10-Q 1 0001.txt 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended June 30, 2000 Or o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 1-11735 99 CENTS ONLY STORES (Exact name of registrant as specified in its charter) California 95-2411605 (State or other Jurisdiction (I.R.S. Employer Identification of Incorporation or Organization) 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 NONE Former name, address and fiscal year, if change since last report Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the last 90 days. x Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date. Common Stock, No Par Value, 33,813,896 Shares as of June 30, 2000 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS 99 CENTS ONLY STORES CONSOLIDATED BALANCE SHEETS (Amounts In Thousands, Except Share Data) ASSETS June 30, December 31, 2000 1999 (Unaudited ) CURRENT ASSETS: Cash $304 $7,984 Short-term investments 61,246 50,971 Accounts receivable, net of allowance for doubtful accounts of $134 and $140 as of June 30, 2000 and December 31, 1999, respectively 3,622 3,356 Income tax receivable 3,210 4,674 Inventories 58,889 53,932 Other 2,265 1,451 Total current assets 129,536 122,368 PROPERTY AND EQUIPMENT, at cost: Land 16,438 11,060 Building and improvement 16,461 12,876 Leasehold improvements 29,092 23,786 Fixtures and equipment 16,921 14,718 Transportation equipment 1,635 1,635 Construction in progress 7,520 5,466 88,067 69,541 Less-Accumulated depreciation and amortization (23,907) (20,119) 64,160 49,422 OTHER ASSETS: Deferred income taxes 11,318 11,318 Long term investments in marketable securities 1,634 8,600 Deposits 242 214 Net assets of discontinued operation. 34,448 26,928 Other 4,632 5,165 52,274 52,225 $245,970 $224,015 The accompanying notes are an integral part of these consolidated balance sheets. 99 CENTS ONLY STORES CONSOLIDATED BALANCE SHEETS (Amounts In Thousands, Except Share Data) LIABILITIES AND SHAREHOLDERS' EQUITY June 30, December 31, 2000 1999 (Unaudited ) CURRENT LIABILITIES: Current portion of capital lease obligation $10,551 $10,601 Accounts payable 7,209 9,010 Accrued expenses: Payroll and payroll-related 840 1,967 Sales tax 914 2,429 Other 833 421 Workers compensation 2,273 2,095 Total current liabilities 22,620 26,523 LONG-TERM LIABILITIES: Deferred rent 2,032 1,952 Total Long-term liabilities 2,032 1,952 COMMITMENTS AND CONTINGENCIES: - - SHAREHOLDERS' EQUITY: Preferred stock, no par value Authorized-1,000,000 shares Issued and outstanding-none - - Common stock, no par value Authorized-100,000,000 shares Issued and outstanding 33,813,896 at June 30, 2000 and 33,425,232 at December 31, 1999 125,458 116,775 Retained earnings 95,860 78,765 221,318 195,540 $245,970 $224,015 The accompanying notes are an integral part of these consolidated balance sheets. 99 CENTS ONLY STORES CONSOLIDATED STATEMENTS OF INCOME THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2000 AND JUNE 30, 1999 (Amounts In Thousands, Except Per Share Data) (Unaudited) Three months Six months ended ended June 30, June 30, 2000 1999 2000 1999 NET SALES: 99 Cents Only Stores $96,407 $69,827 $183,97 $134,46 0 0 Bargain Wholesale 11,540 11,025 24,779 22,119 107,947 80,852 208,749 156,579 COST OF SALES 66,332 49,611 127,632 95,731 Gross profit 41,615 31,241 81,117 60,848 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES: Operating expenses 25,124 18,368 49,996 35,871 Depreciation and amortization 2,081 1,429 3,989 2,823 27,205 19,797 53,985 38,694 Operating income 14,410 11,444 27,132 22,154 OTHER (INCOME) EXPENSE: Interest income (767) (352) (1,485) (864) Interest expense 185 187 370 373 (582) (165) (1,115) (491) Income from continuing operations before provisions for income taxes 14,992 11,609 28,247 22,645 PROVISION FOR INCOME TAXES 5,908 4,591 11,152 8,956 Income from continuing operations 9,084 7,018 17,095 13,689 Loss from discontinued operation - (170) - (543) NET INCOME $9,084 $6,848 $17,095 $13,146 EARNINGS PER COMMON SHARE FROM CONTINUING OPERATIONS: Basic $0.27 $0.21 $0.51 $0.41 Diluted $0.26 $0.21 $0.50 $0.40 LOSS PER COMMON SHARE FROM DISCONTINUED OPERATION: Basic - ($0.01) - ($0.01) Diluted - ($0.01) - ($0.01) NET EARNINGS PER COMMON SHARE: Basic $0.27 $0.20 $0.51 $0.40 Diluted $0.26 $0.20 $0.50 $0.39 WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING: Basic 33,648 33,163 33,525 33,085 Diluted 34,970 34,044 34,489 34,013 The accompanying notes are an integral part of these consolidated financial statements. 99 CENTS ONLY STORES CONSOLIDATED STATEMENTS OF CASH FLOWS SIX MONTHS ENDED JUNE 30, 2000 AND 1999 (Amounts in Thousands) Six months ended June 30, 2000 1999 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $17,095 $13,146 Adjustment to reconcile net income to net cash provided by operating activities: Depreciation and amortization 3,989 2,823 Benefit for deferred income taxes - 141 Changes in assets and liabilities associated with operating activities: Accounts receivable (266) (1,461) Inventories (4,957) (2,578) Other assets (309) (992) Accounts payable (1,801) 2,268 Accrued expenses (2,230) (2,111) Worker's compensation 178 7 Income taxes 4,884 (638) Deferred rent 80 52 Net cash provided by operating activities 16,663 10,657 CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (18,727) (8,156) Purchases of short-term investments (3,309) (1,493) Net asset of discontinued operations. (7,520) (6,262) Net cash used in investing activities (29,556) (15,911) CASH FLOWS FROM FINANCING ACTIVITIES: Payments of capital lease obligation (50) (46) Proceeds from exercise of stock options 5,263 4,170 Net cash provided by financing activities 5,213 4,124 NET DECREASE IN CASH (7,680) (1,130) CASH, beginning of period 7,984 2,699 CASH, end of period $304 $1,569 The accompanying notes are an integral part of these consolidated financial statements. 99 CENTS ONLY STORES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been prepared in conformity with generally accepted accounting principles. However, certain information and footnote disclosures normally included in financial statements prepared in conformity with generally accepted accounting principles have been omitted or condensed pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). These statements should be read in conjunction with the Company's December 31, 1999 audited financial statements and notes thereto included in the Company's Form 10-K filed March 29, 2000. In the opinion of management, these interim consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the consolidated financial position and results of operations for each of the periods presented. The results of operations and cash flows for such periods are not necessarily indicative of results to be expected for the full year. Concentration of Operations The Company's 99 Cents Only Stores are primarily located in Southern California except for two 99 Cents Only Stores, which are located in Las Vegas, Nevada. The Company's current retail expansion plans for the 99 Cents Only Stores anticipates that planned new stores will be primarily located in this general geographic region, as well as anticipated expansion into Arizona. Consequently, the Company's results of operations and financial condition are substantially dependent upon general economic trends and various environmental factors in those regions. 2. EARNINGS PER COMMON SHARE Earnings per share calculations are in accordance with SFAS No. 128, "Earnings per Share" (SFAS 128). Accordingly, "basic" earnings per share is computed by dividing net income by the weighted average number of shares outstanding for the year. "Diluted" earnings per share is computed by dividing net income by the total of the weighted average number of shares outstanding plus the dilutive effect of outstanding stock options (applying the treasury stock method). The table below is a reconciliation of the basic weighted average number of shares outstanding and the diluted weighted average number of shares outstanding for the three and six months ended June 30, 2000 and 1999 (amounts in thousands): 3 Months Ended 6 Months Ended June 30, June 30, 2000 1999 2000 1999 Weighted average number of common shares outstanding-Basic......................... 33,648 33,163 33,525 33,085 ...... Dilutive effect of outstanding stock 1,322 881 964 928 options...... Weighted average number of common shares outstanding-Diluted....................... 34,970 34,044 34,489 34,013 ...... 3. SHORT-TERM INVESTMENTS Investments in debt and equity securities are recorded as required by SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." The Company's investments are comprised primarily of investment grade federal and municipal bonds and commercial paper, primarily with short-term maturities. The Company generally holds investments until maturity and has not experienced any significant gain or loss from sales of its investments. Any premium or discount recognized in connection with the purchase of an investment is amortized over the term of the investment. As of June 30, 2000 and December 31, 1999, the fair value of investments approximated the carrying values and were invested as follows (amounts in thousands): (Unaudited) Maturity Maturity June 30, Within 1 1 year Dec. 31, Within 1 1 year 2000 year or more 1999 year or more Federal $- $- $- $1,500 $- Bonds........ $1,500 Municipal 23,089 21,455 1,634 16,421 9,981 6,440 Bonds...... Corporate 895 895 - 1,560 - 1,560 Securities. Commercial 38,896 38,896 - 40,090 39,490 600 Paper..... $62,880 $61,246 $1,634 $59,571 $50,971 $8,600 4. NEW AUTHORITATIVE PRONOUNCEMENTS In 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133). SFAS 133 is effective in 2001 and management does not expect adoption of this standard to have a material impact on the Company's financial reporting or results of operations. 5. OPERATING SEGMENTS The Company has two business segments, retail operations and wholesale distribution. The retail segment includes 99 Cents Only Stores retail stores. The majority of the product offerings include recognized brand-name consumable merchandise, regularly available for reorder. Bargain Wholesale sells the same merchandise at prices generally below normal wholesale levels to local, regional and national distributors and exporters. The accounting policies of the segments are described in the summary of significant accounting policies noted in the Company's Annual Report on Form 10-K for the year ended December 31, 1999. The Company evaluates segment performance based on the net sales and gross profit of each segment. Management does not track segment data or evaluate segment performance on additional financial information. As such, there are no separately identifiable segment assets nor is there any separately identifiable statements of income data (below gross profit) to be disclosed. The Company accounts for inter-segment transfer at cost through its inventory and inter-company accounts. All such transfers have been eliminated in consolidation. At June 30, 2000, the Company had no customers representing more than 4 percent of Bargain Wholesale's net sales. Substantially all of the Company's net sales were to customers located in the United States. Reportable segment information for the three months ended June 30, 2000, and the six months ended June 30, 2000 follows (amounts in thousands). Three Months Ended June 30, Retail Wholesale Total 2000 Net $96,407 $11,540 $107,947 sales............. Gross 39,161 2,454 41,615 Margin.......... 1999 Net $69,827 $11,025 $80,852 sales............. Gross 28,710 2,531 31,241 Margin.......... Six Months Ended June 30, Retail Wholesale Total 2000 Net $183,970 $24,779 $208,749 sales............. Gross 75,485 5,632 81,117 Margin.......... 1999 Net $134,460 $22,119 $156,579 sales............. Gross 55,763 5,085 60,848 Margin.......... ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General The Company has been engaged since 1976 in the purchase and sale of name-brand, close-out and regularly available general merchandise. Since that time, the Company has sold its merchandise on a wholesale basis through its Bargain Wholesale division. On August 13, 1982, the Company opened its first 99 Cents Only Stores retail location and as of June 30, 2000, operated a chain of 91 deep-discount 99 Cents Only Stores. The Company's growth during the last four years has come primarily from new store openings. The Company opened ten, thirteen and eighteen stores in 1997, 1998 and 1999, respectively (ten, eleven and fourteen respectively, net of relocated stores). The Company opened twelve new 99 Cents Only Stores in the first six months of 2000, eleven in Southern California and one in Las Vegas, Nevada. The Company plans to open at least eight additional 99 Cents Only Stores during the remainder of the year. Bargain Wholesale's growth over the three years ended December 31, 1999 and the first six months of 2000 was primarily attributable to an increased focus on large domestic and international accounts and expansion into new geographic markets. The Company generally realizes a lower gross profit margin on Bargain Wholesale's net sales compared to its retail net sales. However, Bargain Wholesale complements the Company's retail operations by allowing the Company to purchase in larger volumes at more favorable pricing and to generate additional net sales with relatively small incremental increases in operating expenses. As part of its strategy to expand retail operations, the Company has at times opened larger new stores in close proximity to existing stores where the Company determined that the trade area could support a larger facility. In some of these situations, the Company retained its existing store so long as it continued to contribute store-level operating income. While this strategy was designed to increase revenues and store-level operating income, it has had a negative impact on comparable store net sales as some customers migrated from the existing store to the larger new store. The Company believes that this strategy has impacted its historical comparable sales growth. Recent Developments Universal International. The Company has determined it would be in its best interest, and that of its shareholders, to focus its efforts on increasing the growth rate of 99 Cents Only Stores. In conjunction with this revised growth strategy, the Company has decided to sell its Universal subsidiary. Universal operates a multi-price point variety chain, with 65 stores located in the Midwest, Texas and Upstate New York, under the trade names Only Deals and Odd's-N-End's. Among other factors, the Company also considered its successful opening of its first 99 Cents Only Store outside the state of California in Las Vegas, Nevada. The success of the Las Vegas, Nevada store helps to prove that the 99 Cents Only Stores concept is portable to areas outside the State of California. As a result, the Company will focus greater management resources to expand more rapidly in Nevada and into Arizona. The Company has adopted a definitive plan to sell Universal and has engaged an investment-banking firm to evaluate and identify potential buyers for the Universal business. The Company expects to sell Universal within one year. The Company has $34.4 million of net assets of discontinued business at June 30, 2000. The value of Universal's net assets at June 30, 2000 includes $29.6 million in inventory, net fixed assets of $7.8 million,$3.8 million of working capital advances for inventory purchases and $3.0 million of other assets. This is offset by $3.3 million of accounts payable, accrued and other liabilities and $6.5 million of reserve for loss on disposition. The Company's estimated net loss on the disposal of Universal of $9.0 million is based on the net realizable value of the business, a $1.2 million loss from operations to the disposal date, and the estimated selling costs offset by a $2.6 million tax benefit. Universal's results of operations for the quarter ended June 30, 2000 have been included in the reserve for loss on disposal. The Company has made in this Form 10-Q forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 concerning the Company's operations, expansion plans, economic performance, financial condition, store openings, purchasing abilities, sales per square foot and comparable store net sales trends and capital requirements. Such forward-looking statements may be identified by the use of words such as "believe", "anticipate," "intend" and "expect" and variations thereof. Such forward-looking statements are subject to various risks and uncertainties, certain of which are beyond the Company's control. Actual results could differ materially from those currently anticipated due to a number of factors. Some of those factors include (i) the Company's ability to open new stores on a timely basis and operate them profitably, (ii) the Company's ability to sell or otherwise dispose of the Universal operation on a timely basis, (iii) the orderly operation of the Company's receiving and distribution process, (iv) inflation, consumer confidence and other general economic factors, (v) the availability of adequate inventory and capital resources, (vi) the risk of a disruption in sales volume in the fourth quarter and other seasonal factors, (vii) dependence on key personnel and control of the Company by existing shareholders, (viii) increased competition from new entrants into the deep-discount retail industry and (ix) the Company's ability to open new stores and operate them profitably in new regions such as Nevada and Arizona. The Company does not ordinarily make projections of its future operating results and undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Readers of this report should carefully read the risk factors included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1999 and in this Form 10-Q. Results of Operations Three Months Ended June 30, 2000 Compared to Three Months Ended June 30, 1999 NET SALES: Net sales increased $27.1 million, or 33.5%, to $107.9 million in the 2000 period from $80.9 million in the 1999 period. Retail sales increased $26.6 million to $96.4 million in the 2000 period from $69.8 million in the 1999 period. The retail net sales increase was attributable to the net effect of twelve new stores opened in 2000, the full quarter effect of 14 net new stores opened in 1999, and a 5.3% increase in comparable same store sales. Bargain Wholesale net sales were $11.5 million in the 2000 period and $11.0 million in the same period in 1999. GROSS PROFIT: Gross profit increased approximately $10.4 million, or 33.2%, to $41.6 million in the second quarter ended June 30, 2000 from $31.2 million in the 1999 period. The increase in gross profit was due to higher net sales. Overall gross profit margin was 38.6% in the 2000 period was the same as that in the 1999 period. Product category sales mix variations affected the gross profit margin between the retail and wholesale margins as well as merchandise cost factors. SELLING, GENERAL AND ADMINISTRATIVE: SG&A increased by $7.4 million, or 37.4%, to $27.2 million in the 2000 period from $19.8 million in the 1999 period. As a percentage of net sales, total SG&A increased to 25.2% from 24.4% in 1999. This increase in the selling, general and administrative expenses is due to new store opening costs and spending for systems technology and infrastructure to support the recently expanded growth rate and expansion into new markets. OPERATING INCOME FROM CONTINUING OPERATIONS: As a result of the items discussed above, operating income increased $3.0 million, or 25.9%, to $14.4 million in 2000 from $11.4 million in 1999. Operating margin was 13.4% in 2000 versus 14.2% in 1999. INTEREST INCOME (EXPENSE): Interest income (expense) relates to interest on the Company's capitalized leases, net of interest earned on the Company's cash balances and short-term and long-term investments. The change in net interest between 2000 and 1999 was due to interest earned on short-term marketable securities. During 2000 and 1999, the Company had no bank debt. PROVISION FOR INCOME TAXES: The provision for income taxes for the three months ended June 30, 2000, was $5.9 million compared to $4.6 million in 1999. The effective rate of the provision for income taxes was approximately 39.4% in 2000 versus 39.5% 1999. This variance results from available tax credits and tax free interest income earned. NET INCOME FROM CONTINUING OPERATIONS: As a result of the items discussed above, net income increased $2.1 million, or 29.4% to $9.1 million in 2000 from $7.0 million in the 1999 period. Net income as a percentage of sales was 8.4% in 2000 and 8.7% in 1999. Six Months Ended June 30, 2000 Compared to Six Months Ended June 30, 1999 NET SALES: Net sales increased $52.2 million, or 33.3%, to $208.7 million in the 2000 period from $156.6 million in the 1999 period. Retail sales increased $49.5 million to $184.0 million in the 2000 period from $134.5 million in the 1999 period. The retail net sales increase was attributable to the net effect of twelve new stores opened in 2000, the full six months effect of 14 net new stores opened in the first half of 1999, and a 4.1% increase in comparable same store sales for the six-month period. Bargain Wholesale net sales were $24.8 million in first six months of 2000 and $22.1 million for the same period in 1999. GROSS PROFIT: Gross profit increased approximately $20.3 million, or 33.3%, to $81.1 million in the 2000 period from $60.8 million in the 1999 period. The increase in gross profit was due to higher net sales volume. The overall gross profit margin of 38.9% in the 2000 period was the same as that in the 1999 period. The year to date retail gross margin was 41.0% versus 41.5% in 1999. The change in the gross profit margin is due to sales mix and merchandise cost factors. SELLING, GENERAL AND ADMINISTRATIVE: SG&A increased by $15.3 million, or 39.5%, to $54.0 million in the 2000 period from $38.7 million in 1999 period. As a percentage of net sales, total SG&A increased to 25.9% from 24.7% in 1999. This increase in the selling, general and administrative expenses is due to new store opening costs and spending for systems technology and infrastructure to support the recently expanded growth rate and expansion into new markets. OPERATING INCOME FROM CONTINUING OPERATIONS: As a result of the items discussed above, operating income increased $5.0 million, or 22.5%, to $27.1 million in 2000 from $22.2 million in 1999. Operating margin was 13.0% in 2000 versus 14.2% in 1999. INTEREST INCOME (EXPENSE): Interest income (expense) relates to interest on the Company's capitalized leases, net of interest earned on the Company's cash balances and short-term and long-term investments. The change in net interest between 2000 and 1999 was due to interest earned on short-term marketable securities. During 2000 and 1999, the Company had no bank debt. Average interest rates earned on marketable securities has increased as has the average outstanding balance of marketable securities. PROVISION FOR INCOME TAXES: The provision for income taxes for the six months ended June 30, 2000, was $11.2 million compared to $9.0 million in 1999. The effective rate of the provision for income taxes was approximately 39.5% in both 2000 and 1999. NET INCOME FROM CONTINUING OPERATIONS: As a result of the items discussed above, net income increased $3.4 million, or 24.9% to $17.1 million in 2000 from $13.7 million in the 1999 period. Net income as a percentage of sales was 8.2% in 2000 and 8.7% in 1999. LIQUIDITY AND CAPITAL RESOURCES The Company has funded its operations principally from cash provided by operations, and has not generally relied upon external sources of financing. The Company's capital requirements result primarily from purchases of inventory, expenditures related to store openings and the working capital requirements for new and existing stores. The Company takes advantage of close-out and other special situation opportunities which frequently results 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. The Company maintains cash and short-term investments with highly qualified financial institutions. At various times such amounts may be in excess of insured limits. As of June 30, 2000, the Company had purchased the land and buildings for eight of its 99 Cents Only Stores retail store locations and a distribution center in Minnesota for Universal. The Company may purchase other locations in the future. Available cash not immediately needed for such purposes has been invested in short-term investment grade securities. Net cash provided by operations was $16.7 million and $10.7 million for the periods ended June 30, 2000 and June 30, 1999, respectively. In 2000, inventories increased $5.0 million and receivables increased $0.3 million. In 1999, inventories increased $2.6 million and receivables increased $1.5 million. The Company's accounts payable decreased by $1.8 million in 2000. In 1999, accounts payable increased $2.3 million. Other assets increased $0.3 million in 2000 and $1.0 million in 1999. Net cash used in investing activities was $29.6 million in 2000, consisting of expenditures for property and equipment of $18.7 million (which includes $8.4 million for twelve new 99 Cents Only Stores and a purchase of a $7.3 million distribution center in Minnesota for Universal), increases in the net asset of the discontinued operation of $7.5 million and an increase of $3.3 million in marketable securities. In 1999, the Company invested $8.2 million in capital expenditures and $1.5 million in marketable securities. The net assets of the discontinued business increased $6.3 million in 1999. Cash proceeds from financing activities were $5.2 million in 2000. This included $0.1 million for payments on the capitalized warehouse lease offset by $5.3 million of proceeds from the exercise of stock options. In 1999, proceeds from the exercise of stock options were $4.2 million. In 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133). SFAS 133 is effective in 2001 and management does not expect adoption of this standard to have a material impact on the Company's financial reporting or results of operations. The Company plans to open new 99 Cents Only Stores at a targeted annual rate of 25%. The Company's cash needs for new store openings are expected to total approximately $17 million in 2000. Pre-opening expenses are not capitalized by the Company. The Company believes that its total capital expenditure requirements, including new store openings, existing store refurbishment and the exercise of the purchase option for the Company's current distribution facility, will increase to approximately $35 million in 2000. Capital expenditures in 2000 are currently expected to be incurred primarily for new store openings, improvements to existing stores, the purchase of distribution facilities and information systems. The Company believes that cash flow from operations will be sufficient to meet operating needs and capital spending requirements for at least the next twelve months. Risk Factors Inflation The Company's ability to provide quality merchandise at the 99 cents price point is subject to certain economic factors, which are beyond the Company's control, including inflation. Inflation could have a material adverse effect on the Company's business and results of operations, especially given the constraints on the Company to pass on any incremental costs due to price increases or other factors. The Company believes that it will be able to respond to ordinary price increases resulting from inflationary pressures by adjusting the number of items sold at the single price point (e.g., two items for 99 cents instead of three items for 99 cents) and by changing its selection of merchandise. Nevertheless, a sustained trend of significantly increased inflationary pressure could require the Company to abandon its single price point of 99 cents per item, which could have a material adverse effect on the Company's business and results of operations. See also "We are vulnerable to uncertain economic factors and changes in the minimum wage" for a discussion of additional risks attendant to inflationary conditions. We Depend on New Store Openings for Future Growth Our operating results depend largely on our ability to open and operate new stores successfully and to manage a larger business profitably. In 1997, 1998 and 1999, we opened ten, thirteen and eighteen 99 Cents Only Stores, respectively (ten, eleven and fourteen stores, respectively, net of relocated stores). As of June 30, 2000, we opened twelve 99 Cents Only Stores and we expect to open at least 8 additional 99 Cents Only Stores in Southern California and Nevada during the remainder of the year. We plan to open new stores over the next several years at a rate of approximately 25% per year. Our strategy depends on many factors, including our ability to identify suitable markets and sites for our new stores, negotiate leases with acceptable terms, refurbish stores, appropriately upgrade our financial and management information systems and controls and manage our operating expenses. In addition, we must be able to continue to hire, train, motivate and retain competent managers and store personnel. Many of these factors are beyond our control. As a result, we cannot assure you that we will be able to achieve our expansion goals. Any failure by us to achieve our expansion goals on a timely basis, obtain acceptance in markets in which we currently have limited or no presence, attract and retain management and other qualified personnel, appropriately upgrade our financial and management information systems and control or manage operating expenses could adversely affect our future operating results and our ability to execute our business strategy. We also cannot assure you that when we open new stores, we will improve our results of operations. A variety of factors, including store location, store size, rental terms, the level of store sales and the level of initial advertising influence if and when a store becomes profitable. Assuming that our planned expansion occurs as anticipated, our store base will include a relatively high proportion of stores with relatively short operating histories. We cannot assure you that our new stores will achieve the sales per saleable square foot and store-level operating margins currently achieved at our existing stores. If our new stores on average fail to achieve these results, our planned expansion could produce a decrease in our overall sales per saleable square foot and store-level operating margins. Increases in the level of advertising and pre-opening expenses associated with the opening of new stores could also contribute to a decrease in our operating margins. Finally, the opening of new stores in existing markets has in the past and may in the future reduce retail sales of existing stores in those markets, negatively affecting comparable store sales. Our operations are mainly concentrated in Southern California All but two of our 99 Cents Only Stores are currently located in Southern California. The Company currently has two stores in Las Vegas, Nevada. In addition, our year 2000 retail expansion plan includes new stores in these regions and thereafter also in Arizona. As a result, our results of operations and financial condition depend upon trends in the Southern California economy. For example, this region experienced an economic recession in the early 1990s. Although this recession had no material effect on our business, between 1989 and 1993 most California counties, particularly Los Angeles, recorded a significant decline in retail spending. Recovery in these retail markets has continued from 1995 through 1999. However, this trend may not continue and retail spending could decline in the future. In addition, Southern California historically has been vulnerable to certain natural disasters and other risks, such as earthquakes, fires, floods and civil disturbance. At times, these events have disrupted the local economy. These events could also pose physical risks to our properties. Although we maintain standard property and business interruption insurance, we do not have earthquake insurance on our properties. We could experience disruptions in receiving and distribution Our success depends upon whether our receiving and shipment schedules are organized and well managed. As we continue to grow, we may face unexpected demands on our warehouse operations that could cause delays in delivery of merchandise to or from our warehouses to our stores. A fire, earthquake or other disaster at our warehouses could hurt our business, financial condition and results of operations, particularly because much of our merchandise consists of close-outs and other irreplaceable products. Although we maintain standard property and business interruption insurance, we do not have earthquake insurance on our properties. Although we try to limit our risk of exposure to potential product liability claims, we do not know if the limitations in our agreements are enforceable. We maintain insurance covering damage from use of our products. If any product liability claim is successful and large enough, our business could suffer. We depend upon our relationships with our suppliers and the availability of close-out and special-situation merchandise Our success depends in large part on our ability to locate and purchase quality close-out and special-situation merchandise at attractive prices. This helps us maintain a mix of name-brand and other merchandise at the 99 cents price point. We cannot be certain that such merchandise will continue to be available in the future. Further, we may not be able to find and purchase merchandise in quantities necessary to accommodate our growth. Additionally, our suppliers sometimes restrict the advertising, promotion and method of distribution of their merchandise. These restrictions in turn may make it more difficult for us to quickly sell these items from our inventory. Although we believe our relationships with our suppliers are good, we do not have long term agreements with any supplier. As a result, we must continuously seek out buying opportunities from our existing suppliers and from new sources. We compete for these opportunities with other wholesalers and retailers, discount and deep-discount chains, mass merchandisers, food markets, drug chains, club stores and various privately-held companies and individuals. Although we do not depend on any single supplier or group of suppliers and believe we can successfully compete in seeking out new suppliers, a disruption in the availability of merchandise at attractive prices could impair our business. We purchase in large volumes and our inventory is highly concentrated To obtain inventory at attractive prices, we take advantage of large volume purchases, close-outs and other special situations. As a result, our inventory levels are generally higher than other discount retailers. At December 31, 1997, 1998 and 1999, we recorded net inventory of $43.1 million, $49.6 million and $53.9 million, respectively. As of June 30, 2000, net inventory is $58.9 million. We periodically review the net realizable value of our inventory and make adjustments to its carrying value when appropriate. The current carrying value of our inventory reflects our belief that we will realize the net values recorded on our balance sheet. However, we may not be able to do so. If we sell large portions of our inventory at amounts less than their carrying value or if we write down a significant part of our inventory, our cost of sales, gross profits, operating income and net income could suffer greatly during the period in which such event or events occur. We face strong competition We compete in both the acquisition of inventory and sale of merchandise with other wholesalers, discount and deep-discount stores, single price point merchandisers, mass merchandisers, food markets, drug chains, club stores and other retailers. Our industry competitors also include many privately held companies and individuals. At times, these competitors are also customers of our Bargain Wholesale division. In the future, new companies may also enter the deep-discount retail industry. Additionally, we currently face increasing competition for the purchase of quality close-out and other special-situation merchandise. Some of our competitors have substantially greater financial resources and buying power than us. Our capability to compete will depend on many factors including our ability to successfully purchase and resell merchandise at lower prices than our competitors. We cannot assure you that we will be able to compete successfully against our current and future competitors. We are vulnerable to uncertain economic factors and changes in the minimum wage Our ability to provide quality merchandise at our 99 Cents price point could be hindered by certain economic factors beyond our control, including but not limited to: - increases in inflation; - increases in operating costs; - increases in employee health care costs; - increases in prevailing wage levels; and - decreases in consumer confidence levels. As a result, increases in federal and state minimum wage requirements significantly affect our business. In California, the minimum wage increased [in March 1997 from $4.75 to $5.00 per hour], in September 1997 from $5.00 to $5.15 per hour, in March 1998 to $5.75 per hour. The federal minimum wage increased in September 1997 to $5.15 per hour. In addition, the federal government or the state of California may, in the future, implement additional increases to the minimum wage. Since we provide consumers with merchandise at a 99 Cents price point, we typically cannot pass on to them any incremental costs. As a result, significant increases in the minimum wage requirements could impair our business. We face risks associated with international sales and purchases Although international sales historically have not been important to our consolidated net sales, they have contributed to growth in Bargain Wholesale's net sales. In addition, some of the inventory we purchase is manufactured outside the United States. There are many risks associated with doing business internationally. Our international transactions may be subject to risks such as: - political instability; - currency fluctuations; - exchange rate controls; - changes in import and export regulations; - changes in tariff and freight rates. The United States and other countries have also proposed various forms of protectionist trade legislation. Any resulting changes in current tariff structures or other trade policies could lead to fewer purchases of our products and could adversely affect our international operations. We could encounter risks related to transactions with our affiliates We currently lease 12 of our 91, 99 Cents Only Stores and a parking lot for one of these stores from certain members of the Gold family and their affiliates. Our annual rental expense for these facilities totaled approximately $2.0 million, $2.2 million and $1.9 million in 1997, 1998 and 1999, respectively. We believe that our lease terms are just as favorable to us as they would be for an unrelated party. Under our current policy, we enter into real estate transactions with our affiliates only for the renewal or modification of existing leases and on occasions where we determine that such transactions are in our best interests. Moreover, the independent members of our Board of Directors must unanimously approve all real estate transactions between us and our affiliates. They must also determine that such transactions are equivalent to a negotiated arm's-length transaction with a third party. We cannot guarantee that we will reach agreements with the Gold family on renewal terms for the properties we currently lease from them. Also, even if we agree to such terms, we cannot be certain that our independent directors will approve them. If we fail to renew one of these leases, we could be forced to relocate or close the leased store. Any relocations or closures we experience will be costly and could adversely affect our business. We rely heavily on our management team Our success depends substantially on David Gold and Eric Schiffer, our Chief Executive Officer and President, respectively. We also rely on the continued service of our executive officers and other key management, particularly Helen Pipkin, our Senior Vice President of Wholesale Operations. We have not entered into employment agreements with any of our executive officers and we do not maintain key person life insurance on them. As we continue to grow, our success will depend on our ability to identify, attract, hire, train, retain and motivate other highly skilled management personnel. Competition for such personnel is intense, and we may not be able to successfully attract, assimilate or retain sufficiently qualified candidates. Our operating results may fluctuate and may be affected by seasonal buying patterns Historically, our highest net sales and operating income have occurred during the fourth quarter, which includes the Christmas and Halloween selling seasons. During 1998 and 1999, we generated approximately 28.1% and 31.8%, respectively, of our net sales and approximately 32.9% and 36.2%, respectively, of our operating income during the fourth quarter. Accordingly, any decrease in net sales during the fourth quarter could reduce our profitability and impair our results of operations for the entire year. In addition to seasonality, many other factors may cause our results of operations to vary significantly from quarter to quarter. Some of these factors are beyond our control. The factors include: - the number and timing of sales contributed to new stores; - the level of advertising and pre-opening expenses associated with new stores; - the integration of new stores into our operations; - general economic health of the deep-discount retail industry; - changes in the mix of products sold; - unexpected increases in shipping costs; - ability to successfully manage our inventory levels; - changes in our personnel; - fluctuations in the amount of consumer spending; and - the amount and timing of operating costs and capital expenditures relating to the growth of our business. We are subject to environmental regulations Under various federal, state and local environmental laws and regulations, current or previous owners or occupants of property may become liable for the costs of removing any hazardous substances found on the property. These laws and regulations often impose liability without regard to fault. We currently lease all but eight of our stores, as well as our warehouse and distribution facility (where our executive offices are located). We have the option to purchase our warehouse and distribution facility in December 2000, which we plan to do. However, in the future we may be required to incur substantial costs for preventive or remedial measures associated with the presence of hazardous materials. In addition, we operate one underground diesel storage tank and one above-ground propane storage tank at our warehouse. Although we have not been notified of, and are not aware of, any current environmental liability, claim or non-compliance, we could incur costs in the future related to our leased properties and our storage tanks. In the ordinary course of our business, we sometimes handle or dispose of commonplace household products that are classified as hazardous materials under various environmental laws and regulations. We have adopted policies regarding the handling and disposal of these products, and we train our employees on how to handle and dispose of them. We cannot assure you that our policies and training will successfully help us avoid potential violations of these environmental laws and regulations in the future. Anti-takeover Effect; We are controlled by our existing shareholders In addition to some governing provisions in our Articles of Incorporation and Bylaws, we are 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 our control, even if such actions would benefit our shareholders and us. In addition, David Gold, our Chairman and Chief Executive Officer, and members of his immediate family and certain of their affiliates beneficially own 15,421,993 shares of our voting stock. As a result, they have the ability to influence all matters requiring the vote of our shareholders, including the election of our directors and most of our corporate actions. They can also control our policies and potentially prevent a change in our control. This could adversely affect the voting and other rights of our other shareholders and could depress the market price of our common stock. Our stock price could fluctuate widely The market price of our common stock has risen substantially since our initial public offering on May 23, 1996. Trading prices for our common stock could fluctuate significantly due to many factors, including: - the depth of the market for our common stock; - changes in expectations of our future financial performance, including financial estimates by securities analysts and investors; - variations in our operating results; - conditions or trends in our industry or in the industries of any of our significant clients; - additions or departures of key personnel; and - future sales of our common stock. Item 3. Quantitative and Qualitative Disclosures About Market Risk The Company is exposed to interest rate risk for its investments in marketable securities. At June 30, 2000, the Company had $62,900,000 in marketable securities maturing at various dates through October 2001. The Company's investments are comprised primarily of investment grade federal and municipal bonds and commercial paper. The Company generally holds investments until maturity. Any premium or discount recognized upon the purchase of an investment is amortized over the term of the investment. PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None ITEM 2. CHANGES IN SECURITIES None ITEM 3. DEFAULTS UPON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS The Company held its 2000 Annual Meeting of Stockholders on May 11, 2000. There were three matters submitted for a vote of the shareholders. The first matter was the election of eight directors to hold office for a one-year term. The second matter was an amendment to the 99 Cents Only Stores Amended and Restated Articles of Incorporation to increase the authorized number of shares of Common Stock from 40,000,000 shares to 100,000,000 shares. The third matter was to consider and act upon a shareholder proposal. The results of the voting for the directors were 29,930,361 shares voted for each of the directors and 220,087 shares against each of the directors. The results of the voting for the increase in the number of authorized shares was 28,055,883 for, 2,094,269 against and 296 abstain. The results of the voting for the shareholder proposal were 290,451 for 23,701,559 against 1,390,724 abstain and 4,767,714 unvoted. ITEM 5. OTHER INFORMATION None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. EXHIBIT 3.1 Amendment to amended and restated Articles of Incorporation b. EXHIBIT 27.1 Financial Data Schedule SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereto duly authorized. 99 CENTS ONLY STORES Date: July 25, 2000 /s/ Andrew A. Farina Andrew A. Farina Chief Financial Officer (Duly Authorized Officer)
EXHIBIT 27.1 99 Cents Only Stores Financial Data Schedule This Schedule contains summary financial information extracted from 99 Cents Only Stores' Financial Statements and is qualified in its entirety by reference to such financial statements. (amounts in thousands) 6-mos Dec. 31 2000 Jan. 01 2000 June 30,2000 [CASH] 304 [SECURITIES] 61,246 [RECEIVABLES] 6,832 [ALLOWANCES] (134) [INVENTORY] 58,889 129,536 [PP&E] 88,067 [DEPRECIATION] (23,907) 245,970 22,620 [BONDS] 0 0 [PREFERRED] 0 [COMMON] 125,458 95,860 245,970 [SALES] 107,947 107,947 [CGS] 66,332 27,205 0 0 185 14,992 5,908 9,084 [DISCONTINUED] 0 [EXTRAORDINARY] 0 [CHANGES] 0 9,084 0.27 0.26 Retained Earnings