery
    54 %     56 %     52 %
Household and housewares
    14 %     14 %     15 %
Health and beauty care
    10 %     9 %     9 %
Hardware
    3 %     3 %     3 %
Stationery and party
    5 %     5 %     5 %
Seasonal
    4 %     3 %     4 %
Other
    10 %     10 %     12 %
      100 %     100 %     100 %

Fun Treasure-Hunt Shopping Experience. The Company’s practices of buying closeouts and other opportunistic purchases and pricing them primarily at 99.99¢ 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 and increase shopping frequency, while generating customer goodwill, loyalty and awareness via word-of-mouth.

 
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.

 
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 27, 2010, the Company’s 275 existing 99¢ Only Stores averaged approximately 21,300 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.



Growth Strategy
 
The Company’s long-term growth plan is to become a premier nationwide extreme value retailer. Management believes that short-term growth will primarily result from new store openings in its existing markets of California, Arizona, Nevada and Texas.
 
 
 
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.
 
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. Merchandise sold in the Company’s 99¢ Only Stores is priced primarily at or below 99.99¢ per item.
 
The following table sets forth certain relevant information with respect to the Company’s retail operations (dollar amounts in thousands, except sales per square footage):

   
Years Ended
 
   
March 27, 2010
   
March 28, 2009
   
March 29, 2008
   
March 31, 2007
   
March 31, 2006
 
                               
Net retail sales
  $ 1,314,214     $ 1,262,119     $ 1,158,856     $ 1,064,518     $ 984,293  
Annual net sales growth rate
    4.1 %     8.9 %     8.9 %     8.2 %     5.8 %
Store count at beginning of year
    279       265       251       232       219 (h)
New stores
    9       19       16       19       15  
Stores closed
    13 (a)     5 (c)     2 (e)           2 (i)
Total store count at year-end
    275       279       265       251       232  
Average net sales per store open the full years(k)
  $ 4,848 (b)   $ 4,642 (d)   $ 4,547 (f)   $ 4,421 (g)   $ 4,347 (j)
Estimated store saleable square foot
    4,606,728       4,703,630       4,521,091       4,337,974       4,040,096  
Average net sales per estimated saleable square foot(h)
  $ 289 (b)   $ 273 (d)   $ 263 (f)   $ 254 (g)   $ 250 (j)
Change in comparable net sales(l)
    3.9 %     3.7 %     4.0 %     2.4 %     0.3 %

(a) 12 underperforming stores in Texas were closed in fiscal 2010 and one California store was closed due to the expiration of its lease.  See Note 10 to the Consolidated Financial Statements for additional information regarding the Texas Market.

(b) Includes 31 Texas stores open for a full year. Texas stores open for the full year had average sales of $3.4 million per store and average sales per estimated saleable square foot of $180. All non-Texas stores open for the full year had average sales of $5.0 million per store and $305 of average sales per estimated saleable square foot.


(c) Four underperforming stores in Texas were closed in fiscal 2009 and one additional Texas store was closed due to a hurricane which was re-opened in May 2009.  The leases had expired for two of the four stores that were closed in fiscal 2009.

(d) Includes 39 Texas stores open for a full year. Texas stores open for the full year had average sales of $2.7 million per store and average sales per estimated saleable square foot of $142. All non-Texas stores open for the full year had average sales of $5.0 million per store and $301 of average sales per estimated saleable square foot.
 
(e) Two underperforming stores closed in Houston, Texas.

(f) Includes 39 Texas stores open for a full year. Texas stores open for the full year had average sales of $2.6 million per store and average sales per estimated saleable square foot of $128. All non-Texas stores open for the full year had average sales of $4.9 million per store and $291 of average sales per estimated saleable square foot.

(g) Includes 36 Texas stores open for a full year. Texas stores open for the full year had average sales of $2.4 million per store and average sales per saleable square foot of $120. All non-Texas stores open for the full year had average sales of $4.8 million per store and $284 of average sales per estimated saleable square foot.

(h) 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.

(i) One store closed due to relocation and one due to an eminent domain action for the construction of a light railway project.

(j) 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 and average sales per estimated 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 estimated saleable square foot.

(k) For stores open for the entire fiscal year.

(l) Change in comparable store net sales compares net sales for all stores open at least 15 months.

 
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 primarily upon the availability of closeout and other special-situation merchandise at suitable prices. Since commencing its closeout purchasing strategy for its stores, 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, encourage impulse and larger volume purchases, result in customers shopping more frequently, and help 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 in a single transaction.
 
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, baskets and shopping bags. The Company emphasizes a strong visual presentation in all key traffic areas of each 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 $4.1 million, $4.4 million and $5.4 million or 0.3%, 0.4% and 0.5% of net retail sales for fiscal 2010, 2009 and 2008, respectively.  The Company allocates the majority of its advertising budget to print advertising. The Company’s advertising strategy 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 pricing of nine iPods and other high value items at only 99.99¢ 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% of the Company’s total purchases in fiscal 2010. During fiscal 2010, the Company purchased merchandise from more than 999 suppliers, including 3M, Colgate-Palmolive, Con Agra, Dole, Energizer Battery, Frito-Lay, General Mills, Georgia Pacific, Hasbro, Heinz, Hershey Foods, Johnson & Johnson, Kellogg’s, Kraft, Nestle, Procter & Gamble, Quaker, 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 2010 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 buying 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 utilizes and develops private label consumer products to broaden the assortment of merchandise that is consistently available. The Company also imports merchandise in product categories such as kitchen items, housewares, toys, seasonal products, party, 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 products as well as to provide long-term warehousing capabilities for one-time closeout purchases and seasonal or holiday items. A large majority of the merchandise sold by the Company is received, processed for retail sale and then distributed to the retail locations from Company-operated warehouse and distribution facilities.

The Company utilizes its internal fleet and outside carriers for both outbound shipping and a backhaul program.  The Company also receives merchandise shipped by rail to its City of Commerce, California distribution center which has a railroad spur on the property. The Company has primarily used common carriers or owner-operators to deliver to stores outside of Southern California including its stores in Northern and Central California, 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 2011. 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 or to support sales levels at peak seasons for perishable products, that high levels of opportunistic purchases 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 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

Over the last two fiscal years, the Company continued to make significant investments in a variety of infrastructure, data management, and process improvement projects.  Infrastructure investments enabled the Company to achieve level one compliance with Payment Card Industry (PCI) standards, which were certified by a qualified third party IT security firm.  Additionally, store network upgrades including high speed wireless data backup lines were installed to assure a high level of availability and speed for credit card processing and delivery of critical item information to the stores, and wireless network upgrades and hardware capacity improvements improved availability and reliability for warehouse operations to support a successful migration to a perpetual inventory system in fiscal 2010.

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.  The Company completed a major upgrade to its Lawson financial and human resources management systems during fiscal 2009 and is now running Lawson version 9.  This upgrade addressed both security and performance concerns from the prior release and converted many customized features to a standard interface approach, laying a foundation to leverage additional Lawson functionality in the coming years.  In fiscal 2010, a standard sales audit package from Epicor systems was implemented with an enhancement to support short-interval intra-day polling of store systems.

The Company also implemented system improvements to support the reengineering of the processes and information flow in the main Commerce Distribution Center.  Primary amongst these improvements were completion of racking systems, real time pallet movement tracking through wireless command and tracking systems, a perpetual warehouse inventory system that is now updated via periodic cycle counting, and improvements in truck utilization.  In the second half of fiscal 2010, cycle counts and test counts replaced and eliminated the semi-annual physical counts in the Company’s main Commerce distribution center.  These changes helped to reduce transportation costs, improve DC labor productivity and throughput, and enhance DC inventory accounting and expiration date control.

The Company also operates several proprietary systems which accommodate the Company’s unique flexibility requirements in product sourcing and acquisition that are tightly coupled with HighJump warehouse solutions.  These proprietary systems include an IBM UNIX-based purchase order and inventory control system, a store ordering system that utilizes radio frequency hand-held scanning devices in each store, and a back office personal computer system at each store that collects and transmits a variety of operational data to central processing systems.  The Company utilizes a proprietary Point of Sale (“POS’’) barcode scanning system to record and process retail sales in each of its stores and electronic polling to collect sales data for analysis, reporting and processing.


During fiscal 2009 and fiscal 2010, the Company focused its efforts on business process improvement, enhanced data structures, and improved data integrity through modifications to its proprietary systems and upgrades of existing vendor systems.  The first stage of these improvements was to centralize and normalize more of the Company’s critical data in standard, high speed database platforms.  This data integrity and normalization will continue in fiscal 2011.  Over the next 2-3 years, the Company intends to differentiate and isolate proprietary systems from those functions which can be more cost effectively managed on industry standard platforms.  An example of a conversion from the proprietary core to an industry standard platform in fiscal 2010 was the conversion of the sales audit function to an industry leading Epicor package solution. In fiscal 2011, the Company is beginning the process of converting to industry leading packages for Master Data Management and Point-of-Sale systems and enhancing its use of Data Warehouse and proprietary systems for purchasing and store merchandise ordering.

Competition
 
The Company faces competition in both the acquisition of inventory and the sale of merchandise from other 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 extreme value 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 extreme value retail industry that could have an adverse effect on the Company’s business and results of operations.
 
Employees
 
At March 27, 2010, the Company had approximately 11,700 employees including approximately 10,500 in its retail operations, 800 in its warehousing and distribution operations and 400 in its corporate offices. The Company considers relations with its employees to be good. The Company offers certain benefits to benefit-eligible employees, including life, health and disability insurance, paid time off (vacation, holidays, and sick leave), a 401(k) plan with a Company match and a deferred compensation plan for certain key management employees of the Company.

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 routinely undertakes enforcement efforts against certain parties whom it believes are infringing upon its “99¢” family of marks and its other intellectual property rights, although the Company believes that simultaneous litigation against all persons everywhere whom the Company believes to be infringing upon these marks is not feasible.

Seasonality

For information regarding the seasonality of the Company’s business, see “Item 6. Selected Financial Data.  Seasonality and Quarterly Fluctuations,” which is incorporated by reference in this Item 1.


Environmental Matters
 
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. 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 City of Commerce, 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, which is currently being marketed for sale.  The Company has not been notified of, and is not aware of, any material current environmental liability, claim or non-compliance, concerning its owned or leased real estate.

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 keep pricing almost all of its merchandise at 99.99¢ or less
 
The Company’s ability to provide quality merchandise for profitable resale primarily at a price point of 99.99¢ or less 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 customary practice of not pricing its merchandise at more than a dollar, which could have a material adverse effect on its business and results of operations.  The Company can pass price increases on to customers to a certain extent, such as by selling smaller units for the same price and increasing the price of merchandise presently sold at less than 99.99¢ (e.g., the Company currently prices some items at 29.99¢, 59.99¢, and the like, and also sells other items at two at 99.99¢, three at 99.99¢, and so forth, but there are limits to the ability to effectively increase prices on a sufficiently wide range of merchandise in this manner while not exceeding a dollar).  In certain circumstances, the Company has dropped and may continue to drop some items from its offerings due to vendor wholesale price increases or availability, which may adversely affect sales.  In September 2008, the Company increased its primary price point to 99.99¢ from 99¢, and also added 99/100¢ to its price points on almost all items. 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 is dependent primarily on new store openings for future growth
 
The Company’s ability to generate growth in sales and operating income depends in part on its ability to successfully open and operate new stores outside of its 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, local regulations, 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.  As the Company expands beyond its base in the Southwestern United States, differences in the available labor pool and potential customers could adversely impact the Company.

The Company’s operations are concentrated in California

As of March 27, 2010, 206 of the Company’s 275 stores were located in California (with 32 stores in Texas, 25 stores in Arizona and 12 stores in Nevada). The Company expects that it will continue to open additional stores in as well as outside of California. For the foreseeable future, the Company’s results of operations will depend significantly on trends in the California economy. Further declines in retail spending on higher margin discretionary items and continuing trends of increasing demand for lower margin food products due to continuing poor economic conditions in California may negatively impact our operations and profitability.  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) and California typically has other factors making compliance, litigation and workers’ compensation claims more prevalent and costly.  Additional local regulation in certain California cities may further pressure margins.
 
The Company has restructured its Texas market and could be impacted by further restructuring costs

The Company has historically experienced, and currently continues to experience, lower sales per store and sales per estimated saleable square foot in its Texas stores compared to its non-Texas stores.  Although the Company’s operating results in Texas have improved in recent periods, there can be no assurance that such improvements will continue or that the Company’s Texas operations can have any sustained positive impact on the Company’s profitability.  The Company currently has 32 stores in Texas and plans to open several additional stores in fiscal 2011. The Company has incurred cash and non-cash charges in connection with its recent store closings in Texas, and may incur additional charges in connection with the Texas market, as discussed in Note 10 to the Consolidated Financial Statements.  We cannot predict with certainty the amount of these potential charges and the Company could be impacted by additional costs.

Material damage to, or interruptions to, the Company’s information systems as a result of external factors, staffing shortages and difficulties in updating its existing software or developing or implementing new software could have a material adverse effect on its business or results of operations 
 
The Company depends on information technology systems for the efficient functioning of its business. Such systems are subject to damage or interruption from power outages, computer and telecommunications failures, computer viruses, security breaches and natural disasters. Any material interruptions or the cost of replacements may have a material adverse effect on its business or results of operations.
 
The Company also relies heavily on its information technology staff. If the Company cannot meet its staffing needs in this area, the Company may not be able to maintain or improve its systems in the future.  Further, the Company still has certain legacy systems that are not generally supportable by outside vendors, and should those of its information technology team who are conversant with such systems leave, these legacy systems could be without effective support.


The Company relies on certain software vendors to maintain and periodically upgrade many of these systems. The software programs supporting many of the Company’s systems are maintained and supported by independent software companies. The inability of these companies to continue to maintain and upgrade these information systems and software programs might disrupt or reduce the efficiency of its operations if the Company was unable to convert to alternate systems in an efficient and timely manner. In addition, costs and potential interruptions associated with the implementation of new or upgraded systems and technology could also disrupt or reduce the efficiency of the Company’s operations.

Natural disasters, unusually adverse weather conditions, pandemic outbreaks, terrorist acts, and global political events could cause permanent or temporary distribution center or store closures, impair the Company’s ability to purchase, receive or replenish inventory, or decrease customer traffic, all of which could result in lost sales and otherwise adversely affect the Company’s financial performance

The occurrence of natural disasters, such as hurricanes, fires, floods, and earthquakes, unusually adverse weather conditions, pandemic outbreaks, terrorist acts or disruptive global political events, such as civil unrest in countries in which the Company’s suppliers are located, or similar disruptions could adversely affect the Company’s operations and financial performance. These events result in the closure of one or more of the Company’s distribution centers or a significant number of stores, the temporary or long-term disruption in the supply of products from some local and overseas suppliers, the temporary disruption in the transport of goods from overseas, delay in the delivery of goods to the Company’s distribution centers or stores, the temporary reduction in the availability of products in its stores, and disruption to its information systems.

The Company’s current insurance program may expose the Company to unexpected costs and negatively affect its financial performance

The Company’s insurance coverage reflects deductibles, self-insured retentions, limits of liability and similar provisions that the Company believes are prudent. However, there are types of losses the Company may incur but against which it cannot be insured or which the Company believes are not economically reasonable to insure, such as losses due to employment practices, acts of war, employee and certain other crime and some natural disasters, including earthquakes. If the Company incurs these losses and they are material, the Company’s business could suffer. In addition, the Company self-insures a significant portion of expected losses under our workers' compensation and general liability programs. Unanticipated changes in any applicable actuarial assumptions and management estimates underlying the Company’s recorded liabilities for these losses could result in materially different amounts of expense than expected under these programs, which could have a material adverse effect on the Company’s financial condition and results of operations. Although the Company continues to maintain property insurance for catastrophic events, the Company is effectively self-insured for property losses up to the amount of its deductibles. If the Company experiences a greater number of these losses than it anticipates, the Company’s financial performance could be adversely affected.

The Company could experience disruptions in receiving and distribution

The Company’s success depends upon whether receiving and shipments are processed timely, accurately and efficiently. 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. In addition, new store locations receiving shipments from distribution centers that are increasingly further away 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 periodically evaluates new warehouse distribution and merchandising systems and could experience interruptions during implementations of new facilities and systems. A fire, earthquake, or other disaster at the Company’s warehouses could also hurt the Company’s 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 the Company’s receiving, processing, and shipment of merchandise.


The Company depends upon its relationships with suppliers and the availability of closeout and other special-situation merchandise
 
The Company’s success depends in large part on its ability to locate and purchase quality closeout and other special-situation merchandise at attractive prices. This supports a changing mix of name-brand and other merchandise primarily within the 99.99¢ 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, particularly as it grows and therefore requires a greater availability of such merchandise at competitive prices. 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 extreme value 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 the Company’s 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.  This can also result in shrink due to spoilage if merchandise cannot be sold in anticipated timeframes.  The Company’s short-term and long-term store and warehouse inventory approximated $176.0 million and $156.2 million at March 27, 2010 and March 28, 2009, 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 not, 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.

If the Company fails to protect its brand name, competitors may adopt trade names that dilute the value of the Company’s brand name

The Company may be unable or unwilling to strictly enforce its trademark in each jurisdiction in which it does business. Also, the Company may not always be able to successfully enforce its trademarks against competitors or against challenges by others. The Company’s failure to successfully protect its trademarks could diminish the value and efficacy of its brand recognition, and could cause customer confusion, which could, in turn, adversely affect the Company’s sales and profitability.

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 extreme value retail industry. It is also becoming more common for superstores to sell products competitive with the Company’s product offerings. 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.  Also, 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 ability 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 that 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 constrained by our price points that are primarily 99.99¢ or less could be hindered by certain economic factors beyond its control, including but not limited to:
 
-
future inflation both in the United States as well as in other countries in which the products it sells are manufactured or from which parts and materials are sourced;
-
increases in prices from our merchandise, supply and service vendors;
-
increases in employee health and other benefit costs and the impact of new federal health care laws and regulations;
-
increases in minimum and prevailing wage levels, as well as “living wage” pressures;
-
increases in government regulatory compliance costs;
-
decreases in consumer confidence levels;
-
increases in transportation and fuel costs, which affect both the Company, as it ships over longer distances, and its customers and suppliers;
-
increases in unionization efforts, including campaigns at the store and warehouse levels;
-
increases in workers’ compensation costs and self-insured workers’ compensation liabilities due to increased claims costs, as well as political and legislative pressure or judicial rulings.

The Company faces risks associated with international sales and purchases
 
International sales historically have not been important to the Company’s overall net sales. However, 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:
 
-
political instability;
-
lack of knowledge by foreign manufacturers of or compliance with applicable federal and state product, content,packaging and other laws, rules and regulations;
-
foreign currency exchange rate fluctuations;
-
uncertainty in dealing with foreign vendors and countries where the rule of law is less established;
-
risk of loss due to overseas transportation;
-
import and customs review can delay delivery of products as could labor disruptions at ports;
-
changes in import and export regulations, including “trade wars” and retaliatory responses;
-
changes in tariff, import duties and freight rates;
-
testing and compliance.
 
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 has potential risks regarding its store physical inventories
 
The Company had a material weakness in its internal control over financial reporting related to its inventory accounts for a number of years.  Although the Company remediated this material weakness as of March 27, 2010, there still are Company processes and procedures surrounding store physical inventories that the Company believes need to be improved. In particular, the Company has identified that certain personnel managing or performing physical inventories need additional training in order to consistently follow the Company’s physical inventory processes and procedures, and properly document the physical inventory results.


If these physical inventory processes and procedures are not improved, this could have an adverse affect on the Company’s physical inventory results, shrinkage and margins.  See “Item 9A. Controls and Procedures.” for more information regarding the status of the Company’s disclosure controls and procedures and internal control over financial reporting.

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 12 stores are leased on a month to month basis.  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 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 it currently leases from them. Also, even if terms were negotiated that were acceptable to the Company, it cannot be certain that such terms would meet the standard required for approval by the independent directors. 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 the Company’s net sales and operating results.

The Company relies heavily on its executive management team
 
The Company relies heavily on the continued service of its executive management team.  With the exception of Robert Kautz, the Company’s Executive Vice President and Chief Financial Officer, 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 highest operating income have occurred during the quarter ended on or near December 31, which includes the Christmas and Halloween selling seasons. During fiscal 2010 and 2009, the Company generated approximately 26.5% and 26.9%, 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 number, size and location of new stores and timing of new store openings;
-
the distance of new stores from existing stores and distribution sources;
-
the level of advertising and pre-opening expenses associated with new stores;
-
the integration of new stores into operations;
-
the general economic health of the extreme value retail industry;
-
changes in the mix of products sold;
-
increases in fuel, shipping merchandise and energy costs;
-
the ability to successfully manage inventory levels and product mix across its multiple distribution centers and its stores;
-
changes in personnel;
-
the expansion by competitors into geographic markets in which they have not historically had a strong presence;
-
fluctuations in the amount of consumer spending; and
-
the amount and timing of operating costs and capital expenditures relating to the growth of the business and the Company’s ability to uniformly capture such costs.


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 manufactured or distributed by overseas entities, and some of which are purchased by the Company through brokers or other intermediaries as opposed to directly from their manufacturing or distribution sources. Many products are also sourced directly from manufacturers.  The closeout nature of certain of these products and transactions may impact the Company’s opportunity to investigate all aspects of these products. The Company attempts to ensure compliance, and to test products when appropriate, as well as to procure product insurance from its vendors and to be listed as an additional insured for certain products and/or by certain product vendors, and it does not purchase merchandise when it is cognizant of or foresees a problem, but there can be no assurance that the Company will consistently succeed in these efforts.  The Company has or has had, and in the future could face, labeling, environmental, or other claims, from private litigants as well as from governmental agencies, including, without limitation, the Environmental Protection Agency, Consumer Product Safety Commission, and California Air Resources Board.

The Company faces risks related to protection of customers’ credit card data

In connection with credit card sales, the Company transmits confidential credit card information.  Third parties may have the technology or know-how to breach the security of this customer information, and the Company’s security measures and those of our technology vendors may not effectively prohibit others from obtaining improper access to this information.  Any security breach could expose the Company to risks of data loss, litigation and liability and could seriously disrupt our operations and any resulting negative publicity could significantly harm our reputation.

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 City of Commerce, 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, which is currently being marketed for sale. 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, and the Company is still potentially subject to liability under, or violations of, these environmental laws and regulations in the future even if its policies are 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 March 27, 2010, an aggregate of 23,655,774, or 33.9%, 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 significantly>

Trading prices for the Company’s common stock could decrease and fluctuate significantly due to many factors, including:

-
the depth of the market for the Company’s common stock;
-
changes in expectations of future financial performance, including financial estimates by securities analysts;
-
variations in operating results;
-
conditions or trends in the industry or industries of any significant vendors or other stakeholders;
-
the conditions of the market generally or the extreme value or retail industries;
-
additions or departures of key personnel;
-
future sales of common stock by the Company, its officers and the principal shareholders;
-
government regulation affecting the business;
-
increased competition;
-
increases in minimum wages;
-
workers’ compensation costs and new laws and regulations;
-
the Company’s ability to control shrink;
-
consolidation of consumer product companies;
-
municipal regulation of “dollar” stores;
-
future determinations of compliance or noncompliance with Sarbanes Oxley and related requirements; and
-
other risk factors as disclosed herein.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties
 
As of March 27, 2010, the Company owned 54 stores and leased 221 of its 275 store locations. Additionally, as of March 27, 2010, the Company owned three parcels of land and one building for potential store sites.
 
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 12 stores are leased on a month to month basis.  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.

The following table sets forth, as of March 27, 2010, information relating to the calendar year expiration dates of the Company’s current stores leases:

Expiring
2010
 
Expiring
2011-2013
 
Expiring
2014-2016
 
Expiring
2017 and beyond
22(a)
 
82
 
77
 
40

(a)
Includes 15 stores leased on a month-to-month basis.


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 number of stores expiring with no additional options for renewal is set forth below:
 
 
Expiring Without
Renewal Options
2010
 
Expiring Without
Renewal Options
2011-2013
 
Expiring Without
Renewal Options
2014-2016
 
Expiring Without
Renewal Options
2017 and beyond
18(a)
 
4
 
12
 
187

(a)
Includes 15 stores leased on a month-to-month basis.

The Company owns its main warehouse, distribution and executive office facility, located in the City of Commerce, California.  The Company also owns an additional warehouse storage space nearly adjacent to its main distribution facility.
 
The Company owns a warehouse/distribution center in the Houston area to service its Texas operations.
 
The Company also owns a cold storage warehouse/distribution center and leases additional warehouse facilities located near the City of Commerce, California.  As the Company’s needs change, it may relocate, expand, and/or otherwise increase/decrease the size and/or costs of its distribution/warehouse facilities.

The Company also owns a warehouse in Eagan, Minnesota.  The Company commenced marketing this warehouse for sale during the fourth quarter of fiscal 2008, and it is reflected in assets held for sale in the Company’s consolidated balance sheets.  Although the Company anticipates a sale of this warehouse in excess of its book value, no assurance can be given as to how much the warehouse will be sold for.

Item 3. Legal Proceedings

The Company is subject to private lawsuits, administrative proceedings and claims that arise in the ordinary course of business.  A number of these lawsuits, proceedings and claims may exist at any given time.  While the resolution of a lawsuit, proceeding or claim may have an impact on our financial results for the period in which it is resolved, and litigation is inherently unpredictable, in management’s opinion, none of these matters arising in the ordinary course of business are expected to have a material adverse effect on the Company’s financial position, results of operations, or overall liquidity.  Material pending legal proceedings (other than ordinary routine litigation incidental to our business) and material proceedings known to be contemplated by governmental authorities are reported in our Securities Exchange Act reports.  In accordance with ASC 450 “Accounting for Contingencies” (“ASC 450”), previously referred to as SFAS No. 5, the Company records a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated.

The district attorneys of two California counties and one city attorney have notified the Company that they are planning a possible civil action against the Company alleging that its .99 cent pricing policy, adopted in September 2008, constitutes false advertising and/or otherwise violates California's pricing laws.  In response to this notification and an associated invitation from these governmental entities, the Company provided a detailed position statement with respect to its pricing structure.  If such an action is brought, we cannot predict the outcome of such an action or the amount of potential loss, if any.  We believe our pricing structure is lawful, and that our .99 cent pricing policy has an established precedent to the similar .9 cent pricing policy used for decades by gas stations across the country. We believe our .99 cent pricing policy has been well publicized with items properly price signed in the stores such that it would not cause a reasonable consumer to be deceived, and, if such an action is brought, we intend to vigorously defend it.

Item 4. (Removed and Reserved)


PART II

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 fiscal periods indicated, the high and low closing prices per share of the common stock as reported by the New York Stock Exchange.
 
   
Price Range
 
   
High
   
Low
 
Fiscal Year ended March 27, 2010:
           
First Quarter
  $ 13.68     $ 8.94  
Second Quarter
    14.94       12.84  
Third Quarter
    14.12       11.37  
Fourth Quarter
    17.25       12.71  
                 
Fiscal Year ended March 28, 2009:
               
First Quarter
  $ 10.20     $ 6.77  
Second Quarter
    11.11       5.85  
Third Quarter
    12.66       9.34  
Fourth Quarter
    10.93       7.11  

As of April 23, 2010, the Company had 396 shareholders of record and approximately 13,900 beneficial holders of its common stock.

The Company has not paid cash dividends with respect to its common stock since it became a public 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 plan that provides for stock-based compensation (the 1996 Stock Option Plan, as amended). The plan is a fixed plan, which provides for the granting of non-qualified and incentive stock options as well as other types of equity-based awards.  An aggregate of 17,000,000 shares of the Company’s common stock may be issued pursuant to all awards under the plan, of which 2,606,000 are available as of March 27, 2010 for future option grants. Awards may be granted to officers, employees, non-employee directors and consultants. All grants are made at fair market value at the date of grant, either based on the closing price of our stock on the date of grant or, in the case of grants to members of the Board of Directors, based on a formula set forth in the plan. Stock options typically vest over a three-year period, one-third one year from the date of grant and one-third per year thereafter.  Stock options typically expire ten years from the date of grant.  In January 2008, the Compensation Committee approved a long-term incentive program under this plan.  The program included the awarding of both stock options and newly adopted performance stock units to members of management and other key employees as a long-term, stock-based pay for performance award designed to focus the Company’s management on achieving improved operating results and delivering value to shareholders.  Prior to April 1, 2006, the Company accounted for its stock option plan under APB Opinion No. 25 under which no compensation cost has been recognized in fiscal 2006.  In fiscal 2007, the Company adopted ASC 718, “Share-Based Payment” previously referred to as SFAS 123(R).  In fiscal 2010 and 2009 the Company recognized $7.7 million and $3.1 million, respectively, in shared-based compensation expense (see Note 8 to Consolidated Financial Statements for detailed discussion).  The Company’s 1996 Stock Option plan will expire in 2011.


Securities Authorized for Issuance Under Equity Compensation Plans
 
The following table provides information as of March 27, 2010 about the Company’s common stock that may be issued upon the exercise of options granted to employees or members of the Company’s Board of Directors under the Company’s existing 1996 Stock Option Plan.

EQUITY COMPENSATION PLAN INFORMATION
 
                   
   
Number of securities to be issued upon exercise of outstanding options, warrants and rights
   
Weighted-average exercise price of outstanding options, warrants and rights
   
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
 
Plan category
 
(a)
   
(b)
   
(c)
 
                   
Equity compensation plans approved by security holders
    5,124,000 (1)   $ 17.23 (2)     2,606,000  
Equity compensation plans not approved by security holders
                 
Total
    5,124,000     $ 17.23       2,606,000  
 
 
(1)
This amount includes 993,000 shares potentially issuable pursuant to outstanding performance stock units granted under the Company’s 1996 Stock Option Plan. The actual number of shares of Company common stock to be issued depends on the Company’s financial performance over a period of time.
 
(2)
Performance stock units do not have an exercise price and thus they have been excluded from the weighted average exercise price calculation in column (b).

Stock Repurchase Program

For information on common stock repurchases, see Note 9 to Consolidated Financial Statements, which is incorporated by reference in this Item 2.


Performance Graph

The following graph sets forth the percentage change in cumulative total shareholder return of the Company’s common stock during the period from March 31, 2005 to March 27, 2010, compared with the cumulative returns of the S&P Mid Cap 400 Index and the Russell 2000 Index.  The comparison assumes $100 was invested on March 31, 2005 in the common stock and in each of the foregoing indices shown. The stock price performance on the following graph is not necessarily indicative of future stock price performance.

 

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.
 
   
Years Ended
 
   
March 27, 2010
   
March 28, 2009
   
March 29, 2008
   
March 31, 2007
   
March 31, 2006
 
   
(Amounts in thousands, except per share and operating data)
 
Statements of Income Data:
                             
Net Sales:
                             
99¢ Only Stores
  $ 1,314,214     $ 1,262,119     $ 1,158,856     $ 1,064,518     $ 984,293  
Bargain Wholesale
    40,956       40,817       40,518       40,178       39,296  
Total sales
    1,355,170       1,302,936       1,199,374       1,104,696       1,023,589  
                                         
Cost of sales (excluding depreciation and amortization expense as shown separately below)
    797,748       791,121       738,499       672,101       640,140  
Gross profit
    557,422       511,815       460,875       432,595       383,449  
                                         
Selling, general and administrative expenses:
                                       
Operating expenses
    436,608       464,635       433,940       393,351       340,371  
Depreciation and amortization
    27,398       34,266       33,321       32,675       31,424  
Total operating expenses
    464,006       498,901       467,261       426,026       371,795  
Operating income (loss)
    93,416       12,914       (6,386 )     6,569       11,654  
                                         
Other (income), net
    (135 )     (993 )     (6,674 )     (7,432 )     (5,084 )
Income before provision for income taxes and income attributed to noncontrolling interest
     93,551        13,907        288       14,001       16,738  
Provision (benefit) for income taxes
    33,104       4,069       (2,605 )     4,239       5,316  
Net income including noncontrolling interest
    60,447       9,838       2,893       9,762       11,422  
Net income attributable to noncontrolling interest
     —        (1,357 )                  —  
Net income attributable to 99¢ Only Stores
  $ 60,447     $ 8,481     $ 2,893     $ 9,762     $ 11,422  
Earnings per common share attributable to 99¢ Only Stores:
                                       
Basic
  $ 0.88     $ 0.12     $ 0.04     $ 0.14     $ 0.16  
Diluted
  $ 0.87     $ 0.12     $ 0.04     $ 0.14     $ 0.16  
Weighted average number of common shares outstanding:
                                       
Basic
    68,641       69,987       70,044       69,862       69,553  
Diluted
    69,309       70,037       70,117       70,017       69,737  
Company Operating Data:
                                       
Sales Growth:
                                       
99¢ Only Stores
    4.1 %     8.9 %     8.9 %     8.2 %     5.8 %
Bargain Wholesale
    0.3 %     0.7 %     0.8 %     2.2 %     (7.1 )%
Total sales
    4.0 %     8.6 %     8.6 %     7.9 %     5.3 %
                                         
Gross margin
    41.1 %     39.3 %     38.4 %     39.2 %     37.5 %
Operating margin
    6.9 %     1.0 %     (0.5 )%     0.6 %     1.1 %
Net income
    4.5 %     0.7 %     0.2 %     0.9 %     1.1 %


   
March 27, 2010
   
March 28, 2009
   
March 29, 2008
   
March 31, 2007
   
March 31, 2006
 
   
(Amounts in thousands, except per share and operating data)
 
Retail Operating Data (a):
                             
99¢ Only Stores at end of period
    275       279       265       251       232  
Change in comparable stores net sales(b)
    3.9 %     3.7 %     4.0 %     2.4 %     0.3 %
Average net sales per store open the full year
  $ 4,848     $ 4,642     $ 4,547     $ 4,421     $ 4,347  
Average net sales per estimated saleable square foot(c)
  $ 289 (d)   $ 273 (e)   $ 263 (f)   $ 254 (g)   $ 250 (h)
Estimated saleable square footage at year end
    4,606,728       4,703,630       4,521,091       4,337,974       4,040,096  
                                         
Balance Sheet Data:
                                       
Working capital
  $ 271,261     $ 192,365     $ 170,581     $ 209,890     $ 201,475  
Total assets
  $ 745,986     $ 662,873     $ 649,410     $ 643,135     $ 628,708  
Capital lease obligation, including current portion
  $ 519     $ 584     $ 643     $ 699     $ 774  
Long-term debt, including current portion
  $     $     $ 7,319     $ 7,299     $ 6,174  
Total shareholders' equity
  $ 600,422     $ 523,857     $ 526,491     $ 519,227     $ 501,526  

(a)
Includes retail operating data solely for the Company’s 99¢ Only Stores.
(b)
Change in comparable stores net sales compares net sales for all stores open at least 15 months.
(c)
Computed based upon estimated total saleable square footage of stores open for the full year.
(d)
Includes 31 Texas stores open for a full year. Texas stores open for the full year had average sales of $3.4 million per store and average sales per estimated saleable square foot of $180. All non-Texas stores open for the full year had average sales of $5.0 million per store and $305 of average sales per estimated saleable square foot.
(e)
Includes 39 Texas stores open for a full year. Texas stores open for the full year had average sales of $2.7 million per store and average sales per estimated saleable square foot of $142. All non-Texas stores open for the full year had average sales of $5.0 million per store and $301 of average sales per estimated saleable square foot.
(f)
Includes 39 Texas stores open for a full year. Texas stores open for the full year had average sales of $2.6 million per store and average sales per estimated saleable square foot of $128. All non-Texas stores open for the full year had average sales of $4.9 million per store and $291 of average sales per estimated saleable square foot.
(g)
Includes 36 Texas stores open for a full year. Texas stores open for the full year had average sales of $2.4 million per store and average sales per estimated saleable square foot of $120. All non-Texas stores open for the full year had average sales of $4.8 million per store and $284 of average sales per estimated saleable square foot.
(h)
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 and average sales per estimated 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 estimated saleable square foot.


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 2010, 99¢ Only Stores had net sales of $1,355.2 million, operating income of $93.4 million and net income of $60.4 million.  Net sales increased 4.0% over fiscal 2009 primarily due to the nine new store openings since the end of fiscal 2009 and a 3.9% increase in same-store sales.  Average sales per store open the full year increased to $4.8 million in fiscal 2010 from $4.6 million, in fiscal 2009.  Average net sales per estimated saleable square foot (computed for stores open for the full year) increased to $289 per square foot at March 27, 2010 from $273 per square foot at March 28, 2009. This increase reflects the Company’s opening of smaller locations for new store development and increases in same-store sales. Existing stores at March 27, 2010 average approximately 21,300 gross square feet.  The Company currently is targeting locations between 15,000 and 19,000 gross square feet.

In fiscal 2010, the Company continued to expand its store base, opening nine new stores. Of these newly opened stores, eight stores are located in California, and one Texas store re-opened which was closed due to a hurricane.  The Company closed 12 stores in Texas and one store in California during fiscal 2010.  In fiscal 2011, the Company plans to increase its store count by approximately 5%, with the majority of new stores expected to be opened in California during the second half of fiscal 2011, and the Company believes that near term growth in fiscal 2011 will primarily result from new store openings in its existing territories and increases in same-store sales.
 
On February 1, 2008, the Company changed its fiscal year end from March 31 to the Saturday nearest March 31 of each year. The Company now follows a fiscal calendar consisting of four quarters with 91 days, each ending on the Saturday closest to the calendar quarter-end and a 52-week fiscal year with 364 days, with a 53-week year every five to six years. The Company’s fiscal year 2011 (“fiscal 2011”) which began on March 28, 2010 and will end on April 2, 2011, will consist of 53 weeks.  The Company’s fiscal year 2010 (“fiscal 2010”) began on March 29, 2009 and ended March 27, 2010, its fiscal year 2009 (“fiscal 2009”) began on March 30, 2008 and ended on March 28, 2009, and its fiscal year 2008 (“fiscal 2008”) began on April 1, 2007 and ended on March 29, 2008.

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, taxes and share-based compensation.

The Company believes that the following represent the areas where more critical estimates and assumptions are used in the preparation of our 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 and shrinkage are also recorded. Shrinkage 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 for obsolete and excess inventory 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.  The Company does not believe that there is a reasonable likelihood that there will be a material change in the future estimates or assumptions that the Company uses to calculate these inventory valuation reserves.  As an indicator of the sensitivity of this estimate, a 10% increase in our estimates of expected losses from excess and obsolete inventory and the shrinkage provision at March 27, 2010, would have increased these reserves by approximately $0.4 million and $1.5 million, respectively and reduced fiscal 2010 pre-tax earnings by the same amounts.


Long-lived asset impairment: In accordance with ASC 360 “Accounting for the Impairment or Disposal of Long-lived Assets” (“ASC360”), previously referred to as SFAS No. 144, the Company assesses the impairment of long-lived assets annually or 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 the Company’s 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. The primary factor that could impact the outcome of an impairment evaluation is the estimate of future cash flows expected to be generated by the asset being evaluated. Considerable management judgment is necessary to estimate the cash flows.  Accordingly, if actual results fall short of such estimates, significant future impairments could result. In fiscal 2010, due to the underperformance of one California store, the Company concluded that the carrying value of its long-lived asset was not recoverable and accordingly recorded an asset impairment charge of $0.4 million.  In fiscal 2009, the Company recorded impairment charges of $10.4 million because it concluded that the carrying value of certain long-lived assets was not recoverable.  These charges primarily consisted of a leasehold improvement impairment charge of approximately $10.1 million related to the Company’s Texas market plan and an impairment charge of approximately $0.2 million related to the underperformance of a store in California.  See Note 10 to Consolidated Financial Statements for further information regarding the charges related to the Company’s Texas operations.  In fiscal 2008, the Company recorded an asset impairment charge of $0.5 million related to one underperforming store in Texas. The Company has not made any material changes to its long-lived asset impairment methodology during fiscal 2010.

Legal reserves: >The Company is subject to private lawsuits, administrative proceedings and claims that arise in the ordinary course of business.  A number of these lawsuits, proceedings and claims may exist at any given time.  While the resolution of a lawsuit, proceeding or claim may have an impact on our financial results for the period in which it is resolved, and litigation is inherently unpredictable, in management’s opinion, none of these matters arising in the ordinary course of business are expected to have a material adverse effect on the Company’s financial position, results of operations, or overall liquidity.  Material pending legal proceedings (other than ordinary routine litigation incidental to our business) and material proceedings known to be contemplated by governmental authorities are reported in our Exchange Act reports.  In accordance with ASC 450 “Accounting for Contingencies” (“ASC 450”), previously referred to as SFAS No. 5, the Company records a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated.

There were no material changes in the estimates or assumptions used to determine legal reserves during fiscal 2010 and a 10% change in legal reserves will not be material to the Company’s consolidated financial position or results of operations.

Self-insured workers’ compensation liability: The Company self-insures for workers’ compensation claims in California and Texas. The Company establishes a reserve for losses of both estimated known claims and incurred but not reported insurance claims. The estimates are based on reported claims and actuarial valuations of estimated future costs of reported and incurred but not yet reported claims. Should the estimates fall short of the actual claims paid, the liability recorded would not be sufficient and additional workers’ compensation costs, which may be significant, would be incurred. The Company does not discount the projected future cash outlays for the time value of money for claims and claim related costs when establishing its workers’ compensation liability.  As an indicator of the sensitivity of this estimate, at March 27, 2010, a 10% increase in our estimate of expected losses from workers compensation claims would have increased this reserve by approximately $4.7 million and reduced fiscal 2010 pre-tax earnings by the same amount.



For store closures where a lease obligation still exists, the Company records the estimated future liability associated with the rental obligation on the cease use date (when the store is closed) in accordance with ASC 420 “Accounting for Exit or Disposal Cost Obligations” (“ASC420”), previously referred to as SFAS No. 146.  Liabilities are established at the cease use date for the present value of any remaining operating lease obligations, net of estimated sublease income, and at the communication date for severance and other exit costs, as prescribed by ASC 420. Key assumptions in calculating the liability include the timeframe expected to terminate lease agreements, estimates related to the sublease potential of closed locations, and estimation of other related exit costs. If actual timing and potential termination costs or realization of sublease income differ from our estimates, the resulting liabilities could vary from recorded amounts. These liabilities are reviewed periodically and adjusted when necessary.

During fiscal 2010, the Company closed 12 of its Texas stores and accrued approximately $3.0 million in lease termination costs associated with the closing of seven out of the 12 Texas stores.  Of the $3.0 million lease termination costs accrual, the Company recognized a net expense of $2.5 million as these costs were partially offset by a reduction in expenses of $0.5 million due to the reversal of deferred rent and tenant improvements related to these stores during fiscal 2010.  During fiscal 2009, the Company accrued approximately $1.3 million in lease termination costs associated with the closing of four of its Texas stores during fourth quarter of fiscal 2009 and lease termination costs for one contracted store. See Note 10 to Consolidated Financial Statements for further information regarding the lease termination charges related to Company’s Texas operations.

Tax Valuation Allowances and Contingencies: >The Company accounts for income taxes in accordance with ASC 740 “Accounting for Income Taxes” (“ASC 740”), previously referred to as 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. ASC 740-10-55 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 assets will not be realized. The Company had approximately $70.9 million and $68.5 million in net deferred tax assets that are net of tax valuation allowances of $5.8 million and $3.9 million for the year ended March 27, 2010 and March 28, 2009, respectively. Management evaluated the available evidence in assessing the Company’s ability to realize the benefits of the net deferred tax assets at March 27, 2010 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.  Income tax contingencies are accounted for in accordance with ASC 740-10-50, previously referred to as FIN 48, and may require significant management judgment in estimating final outcomes.  The Company had approximately $1.4 million at March 28, 2009 of unrecognized tax benefits related to uncertain tax positions.  The statutes of limitations have expired for the periods related to these uncertain tax positions at the end of fiscal 2010.  Accordingly, in fiscal 2010, the Company has derecognized these liabilities. See Note 5 “Income Tax Provision” to Consolidated Financial Statements for further discussion of income taxes.

Share-Based Compensation:> The Company has a stock incentive plan in effect under which the Company grants stock options and Performance Stock Units (“PSUs”).  The Company accounts for stock-based compensation expense under the fair value recognition provisions of ASC 718, “Shared-based compensation” (“ASC 718”), previously referred to as SFAS 123(R).  ASC 718 requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model.  The value of the portion of the award that is ultimately expected to vest is recognized as an expense ratably over the requisite service periods.  The Company estimates the fair value for each option award as of the date of grant using the Black-Scholes option pricing model.  The Black-Scholes model considers, among other factors, the expected life of the award and the expected volatility of the Company’s stock price.  Stock options are granted to employees at exercise prices equal to the fair market value of the Company’s stock at the dates of grant.  The Company recognizes the stock-based compensation expense ratably over the requisite service periods, which is generally a vesting term of three years.  Stock options typically have a term of 10 years.  The fair value of the PSUs is based on the stock price on the grant date.  The compensation expense related to PSUs is recognized only when it is probable that the performance criteria will be met.   During fiscal 2010, expected stock price volatility and the assumed risk free rate decreased slightly based upon recent historical trends. These changes are not material to the Company’s consolidated financial position or results of operations.  There were no other material changes in the estimates or assumptions used to determine stock-based compensation during fiscal 2010.


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.”
 

Cost of Sales: Cost of sales includes the cost of inventory, freight in, inter-state warehouse transportation costs, inventory shrinkage (obsolescence, spoilage and shrink), and is net of discounts and allowances. 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, distribution, warehouse costs and transportation to and from stores in its cost of sales, which totaled $66.3 million, $74.1 million and $72.1 million as of fiscal 2010, 2009 and 2008, 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, stock-based compensation expense 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 the impairment charge related to the Company’s marketable securities.


The following table sets forth for the periods indicated, certain selected income statement data, including such data as a percentage of net sales (percentages may not add up due to rounding):

   
Year Ended
 
   
March 27, 2010
   
% of Net Sales
   
March 28, 2009
   
% of Net Sales
   
March 29, 2008
   
% of Net Sales
 
   
(Amounts in thousands)
 
Net Sales:
                                   
99¢ Only Stores
  $ 1,314,214    
97.0
%   $ 1,262,119    
96.9
%   $ 1,158,856       96.6 %
Bargain Wholesale
    40,956       3.0       40,817       3.1       40,518       3.4  
Total sales
  $ 1,355,170       100.0     $ 1,302,936       100.0     $ 1,199,374       100.0  
Cost of sales
    797,748       58.9       791,121       60.7       738,499       61.6  
Gross profit
    557,422       41.1       511,815       39.3       460,875       38.4  
Selling, general and administrative expenses:
                                               
Operating expenses
    436,608       32.2       464,635       35.7       433,940       36.2  
Depreciation and amortization
    27,398       2.0       34,266       2.6       33,321       2.8  
Total operating expenses
    464,006       34.2       498,901       38.3       467,261       39.0  
Operating income (loss)
    93,416       6.9       12,914       1.0       (6,386 )     (0.5 )
Other income, net
    (135 )     (0.0 )     (993 )     (0.1 )     (6,674 )     (0.6 )
Income before provision for income taxes and income attributed to noncontrolling interest
     93,551       6.9        13,907       1.1       288       0.0  
Provision (benefit) for income taxes
    33,104       2.4       4,069       0.3       (2,605 )     (0.2 )
Net income attributable to noncontrolling interest
     —        —       (1,357 )     (0.1 )            
Net income attributable to 99¢ Only Stores
  $ 60,447       4.5 %   $ 8,481       0.7 %   $ 2,893       0.2 %


Fiscal Year Ended March 27, 2010 Compared to Fiscal Year Ended March 28, 2009

Net sales. Total net sales increased $52.2 million, or 4.0%, to $1,355.2 million in fiscal 2010 from $1,302.9 million in fiscal 2009. Net retail sales increased $52.1 million, or 4.1%, to $1,314.2 million in fiscal 2010 from $1,262.1 million in fiscal 2009.  Of the $52.1 million increase in net retail sales, $47.6 million was due to a 3.9% increase in comparable stores net sales for all stores open at least 15 months in fiscal 2010 and 2009.  The comparable stores net sales increase was attributable to a 4.0% increase in transaction counts and decrease in average ticket size by 0.1% to $9.59 from $9.60.  The full year fiscal 2010 effect of stores opened in fiscal 2009 increased sales by $19.5 million and the effect of nine new stores opened during fiscal 2010 increased net retail sales by $19.7 million.  The increase in sales was partially offset by a decrease in sales of approximately $34.7 million due to the effect of the closing of 17 stores in Texas and one in California during fiscal 2010 and fiscal 2009. Bargain Wholesale net sales increased $0.1 million, or 0.3%, to $41.0 million in fiscal 2010 from $40.8 million in fiscal 2009.

During fiscal 2010, the Company added nine stores: eight in California and re-opened one store in Texas, which was closed due to a hurricane. The Company closed 12 stores in Texas and one in California during fiscal 2010.  At the end of fiscal 2010, the Company had 275 stores compared to 279 as of the end of fiscal 2009. Gross retail square footage at the end of fiscal 2010 and fiscal 2009 was 5.86 million and 5.99 million, respectively.  For 99¢ Only Stores open all of fiscal 2010, the average net sales per estimated saleable square foot was $289 and the average annual net sales per store were $4.8 million, including the Texas stores open for the full year. Non-Texas stores net sales averaged $5.0 million per store and $305 per square foot. Texas stores open for a full year averaged net sales of $3.4 million per store and $180 per square foot.
 
Gross profit. Gross profit increased $45.6 million, or 8.9%, to $557.4 million in fiscal 2010 from $511.8 million in fiscal 2009.  As a percentage of net sales, overall gross margin increased to 41.1% in fiscal 2010 from 39.3% in fiscal 2009.  The increase in gross profit margin was primarily due to a decrease in cost of products sold to 56.1% of net sales for fiscal 2010 compared to 57.1% of net sales for fiscal 2009 due to a favorable shift in product mix and new buying and merchandising initiatives to drive sales of higher margin items. In addition, an increase in gross profit margin was also due to a decrease in spoilage/shrinkage to 2.6% of net sales in fiscal 2010 compared to 3.2% in fiscal 2009.  This reduction in shrinkage is primarily due to a one time reduction in shrink reserves of approximately $1.8 million for Texas based on the shrink analysis performed at the end of fiscal 2010 and lower overall shrink as a result of the trend of physical inventories taken during fiscal 2010 as well as a decrease in recorded scrap from perishables.  The remaining change was made up of increases and decreases in other less significant items included in cost of sales.
 
Operating expenses. Operating expenses decreased by $28.0 million, or 6.0%, to $436.6 million in fiscal 2010 from $464.6 million in fiscal 2009. As a percentage of net sales, operating expenses decreased to 32.2% for fiscal 2010 from 35.7% for fiscal 2009.  Of the 340 basis points decrease in operating expenses as a percentage of net sales, retail operating expenses decreased by 150 basis points, distribution and transportation costs decreased by 80 basis points, corporate expenses decreased by 70 basis points, and other items decreased by 40 basis points as described below.

Retail operating expenses for fiscal 2010 decreased as a percentage of net sales by 150 basis points to 22.9% of net sales, compared to 24.4% of net sales for fiscal 2009. The majority of the decrease as a percentage of net sales was due to lower payroll-related expenses as a result of improvement in labor productivity, lower rent expenses and the implementation of new cost control methods resulting in lower utilities and supplies costs.

Distribution and transportation expenses for fiscal 2010 decreased as a percentage of net sales by 80 basis points to 4.9% of net sales, compared to 5.7% of net sales for fiscal 2009.  The decrease as a percentage of net sales was primarily due to improvements in labor efficiencies, improved processing methods, lower fuel costs and improved trailer utilization.

Corporate operating expenses for fiscal 2010 decreased as a percentage of net sales by 70 basis points to 3.5% of net sales, compared to 4.2% of net sales for fiscal 2009.  The decrease as a percentage of net sales was primarily due to lower payroll and payroll related expenses, consulting and professional fees, and legal costs.

The remaining operating expenses for fiscal 2010 decreased as a percentage of net sales by 40 basis points to 1.0% of net sales, compared to 1.4% for fiscal 2009.  The decrease in other operating expenses compared to the fiscal 2009 was primarily due to a reduction in an asset impairment charge of $9.9 million, and a severance charge of approximately $1.4 million related to the Company’s Texas operations, as well as the recording of a $0.8 million loss on a foreclosure sale of a shopping center owned by the La Quinta Partnership, partially offset by the recording of the Company’s share of a gain on a sale of the primary asset of the Reseda Partnership of approximately $0.2 million and consolidation of the partner’s gain of the Reseda Partnership of approximately $1.4 million during fiscal 2009.


The decreases in fiscal 2010 operating expenses compared to fiscal 2009 were partially offset by an increase of $4.6 million in stock-based compensation expense primarily related to performance stock unit expense, and lease termination and closing costs of approximately $1.2 million related to the closure of some Texas stores in fiscal 2010.  The remaining change of $0.3 million was made up of increases and decreases in other less significant items included in other operating expenses.  

Depreciation and amortization. Depreciation and amortization decreased $6.9 million, or 20.0%, to $27.4 million in fiscal 2010 from $34.3 million in fiscal 2009. The decrease was primarily a result of closing 17 stores in Texas and one store in California and also due to the assets that became fully depreciated in existing stores compared to the amount of new depreciable assets added as a result of new store openings.   Depreciation as a percentage of net sales decreased to 2.0% from 2.6% of net sales for the reasons discussed above as well as due to sales improvements.

Operating income. Operating income was $93.4 million for fiscal 2010 compared to operating income of $12.9 million for fiscal 2009. Operating income as a percentage of net sales was 6.9% in fiscal 2010 compared to operating income as a percentage of net sales of 1.0% in fiscal 2009.  This was primarily due to the changes in gross margin and operating expenses discussed above.
 
Other income, net. Other income decreased $0.9 million to $0.1 million in fiscal 2010 compared to $1.0 million in fiscal 2009.  The decrease in other income was primarily due to lower interest income which decreased to $1.1 million for fiscal 2010 from $3.5 million for fiscal 2009, primarily due to lower interest rates.  The decrease in other income for fiscal 2010 was partially offset by a decrease of $0.9 million for an investment impairment charge related to the Company’s available for sale securities.  The Company recorded an investment impairment charge related to credit losses of approximately $0.8 million for fiscal 2010 compared to an investment impairment charge of $1.7 million for fiscal 2009 related to the Company’s available for sale securities.  The decrease was also offset by lower interest expense which was $0.2 million for fiscal 2010 compared to interest expense of $0.9 million for fiscal 2009.

Provision for income taxes. The income tax provision in fiscal 2010 was $33.1 million compared to $4.1 million in fiscal 2009, due to the increase in pre-tax income.  The effective tax rate for fiscal 2010 was 35.4% compared to an effective tax rate of 29.3% for fiscal 2009.   In fiscal 2009, the Company wrote off approximately $1.4 million of Texas net operating loss credits due to the Company’s decision to exit the Texas market. The effective combined federal and state income tax rates are less than the statutory rates in each period due to 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 increased $52.0 million, or 612.7%, to $60.4 million in fiscal 2010 from $8.5 million in fiscal 2009. Net income as a percentage of net sales increased to 4.5% in fiscal 2010 from 0.7% in fiscal 2009.

Fiscal Year Ended March 28, 2009 Compared to Fiscal Year Ended March 29, 2008

Net sales. Total net sales increased $103.5 million, or 8.6%, to $1,302.9 million in fiscal 2009 from $1,199.4 million in fiscal 2008. Net retail sales increased $103.2 million, or 8.9%, to $1,262.1 million in fiscal 2009 from $1,158.9 million in fiscal 2008.  Of the $103.2 million increase in net retail sales, $41.7 million was due to a 3.7% increase in comparable stores net sales for all stores open at least 15 months in fiscal 2009 and 2008.  The comparable stores net sales increase was attributable to a 0.1% increase in transaction counts as well as an increase in average ticket size by 3.6% to $9.79 from $9.45.  The full year fiscal 2009 effect of stores opened in fiscal 2008 increased sales by $16.6 million and the effect of 19 new stores opened during fiscal 2009 increased net retail sales by $44.9 million.  Bargain Wholesale net sales increased $0.3 million, or 0.7%, to $40.8 million in fiscal 2009 from $40.5 million in fiscal 2008.

During fiscal 2009, the Company added 19 stores: 13 in California, three in Arizona, two in Texas and one in Nevada. The Company closed five stores in Texas during fiscal 2009, including one store due to the hurricane which was re-opened in May 2009.  At the end of fiscal 2009, the Company had 279 stores compared to 265 at the end of fiscal 2008. Gross retail square footage at the end of fiscal 2009 and fiscal 2008 was 5.99 million and 5.76 million, respectively.  For 99¢ Only Stores open all of fiscal 2009, the average net sales per estimated saleable square foot was $273 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 $5.0 million per store and $301 per square foot. Texas stores open for a full year averaged net sales of $2.7 million per store and $142 per square foot.


Gross profit. Gross profit increased $50.9 million, or 11.0%, to $511.8 million in fiscal 2009 from $460.9 million in fiscal 2008.  As a percentage of net sales, overall gross margin increased to 39.3% in fiscal 2009 from 38.4% in fiscal 2008.  The increase in gross profit margin was primarily due to a decrease in spoilage/shrinkage to 3.2% of net sales in fiscal 2009 compared to 3.6% in fiscal 2008.  Shrinkage decreased due to lower losses in inventory as a percentage of sales which was partially offset by slightly higher spoilage primarily due to a shift in sales mix for grocery items which have a higher spoilage rate than other categories.  In addition, an increase in gross profit was also due to a decrease in cost of products sold to 57.1% for fiscal 2009 compared to 57.7% for fiscal 2008 due to the full year effect of new pricing strategies including variable pricing that were implemented in the second half of fiscal 2008, and an increase in all of its price points by adding 99/100 of one cent to every price point (e.g. 99¢ increased to 99.99¢) implemented in September 2008.  The pricing strategies increased gross profit, but were partially offset by a shift in the sales mix towards lower margin categories. 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 $30.7 million, or 7.1%, to $464.6 million in fiscal 2009 from $433.9 million in fiscal 2008. As a percentage of net sales, operating expenses decreased to 35.7% for fiscal 2009 from 36.2% for fiscal 2008.  Of the 50 basis points decrease in operating expenses as a percentage of sales, retail operating expenses decreased by 90 basis points, distribution and transportation costs decreased by 30 basis points, and corporate expenses decreased by 10 basis points. These decreases were offset by an 80 basis points increase in other items primarily related to the Company’s Texas market plan as discussed further below.

Retail operating expenses decreased as a percentage of sales by 90 basis points to 24.4% of net sales, increasing by $15.1 million for fiscal 2009 compared to fiscal 2008. The decrease as a percentage of sales was primarily due to lower payroll-related expenses as a result of improvement in labor productivity despite increased minimum wage rates, and also due to leveraging the increases in same-stores sales as well as lower advertising expenses during fiscal 2009.  These decreases were partially offset by slight increases in costs related to various services and fees as well as repairs and maintenance as a percentage of net sales.

Distribution and transportation expenses decreased as a percentage of sales by 30 basis points to 5.7% of net sales, increasing by $2.0 million for fiscal 2009 compared to fiscal 2008.  The decrease as a percentage of sales, despite year over year increases in minimum wage and freight rates, was primarily due to improvements in labor efficiencies, improved processing methods and increased efficiencies in transportation.

Corporate operating expenses decreased as a percentage of sales by 10 basis points to 4.2% of net sales, increasing $3.0 million for fiscal 2009 compared to fiscal 2008.  The decrease as a percentage of sales was primarily due to lower outside services and consulting and professional fees.  These decreases were partially offset by slight increases in salaries, benefits, and legal costs as a percentage of net sales.

The remaining operating expenses increased as a percentage of sales by 80 basis points to 1.4% of net sales, increasing by $10.5 million for fiscal 2009.  The increase was primarily due to an impairment charge of approximately $10.4 million in fiscal 2009 compared to $0.5 million in fiscal 2008. The impairment charge of approximately $10.4 million in fiscal 2009 primarily consisted of a leasehold improvement impairment charge of approximately $10.1 million related to the Company’s Texas market plan and an impairment charge of approximately $0.2 million related to the underperformance of a store in California. During fiscal year 2008, the Company recorded an asset impairment charge of $0.5 million related to one underperforming store in Texas.  The Company also recorded in fiscal 2009 a charge of approximately $1.3 million related to lease termination and store closing costs and a $1.4 million severance charge all in the Texas market.   See Note 10 to Consolidated Financial Statements for further discussion of our Texas market.  In addition, the increase was also due to a loss on a sale of the primary asset of the La Quinta Partnership of approximately $0.5 million and inclusion of the partner’s loss of approximately $0.3 million during fiscal 2009.  These increases are partially offset by the non-recurring gains related to a sale of the primary asset of the Reseda Partnership of approximately $0.2 million and consolidation of the partner’s gain of approximately $1.4 million during fiscal 2009.  The Company has included $1.4 million of minority interest in its Consolidated Statements of Income related to the aforementioned gain in fiscal 2009. See Note 4 to Consolidated Financial Statements for further discussion of gains and losses related to the Company’s partnerships during fiscal 2009.  In addition, there was a reduction in stock based compensation expense of $1.0 million for fiscal 2009 compared to fiscal 2008.  The remaining change of $0.3 million was made up of increases and decreases in other less significant items included in other operating expenses.


Depreciation and amortization. Depreciation and amortization increased $1.0 million, or 2.6%, to $34.3 million in fiscal 2009 from $33.3 million in fiscal 2008 primarily as a result of the opening of 19 new stores during fiscal 2009, the full year effect of fiscal 2008 store additions, and additions to existing stores and distribution centers. The increase was partially offset by fully depreciated assets in existing stores and the disposal of certain fixed assets.

Operating income/loss. Operating income was $12.9 million for fiscal 2009 compared to operating loss of $6.4 million for fiscal 2008. Operating income as a percentage of net sales was 1.0% in fiscal 2009 compared to operating loss as a percentage of net sales of negative 0.5% in fiscal 2008.  This was primarily due to changes in gross margin and operating expenses as discussed above.
 
Other income, net. Other income decreased $5.7 million to $1.0 million in fiscal 2009 compared to $6.7 million in fiscal 2008.  Interest income earned on the Company’s investments decreased to $3.5 million in fiscal 2009 from $7.2 million in fiscal 2008, primarily as a result of decreases in interest rates and slightly lower investment balances.  The decrease was also due to an impairment charge of approximately $1.7 million related to certain available for sale securities in fiscal 2009.  The remaining decrease of $0.3 million in other income is due to increases and decreases in other less significant items included in other income.

Provision (benefit) for income taxes. The income tax provision in fiscal 2009 was $4.1 million compared to an income tax benefit of $2.6 million in fiscal 2008, due to the increase in pre-tax income.  The effective tax rate for fiscal 2009 was 29.3% compared to a tax benefit for fiscal 2008.   Additionally, in fiscal 2009, the Company wrote off approximately $1.4 million of Texas net operating loss credits due to the Company’s decision to exit the Texas market, compared to a discrete tax benefit recorded in fiscal 2008 related to prior year tax credits of approximately $1.4 million. The effective combined federal and state income tax rates are less than the statutory rates in each period due to 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 increased $5.6 million, or 193.1%, to $8.5 million in fiscal 2009 from $2.9 million in fiscal 2008. Net income as a percentage of net sales increased to 0.7% in fiscal 2009 from 0.2% in fiscal 2008.

Effects of Inflation

The Company experienced small increases in vendor prices, labor, energy, and transportation and fuel costs during fiscal 2010.  The Company also experienced such increases during the first half of fiscal 2009 which the Company believes were due to inflation.  However, the economic downturn in the second half of fiscal 2009 reversed some inflation factors with respect to energy, transportation and fuel costs.  The Company has benefited from the economic downturn and believes inflation had a minimal impact on the Company’s overall operations during fiscal 2010 and the second half of fiscal 2009.  However, increases in various costs due to future inflation may adversely impact the Company’s operating results to the extent that such increases cannot be passed along to its customers.  See Item 1A, “Risk Factor – Inflation may affect the Company’s ability to keep pricing almost all of its merchandise at 99.99¢ or less.”

Liquidity and Capital Resources
 
The Company funds its operations principally from cash provided by operations, short-term investments and cash on hand, and has generally not relied upon external sources of financing. The Company’s capital requirements result primarily from purchases of inventory, expenditures related to new store openings, including purchases of land, 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 2010, 2009, and 2008 was $74.9 million, $62.9 million, and $45.2 million, respectively, consisting primarily of $89.9 million, $47.9 million, and $30.2 million, respectively of net income adjusted for depreciation and other non-cash items. Net cash used in working capital activities was $12.6 million in fiscal 2010.  Net cash provided by working capital activities was $23.2 million and $11.4 million in fiscal 2009 and 2008, respectively.  Net cash used by working capital activities in fiscal 2010 primarily reflects the increases in inventories and income taxes receivable, which were partially offset by the increases in accounts payable, accrued expenses and workers’ compensation liability.  Net cash provided by working capital activities in fiscal 2009 primarily reflects increases in accounts payable and other accrued expenses, partially offset by increases in inventories.  Net cash provided by working capital activities in fiscal 2008 primarily reflects decreases in inventories, partially offset by decreases in accounts payable.  In fiscal 2010, the Company’s inventories increased by $19.3 million compared to fiscal 2009, primarily due to the increase in sales and the Easter selling season.  In fiscal 2009, the Company’s inventories increased by $11.6 million compared to fiscal 2008, primarily due to increases in inventory levels for the Easter selling season.

Net cash used in investing activities during fiscal 2010, 2009, and 2008 was $83.6 million, $37.6 million and $37.6 million, respectively. In fiscal 2010, 2009, and 2008 the Company used $34.8 million, $34.2 million and $54.4 million, respectively, for the purchase of property and equipment due to new store openings.  In addition, during fiscal 2009, the Company paid $4.6 million for the purchase of assets related to its partnerships.  In fiscal 2010, 2009 and 2008, the Company received cash inflows of $31.5 million, $59.2 million and $168.1 million, respectively, from the sale and maturity of available for sale securities, and paid $81.1 million, $60.7 million, and $151.4 million, respectively, for the purchase of investments. The investing activities in fiscal 2010 also reflect the proceeds of $0.8 million from the disposal and sale of fixed assets during fiscal 2010. The investing activities in fiscal 2009 also reflect the proceeds of $2.2 million from the sale of the assets of the Company’s partnerships as well as $0.5 million from the disposal of fixed assets.
 
Net cash provided by financing activities during fiscal 2010 was $6.7 million, which is composed primarily of proceeds of $7.8 million from the exercise of stock options partially offset by payments of $2.7 million to satisfy employees tax obligations related to the issuance of performance stock units as part of the Company’s equity incentive plan.  The Company also paid approximately $0.3 million to acquire the remaining noncontrolling interest in a partnership during fiscal 2010.  Net cash used in financing activities during fiscal 2009 was $12.9 million, which consisted primarily of repurchases of the Company’s common stock.   Net cash provided by financing activities during fiscal 2008 was $0.9 million, which consisted primarily of proceeds from the exercise of stock options.

The Company estimates that total capital expenditures in fiscal year 2011 will be approximately $54.0 million and relate principally to property acquisitions of approximately $24.0 million, $14.0 million for leasehold and fixtures and equipment for new store openings, and $16.0 million for other capital projects. In addition, the Company will also consider additional opportunistic real estate purchases primarily to reduce its rental expense. The Company intends to fund its liquidity requirements in fiscal 2011 from net cash provided by operations, short-term investments, and cash on hand.

In June 2008, based on the Company’s outlook, cash position, and stock price relative to potential value, the Company's Board of Directors authorized a share repurchase program for the purchase of up to $30 million of the Company's common stock. Under the authorization, the Company may purchase shares from time to time in the open market or in privately negotiated transactions in compliance with the applicable rules and regulations of the Securities and Exchange Commission.  However, the timing and amount of such purchases will be at the discretion of management, and will depend on market conditions and other considerations which may change. As of March 28, 2009, the Company had repurchased a total of 1,660,296 shares of common stock at an average price of $7.76 per share, for a total of $12.9 million.  The Company has approximately $17.1 million that remains authorized and available to repurchase shares of Company’s common stock under this program. The Company had no share purchases during fiscal 2010.

The Company issues performance stock units as part of our equity incentive plan.  The number of shares issued on the date the performance stock units vest is net of the statutory withholding requirements that the Company pays in cash to the appropriate taxing authorities on behalf of the employees.  During fiscal 2010, the Company withheld approximately 187,510 shares to satisfy $2.7 million of employee tax obligations.  Although shares withheld are not issued, they are treated as common stock repurchases in the Company’s Consolidated Financial Statements, as they reduce the number of shares that would have been issued upon vesting.


Off-Balance Sheet Arrangements

As of March 27, 2010, the Company had no off-balance sheet arrangements.

Contractual Obligations

The following table summarizes the Company’s consolidated contractual obligations (in thousands) as of March 27, 2010.

Contractual obligations
 
Total
   
Less than 1 year
   
1-3 years
   
3-5 years
   
More than 5 years
 
                               
Capital lease obligations
  $ 519     $ 70     $ 156     $ 182     $ 111  
Operating lease obligations
    193,607       42,548       64,390       45,393       41,276  
Deferred compensation liability
    4,274                         4,274  
Total
  $ 198,400     $ 42,618     $ 64,546     $ 45,575     $ 45,661  

The Company does not have any liabilities related to uncertain tax positions as of March 27, 2010.  See Note 5, “Income Tax Provision” to Consolidated Financial Statements.

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 fiscal year 2031. Most of the lease agreements contain renewal options and/or provide for fixed 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 2010, 2009, and 2008 were approximately $60.7 million, $60.6 million and $54.1 million, respectively.  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.

Variable Interest Entities

At March 27, 2010 and March 28, 2009, the Company no longer has any variable interest entities.

The Company was the primary beneficiary of a variable interest entity known as the La Quinta Partnership to develop a shopping center in La Quinta, California, where the Company leased a store.  In January 2008, the Company received a buy-sell offer from the managing member of the La Quinta Partnership.  The Company accepted the offer to sell its interest to the noncontrolling partner on January 30, 2008.  After the timeline for completion of this offer passed, the Company notified the managing member that the managing member was in default of closing the transaction within the agreed-upon timeframe.  In addition, the partnership had a $7.5 million loan, including principal of $7.3 million and accrued interest of $0.2 million, due to a bank on June 1, 2008, on which the partnership was in default.  In December 2008, the bank foreclosed on the shopping center.   Eighty-nine percent of the land and all of the buildings were sold in the foreclosure sale for $9.3 million.  The proceeds of $9.3 million included the Company’s purchase of the land and building related to its store for approximately $2.9 million and the rest of the center was sold for $6.4 million to a third party, except for a small parcel of undeveloped land which remains in the partnership at this time.  As a result of the foreclosure, the bank received $7.9 million, including principal, interest and penalties.  The partnership’s loss from the foreclosure sales of the shopping center was $0.8 million.  Of the $0.8 million loss, the Company recognized its share of the loss of approximately $0.5 million in the third quarter of fiscal 2009.  In accordance with ASC 810, the Company included the partner’s share of the loss of approximately $0.3 million in its operating expenses during the third quarter of fiscal 2009.  As a result of the foreclosure of the shopping center, the Company became the managing partner of the partnership.  The Company consolidated this partnership as of March 28, 2009.  The Company purchased its noncontrolling partner’s share of the partnership which consisted of the small parcel of land described above, for approximately $0.3 million during the third quarter of fiscal 2010.  The acquisition was recorded as an equity transaction in accordance with the guidance of ASC 810-10-45.  Due to the purchase of the noncontrolling partner’s share of the partnership, the Company became the sole owner of the partnership.


The Company also had an interest in another partnership known as the Wilshire Alvarado Partnership, which the Company consolidated at March 29, 2008 in accordance with ASC 810. The assets of the partnership consisted of real estate with a carrying value of approximately $1.5 million, and there was no mortgage debt or other significant liabilities associated with the entity, other than notes payable to the Company.  In November 2008, the Company purchased its partner’s share of this partnership, consisting of one of the Company’s leased stores with an approximate carrying value of $1.5 million. The Company paid approximately $1.6 million, including estimated selling costs, to acquire its partner’s share in the partnership. The Company increased its building and land value by approximately $1.6 million as result of this purchase. Due to the purchase of the primary asset of the partnership, the Company became the sole owner of the partnership.

At March 29, 2008, the Company had an interest in an additional partnership known as the Reseda Partnership, the assets of which consisted of real estate with a carrying value of approximately $1.2 million.  The balance sheet effect of consolidating this entity at March 29, 2008 was a reclassification of approximately $1.2 million from investments to assets held for sale with no corresponding impact on the Company’s recorded liabilities.  In April 2008, the partnership sold its primary asset, with an approximate carrying value of $1.2 million, to a third party.  The Company's lease for the store in this partnership continued after the sale and the Company's operation of that store was unaffected by the transaction.  Net proceeds to the Company of the sale were $2.2 million.  The transaction was recorded as a sale leaseback in the first quarter of fiscal 2009.  The partnership’s gain from the sale of real estate was approximately $2.4 million, of which the Company’s net gain was approximately $1.0 million. Of the $1.0 million net gain, the Company recognized approximately $0.2 million in the first quarter of fiscal 2009 and approximately $0.8 million is being recognized over the remaining lease term of 46 months. In accordance with ASC 810, the Company had included the partner’s share of the gain of approximately $1.4 million in its operating expenses during the first quarter of fiscal 2009.  Additionally, the proceeds of the sale were distributed to the partners in April 2008, and the Company had included $1.4 million of minority interest in its Consolidated Statements of Operations for the first quarter of fiscal 2009.  As a result of the sale of the primary asset of the partnership, the Company is no longer a primary beneficiary and therefore has not consolidated the remaining immaterial assets of the partnership as of March 27, 2010 and March 28, 2009.

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, Halloween and Easter seasons. A proportionately greater amount of the Company’s net sales and operating and net income is generally realized during the quarter ended on or near 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

Information regarding new authoritative pronouncements is contained in Note 1 to the Consolidated Financial Statements for the year ended March 27, 2010, which is incorporated herein by this reference.


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 27, 2010, the Company had $170.4 million in securities maturing at various dates through May 2046, with approximately 91.3% maturing within one year.  At March 28, 2009, the Company had $119.4 million in securities maturing at various dates through May 2047, with approximately 77.9% maturing within one year. The Company’s investments are comprised primarily of marketable investment grade government and municipal bonds, corporate bonds, auction rate securities, asset-backed securities, commercial paper, and money market funds.  Because the Company generally invests in securities with terms of one year 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. The Company’s investment portfolio has certain perpetual preferred stocks with periodic recurring dividend payments that were approximately 1.0% of the Company’s investment portfolio in fiscal 2010.  At March 27, 2010, the fair value of investments approximated the carrying value. Based on the investments outstanding at March 27, 2010, a 1% increase in interest rates would reduce the fair value of the Company’s total investment portfolio by approximately $0.3 million or 0.2%.  The Company has no outstanding debt as of March 27, 2010.


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, BDO Seidman, LLP
39
Consolidated Balance Sheets as of March 27, 2010 and March 28, 2009
40
Consolidated Statements of Income for the years ended March 27, 2010, March 28, 2009 and March 29, 2008
41
Consolidated Statements of Shareholders’ Equity for the years ended March 27, 2010, March 28, 2009 and March 29, 2008
42
Consolidated Statements of Cash Flows for the years ended March 27, 2010,  March 28, 2009 and March 29, 2008
43
Notes to Consolidated Financial Statements
44
Schedule II – Valuation and Qualifying Accounts
73


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 27, 2010 and March 28, 2009 and the related consolidated statements of income, shareholders’ equity, and cash flows for the years ended March 27, 2010, March 28, 2009 and March 29, 2008. We also have audited the schedule as listed in the accompanying index. These 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 financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company at March 27, 2010 and March 28, 2009, and the results of its operations and its cash flows for the years ended March 27, 2010, March 28, 2009 and March 29, 2008 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 the years ended March 27, 2010, March 28, 2009 and March 29, 2008.

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 27, 2010, 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 May 27, 2010 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

 
/s/ BDO Seidman, LLP
Los Angeles, California
May 27, 2010


99¢ Only Stores
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)

   
March 27, 2010
   
March 28, 2009
 
ASSETS
           
Current Assets:
           
Cash
  $ 19,877     $ 21,930  
Short-term investments
    155,657       93,049  
Accounts receivable, net of allowance for doubtful accounts of $501 and $44 as of March 27, 2010 and March 28, 2009, respectively
    2,607        2,490  
Income taxes receivable
    4,985       1,161  
Deferred income taxes
    36,419       32,861  
Inventories, net
    171,198       151,928  
Assets held for sale
          397  
Other
    4,978       4,038  
Total current assets
    395,721       307,854  
Property and equipment, net
    278,858       271,286  
Long-term deferred income taxes
    34,483       35,685  
Long-term investments in marketable securities
    14,774       26,351  
Assets held for sale
    7,356       7,356  
Deposits and other assets
    14,794       14,341  
Total assets
  $ 745,986     $ 662,873  
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Current Liabilities:
               
Accounts payable
  $ 42,593     $ 36,009  
Payroll and payroll-related
    15,097       13,731  
Sales tax
    5,635       5,334  
Other accrued expenses
    21,398       23,342  
Workers’ compensation
    47,023       44,364  
Current portion of capital lease obligation
    70       65  
Total current liabilities
    131,816       122,845  
Deferred rent
    8,844       10,318  
Deferred compensation liability
    4,274       2,995  
Capital lease obligation, net of current portion
    449       519  
Other liabilities
    181       2,339  
Total liabilities
    145,564       139,016  
Commitments and contingencies (Note 6 and 7)
               
Shareholders’ Equity:
               
Preferred stock, no par value – authorized, 1,000,000 shares; no shares issued or outstanding
           
Common stock, no par value – authorized, 200,000,000 shares; issued and outstanding, 69,556,930 shares at March 27, 2010 and 68,407,486  shares at March 28, 2009
    246,353       231,867  
Retained earnings
    354,528       294,081  
Other comprehensive loss
    (459 )     (2,091 )
Total shareholders’ equity
    600,422       523,857  
Total liabilities and shareholders’ equity
  $ 745,986     $ 662,873  

The accompanying notes are an integral part of these financial statements.


99¢ Only Stores
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share data)

   
Years Ended
 
   
March 27, 2010
   
March 28, 2009
   
March 29, 2008
 
Net Sales:
                 
99¢ Only Stores
  $ 1,314,214     $ 1,262,119     $ 1,158,856  
Bargain Wholesale
    40,956       40,817       40,518  
Total sales
    1,355,170       1,302,936       1,199,374  
Cost of sales (excluding depreciation and amortization expense shown separately below)
    797,748       791,121       738,499  
Gross profit
    557,422       511,815       460,875  
Selling, general and administrative expenses:
                       
Operating expenses (includes asset impairment of $431, $10,335 and $531 for the years ended March 27, 2010, March 28, 2009 and March 29, 2008
    436,608       464,635       433,940  
Depreciation and amortization
    27,398       34,266       33,321  
Total selling, general and administrative expenses
    464,006       498,901       467,261  
Operating income (loss)
    93,416       12,914       (6,386 )
Other (income) expense:
                       
Interest income
    (1,117 )     (3,508 )     (7,182 )
Interest expense
    174       937       953  
Other-than-temporary investment impairment due to credit loss
    843              
Other
    (35 )     1,578       (445 )
Total other (income), net
    ( 135 )     ( 993 )     (6,674 )
Income before provision for income taxes and income attributed to noncontrolling interest
    93,551       13,907       288  
Provision (benefit) for income taxes
    33,104       4,069       (2,605 )
Net income including noncontrolling interest
    60,447       9,838       2,893  
Net income attributable to noncontrolling interest
          (1,357 )      
Net income attributable to 99¢ Only Stores
  $ 60,447     $ 8,481     $ 2,893  
                         
                         
Earnings per common share attributable to 99¢ Only Stores:
                       
Basic
  $ 0.88     $ 0.12     $ 0.04  
Diluted
  $ 0.87     $ 0.12     $ 0.04  
                         
Weighted average number of common shares outstanding:
                       
Basic
    68,641       69,987       70,044  
Diluted
    69,309       70,037       70,117  
 
The accompanying notes are an integral part of these financial statements.


99¢ Only Stores
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
YEARS ENDED MARCH 27, 2010, MARCH 28, 2009 and MARCH 29, 2008
(Amounts in thousands)

   
Common Stock
   
Accumulated Other Comprehensive Income
   
Retained
   
Shareholders’
 
   
Shares
   
Amount
   
(Loss)
   
Earnings
   
Equity
 
                               
BALANCE, March 31, 2007
    69,942     $ 223,414     $ 228     $ 295,585     $ 519,227  
Net income
                      2,893       2,893  
Net unrealized investment losses
                (888 )           (888 )
Total comprehensive income (loss)
                (888 )     2,893       2,005  
Tax benefit from exercise of stock options
          263                   263  
Proceeds from exercise of stock options
    118       812                   812  
Stock-based compensation expense
          4,184                   4,184  
BALANCE, March 29, 2008
    70,060       228,673       (660 )     298,478       526,491  
Net income
                      8,481       8,481  
Net unrealized investment losses
                (1,431 )           (1,431 )
Total comprehensive income (loss)
                (1,431 )     8,481       7,050  
Tax deficiency from exercise of stock options
          (10 )                  (10 )
Proceeds from exercise of stock options
    7       68                   68  
Stock-based compensation expense