10-Q 1 form10-q.txt 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, 2002 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 1-11735 99 CENTS ONLY STORES (Exact name of registrant as specified in its charter) CALIFORNIA 95-2411605 (State or other Jurisdiction (I.R.S. Employer of Incorporation or Organization) 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 Former name, address and fiscal year, if change since last report: NONE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the 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, 70,141,440 Shares as of July 1, 2002 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS
99 CENTS ONLY STORES BALANCE SHEETS (Amounts In Thousands, Except Share Data) ASSETS JUNE 30, DECEMBER 31, 2002 2001 ----------- ------------- (Unaudited) (Audited) CURRENT ASSETS: Cash................................................................. $ 178 $ 232 Short-term investments............................................... 117,012 147,566 Accounts receivable, net of allowance for doubtful accounts of $165 as of June 30, 2002 and December 31, 2001, respectively.... 2,977 3,523 Income tax receivable................................................. 4,599 1,384 Inventories.......................................................... 78,744 66,528 Other................................................................ 3,504 3,886 ---------- ---------- Total current assets............................................... 207,014 223,119 PROPERTY AND EQUIPMENT, at cost: Land................................................................. 24,064 20,715 Building and improvements............................................ 26,186 24,007 Leasehold improvements............................................... 76,203 50,602 Fixtures and equipment............................................... 21,463 28,421 Transportation equipment............................................. 2,998 2,836 Construction in progress............................................. 12,152 17,856 ---------- ---------- 163,066 144,437 Less-Accumulated depreciation and amortization....................... (48,979) (40,798) ---------- ---------- 114,087 103,639 OTHER ASSETS: Deferred income taxes................................................ 15,688 15,688 Long term investments in marketable securities....................... 35,045 533 Deposits............................................................. 296 296 Long term investments in partnerships................................ 4,692 4,702 Other................................................................ 5,928 4,181 ---------- ---------- 61,649 25,400 ---------- ---------- $ 382,750 $ 352,158 ========== ==========
The accompanying notes are an integral part of these interim financial statements. Page 2
99 CENTS ONLY STORES BALANCE SHEETS (Amounts In Thousands, Except Share Data) LIABILITIES AND SHAREHOLDERS' EQUITY JUNE 30, DECEMBER 31, 2002 2001 ----------- ------------- (Unaudited) (Audited) CURRENT LIABILITIES: Current portion of capital lease obligation........................ $ 41 $ 40 Accounts payable................................................... 7,520 15,244 Accrued expenses: Payroll and payroll-related..................................... 4,858 2,771 Sales tax....................................................... 1,495 3,011 Other........................................................... 1,190 562 Workers compensation.............................................. 6,052 5,534 Due to shareholders............................................... - 1,655 ---------- ---------- Total current liabilities 21,156 28,817 LONG-TERM LIABILITIES: Deferred compensation.............................................. 950 - Deferred rent..................................................... 2,120 2,061 Capitalized lease obligation...................................... 1,627 1,637 ---------- ---------- Total Long-term liabilities 4,697 3,698 ---------- ---------- COMMITMENTS AND CONTINGENCIES: - - SHAREHOLDERS' EQUITY: Preferred stock, no par value Authorized-100,000,000 shares Issued and outstanding-none....................................... - - Common stock, no par value Authorized-100,000,000 shares Issued and outstanding 70,141,440 shares at June 30, 2002 and 69,506,103 shares at December 31, 2001.................... 167,418 156,154 Retained earnings................................................. 189,479 163,489 ---------- ---------- 356,897 319,643 ---------- ---------- $ 382,750 $ 352,158 ========== ==========
The accompanying notes are an integral part of these interim financial statements. Page 3
99 CENTS ONLY STORES STATEMENTS OF INCOME THREE AND SIX MONTHS ENDED JUNE 30, 2002 AND 2001 (Amounts In Thousands, Except Per Share Data) (Unaudited) THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 2002 2001 2002 2001 ---------- ---------- ---------- ---------- NET SALES: 99 Cents Only Stores..................................... $155,436 $122,522 $305,083 $232,734 Bargain Wholesale (includes sales to an affiliate of $1,217 for the three months ended June 30, 2001 and $3,020 for the six months ended June 30, 2001)............................ 12,425 13,852 25,882 28,609 ---------- ---------- ---------- ---------- 167,861 136,374 330,965 261,343 COST OF SALES.............................................. 100,298 83,195 199,159 160,094 ---------- ---------- ---------- ---------- Gross profit............................................ 67,563 53,179 131,806 101,249 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES: Operating expenses...................................... 42,280 33,817 83,263 64,656 Depreciation and amortization........................... 4,259 2,897 8,199 5,524 ---------- ---------- ---------- ---------- 46,539 36,714 91,462 70,180 ---------- ---------- ---------- ---------- Operating income........................................ 21,024 16,465 40,344 31,069 OTHER INCOME: Interest income......................................... (851) (1,091) (1,576) (2,426) Other................................................... (360) (360) (720) (720) ---------- ---------- ---------- ---------- (1,211) (1,451) (2,296) (3,146) ---------- ---------- ---------- ---------- Income before provision for income taxes................. 22,235 17,916 42,640 34,215 PROVISION FOR INCOME TAXES................................. 8,717 6,987 16,652 13,323 ---------- ---------- ---------- ---------- NET INCOME................................................. $13,518 $10,929 $25,988 $20,892 ========== ========== ========== ========== NET EARNINGS PER COMMON SHARE: Basic................................................... $0.19 $0.16 $0.37 $0.31 Diluted................................................. $0.19 $0.16 $0.37 $0.30 WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING: Basic................................................... 69,888 68,506 69,726 68,455 Diluted................................................. 71,275 69,499 71,100 69,341
The accompanying notes are an integral part of these interim financial statements. Page 4
99 CENTS ONLY STORES STATEMENTS OF CASH FLOWS SIX MONTHS ENDED JUNE 30, 2002 AND 2001 (Amounts in Thousands) (Unaudited) JUNE 30, 2002 2001 ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income....................................................... $ 25,988 $ 20,892 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization.................................. 8,199 5,524 Tax benefit from exercise of non-qualified Employee stock options......................................... 3,122 872 Other.......................................................... (15) (190) Changes in assets and liabilities associated with operating activities: Accounts receivable............................................ 546 (59) Inventories.................................................... (12,216) (4,913) Other assets................................................... 382 (4,758) Accounts payable............................................... (7,724) (901) Accrued expenses............................................... 1,199 (2,624) Workers compensation........................................... 518 497 Income taxes................................................... (3,215) 4,143 Deferred rent.................................................. 60 60 Due to shareholders............................................ (1,655) - ---------- ---------- Net cash provided by operating activities........................... 15,189 18,543 ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment.............................. (18,629) (17,810) Reduction in short-term investments.............................. 30,554 (9,436) Purchases of long-term investments............................... (34,512) (1,825) Net purchases of short-term and long-term investments............ (787) - ---------- ---------- Net cash used in investing activities.......................... (23,374) (29,071) ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Payments of capital lease obligation............................. (11) - Proceeds from exercise of stock options.......................... 8,142 1,705 ---------- ---------- Net cash provided by financing activities.................... 8,131 1,705 ---------- ---------- NET DECREASE IN CASH................................................ (54) (8,823) CASH, beginning of period........................................... 232 9,034 ---------- ---------- CASH, end of period................................................. $ 178 $ 211 ========== ==========
The accompanying notes are an integral part of these interim financial statements. Page 5 99 CENTS ONLY STORES NOTES TO THE FINANCIAL STATEMENTS (Unaudited) 1. BASIS OF PRESENTATION The accompanying unaudited financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. However, certain information and footnote disclosures normally included in financial statements prepared in conformity with accounting principles generally accepted in the United States 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, 2001 audited financial statements and notes thereto included in the Company's Form 10-K filed April 1, 2002. In the opinion of management, these interim financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary for a fair statement of the results for 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 located in California, Nevada and Arizona. The Company's current retail expansion plans for the 99 Cents Only Stores include planned new stores in these geographic regions. 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 period. "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, 2002 and 2001 (amounts in thousands):
3 MONTHS ENDED 6 MONTHS ENDED JUNE 30, JUNE 30, ------------------- ------------------- 2002 2001 2002 2001 ------- ------- ------- ------- Weighted average number of common shares outstanding-Basic............................. 69,888 68,506 69,726 68,455 Dilutive effect of outstanding stock options..... 1,387 993 1,374 886 ------- ------- ------- ------- Weighted average number of common shares outstanding-Diluted........................... 71,275 69,499 71,100 69,341 ======= ======= ======= =======
Page 6 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 the 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, 2002 and December 31, 2001, 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 OR DEC. 31, WITHIN 1 1 YEAR OR --------- --------- ---------- --------- --------- --------- 2002 YEAR MORE 2001 YEAR MORE ---- ---- ---- ---- ---- ---- Municipal Bonds...... $123,571 $88,526 $35,045 $113,075 $112,542 $533 Corporate Securities. 1,184 1,184 0 981 981 - Commercial Paper..... 27,302 27,302 0 34,043 34,043 - $152,057 $117,012 $35,045 $148,099 $147,566 $533
4. NEW AUTHORITATIVE PRONOUNCEMENTS In June 2001, the FASB approved two final statements: SFAS No. 141, "Business Combinations," which provides guidance on the accounting for business combinations and was effective July 1, 2001 and SFAS No. 142, "Goodwill and Other Intangible Assets," which defines when and how goodwill and other intangible assets are amortized and was effective as of January 1, 2002. These statements did not have an impact on the Company's financial position or results of operations. In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations" (SFAS 143). This statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement cost. SFAS 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002. Management does not expect that the adoption of SFAS 143 will have an impact on the Company's financial position or results of operations. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS 144). SFAS 144 was effective for the financial statements issued for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The adoption of SFAS 144 did not have an impact on the Company's financial position or results of operations. 5. RELATED-PARTY TRANSACTIONS The Company leases certain retail facilities from its principal shareholders. Rental expense for these facilities was approximately $1.9 million for each of the fiscal years 1999, 2000 and 2001. Effective September 30, 2000, the Company sold its discontinued operation, Universal International, Inc. ("Universal")to a Company owned 100% by Dave and Sherry Gold, both significant shareholders of 99 Cents Only Stores. Mr. Gold is also the Chief Executive Officer and a director. Subsequent to December 31, 2001, Universal ceased operations and closed its business. It is expected that Universal will terminate its Service Agreement and Lease Agreement with 99 Cents Only Stores some time during 2002. From January 1, 2002 to June 30, 2002, the Company recorded $0.8 million and $0.7 million of revenue under a Services Agreement and Lease Agreement, respectively, and purchased $0.4 million of close Page 7 out inventory from Universal related to this transaction. From January 1, 2001 to June 30, 2001, the Company recorded $1.6 million and $0.7 million under a Services Agreement and Lease Agreement, respectively, related to this transaction. 6. 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, 2001. 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 accounts. At June 30, 2002, the Company had no customers representing more than 4.5% 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 month and the six month periods ended June 30, 2002 and June 30, 2001 follows (amounts in thousands):
THREE MONTHS ENDED JUNE 30 RETAIL WHOLESALE TOTAL -------- --------- -------- 2002 Net sales............. $155,436 $12,425 $167,861 Gross margin.......... 64,988 2,575 67,563 2001 Net sales............. $122,522 $13,852 $136,374 Gross margin.......... 50,472 2,707 53,179 SIX MONTHS ENDED JUNE 30 RETAIL WHOLESALE TOTAL -------- --------- -------- 2002 Net sales............. $305,083 $25,882 $330,965 Gross margin.......... 126,637 5,169 131,806 2001 Net sales............. $232,734 $28,609 $261,343 Gross margin.......... 95,718 5,531 101,249
Page 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following management's discussion and analysis should be read in connection with "Item 1. Financial Statements." 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 location and as of June 30, 2002, operated a chain of 139 deep-discount 99 Cents Only Stores. The Company's growth during the last three fiscal years has come primarily from new store openings, and growth in its Bargain Wholesale division. The Company opened eighteen, twenty and twenty-six stores in 1999, 2000 and 2001, respectively (fourteen, twenty and twenty-five, respectively, net of relocated stores). The Company opened sixteen stores through June 30, 2002 (three stores in Southern California, four in Central California, two in Northern California, two in Las Vegas, Nevada and five in Phoenix, Arizona). The Company plans to open an additional 15 net new stores during the remainder of the year, including stores in Las Vegas, Nevada and Phoenix, Arizona. Of the 15 intended new locations, as of June 30, 2002, the Company has secured sites for seven of these additional store locations. Bargain Wholesale sales are primarily focused on large domestic and international accounts and local and regional independent retailers. 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. In the past, as part of its strategy to expand retail operations, the Company has at times opened larger new stores in close proximity to existing stores where the Company determined that the trade area could support a larger store. In some of these situations, the Company retained its existing store so long as it continued to contribute store-level operating income. While this strategy was designed to increase revenues and store-level operating income, it has had a negative impact on comparable store net sales as some customers migrated from the existing store to the larger new store. The Company believes that this strategy has impacted its historical comparable sales growth. The Company currently targets larger locations for new store development which are between 15,000 and 20,000 gross square feet. Although it is the Company's experience that the larger stores generally have lower average net sales per square foot than smaller stores, larger stores generally achieve higher average annual store revenues and operating income. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements requires management to make estimates and assumptions that affect reported earnings. The estimates and assumptions are evaluated on an on-going basis and are based on historical experience and on other factors that management believes are reasonable. Estimates and assumptions include, but are not limited to, the areas of customer receivables, inventories, income taxes, self-insurance reserves, and commitments and contingencies. The Company believes that the following represent the areas where more critical estimates and assumptions are used in the preparation of the financial statements: Page 9 INVESTMENTS: The Company records its investments, which are comprised primarily of investment grade federal and municipal bonds and commercial paper, at fair value. The Company generally holds investments until maturity. Any premium or discount recognized in connection with the purchase of an investment is amortized over the term of the investment. LONG-LIVED ASSET IMPAIRMENTS: The Company records impairments when the carrying amounts of long-lived assets are determined not to be recoverable. Impairment is assessed and measured by an estimate of future cash flows expected to result from the use of the asset and its eventual disposition. Changes in market conditions can impact estimated future cash flows from use of these assets and additional impairments may be required should such changes occur. SELF-INSURANCE RESERVES: The Company is self-insured in relation to workers' compensation claims. The Company carries excess workers' compensation insurance, which covers individual claims up to the policy deductible amount. The Company provides for losses of estimated known and incurred but not reported insurance claims. These estimates are based on reported claims and actuarial valuations. Should a greater amount of claims occur compared to what was estimated, reserves recorded may not be sufficient and additional expense could be incurred. SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION This Form 10-Q contains statements that constitute "forward-looking statements" within the meaning of Section 21E of the Exchange Act and Section 27A of the Securities Act. The words "expect," "estimate," "anticipate", "predict," "believe" and similar expressions and variations thereof are intended to identify forward-looking statements. Such statements appear in a number of places in this filing and include statements regarding the intent, belief or current expectations of 99 Cents Only Stores, its directors or officers with respect to, among other things, (a) trends affecting the financial condition or results of operations of the Company and (b) the business and growth strategies of the Company. The shareholders of the Company are cautioned not to put undue reliance on such forward-looking statements. Such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and actual results may differ materially from those projected in this Report, for the reasons, among others, discussed in the Sections - "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Risk Factors." The Company undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof. Readers should carefully review the risk factors described in other documents the Company files from time to time with the Securities and Exchange Commission, including the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2001 and in this Form 10-Q. RESULTS OF OPERATIONS THREE MONTHS ENDED JUNE 30, 2002 COMPARED TO THREE MONTHS ENDED JUNE 30, 2001 NET SALES: Net sales increased $31.5 million, or 23.1%, to $167.9 million in the 2002 period from $136.4 million in the 2001 period. Retail sales increased $32.9 million to $155.4 million in the 2002 period from $122.5 million in the 2001 period. The retail net sales increase primarily was attributable to the net effect of sixteen new stores opened in 2002, the full quarter effect of 25 net new stores opened in 2001 and the 2.1% increase in same store sales. Bargain Wholesale net sales were $12.4 million in the 2002 period and were $13.9 million in the 2001 period. The 2001 period included $1.2 million in net sales to Universal as compared to none for the 2002 period. GROSS PROFIT: Gross profit increased approximately $14.4 million, or 27.1%, to $67.6 million in the 2002 period from $53.2 million in the 2001 period. The increase in gross Page 10 profit was due to higher net retail sales and favorable purchase cost variances for close-out merchandise. Overall gross profit margin for the 2002 period was 40.3% versus 39.0% for the 2001 period. SELLING, GENERAL AND ADMINISTRATIVE: SG&A increased by $9.8 million, or 26.8%, to $46.5 million in the 2002 period from $36.7 million in the 2001 period. As a percentage of net sales, total SG&A increased to 27.7% for the 2002 period from 26.9% for the 2001 period. This increase primarily is related to the California minimum wage increase in January 2002 and depreciation cost increases. OPERATING INCOME: As a result of the items discussed above, operating income increased $4.6 million, or 27.7%, to $21.0 million for the 2002 period from $16.4 million for the 2001 period. Operating margin was 12.5% for the 2002 period versus 12.1% for the 2001 period. OTHER INCOME (EXPENSE): Other income (expense) includes interest income on the Company's marketable securities and interest income from a lease agreement with Universal. Interest income was $.9 million for the 2002 period and $1.1 million for the 2001 period. The decrease in interest income is a result of lower interest rates during the 2002 period than were in effect for the 2001 period. During 2002 and 2001, the Company had no bank debt. At June 30, 2002, the Company held $117.0 million in short-term investments and $35.0 million in long-term investments. The Company's short-term and long-term investments are comprised primarily of investment grade federal bonds, municipal bonds and commercial paper. The Company generally holds investments until maturity. In each of the 2002 and 2001 periods, the Company recorded $0.4 million of rent income under a lease agreement with Universal. PROVISION FOR INCOME TAXES: The provision for income taxes was $8.7 million in the 2002 period compared to $7.0 million for the 2001 period. The effective rate of the provision for income taxes was approximately 39.2% for the 2002 period and 39.0% for the 2001 period. This variance results from available tax credits and tax-free interest income earned. NET INCOME: As a result of the items discussed above, net income increased $2.6 million, or 23.9%, to $13.5 million for the 2002 period from $10.9 million for the 2001 period. Net income as a percentage of sales was 8.1% for the 2002 period and 8.0% for the 2001 period. SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO SIX MONTHS ENDED JUNE 30, 2001 NET SALES: Net sales increased $69.6 million, or 26.6%, to $331.0 million in the 2002 period from $261.3 million in the 2001 period. Retail sales increased $72.3 million to $305.1 million in the 2002 period from $232.7 million in the 2001 period. The retail net sales increase primarily was attributable to the net effect of sixteen net new stores opened in the first six months of 2002, the full six months effect of 25 net new stores opened in 2001, and a 5.0% increase in comparable same store sales for the six-month period. Bargain Wholesale net sales were $25.9 million for the 2002 period and $28.6 million for the 2001 period. Included in Bargain Wholesale net sales for the 2001 period were $3.1 million of shipments to Universal at a 10% gross margin. No shipments to Universal were made in the first six months of 2002 as a result of the closing of Universal. GROSS PROFIT: Gross profit increased approximately $30.6 million, or 30.2%, to $131.8 million in the 2002 period from $101.2 million in the 2001 period. The increase in gross profit primarily was due to higher net sales volume and margin improvement resulting from favorable product cost factors. The gross profit margin as a percentage of net sales was 39.8% in the 2002 period versus 38.7% in the 2001 period. The year to date retail gross margin was 41.5% for the 2002 period versus 41.1% for the 2001 period. The change in the Page 11 retail gross profit margin is due to product cost factors and category sales mix. The wholesale gross profit margin was 20.0% for the 2002 period and 19.3% for 2001 period. SELLING, GENERAL AND ADMINISTRATIVE: SG&A increased by $21.3 million, or 30.3%, to $91.5 million in the 2002 period from $70.2 million in the 2001 period. As a percentage of net sales, total SG&A increased to 27.6% for the 2002 period from 26.9% for the 2001 period. This increase was a result of the California minimum wage increase in January 2002, which was partially offset by $0.8 million in management fees earned for administrative services provided to Universal. Additional cost increases included depreciation. OPERATING INCOME: As a result of the items discussed above, operating income increased $9.3 million, or 29.9%, to $40.3 million for the 2002 period from $31.1 million for the 2001 period. Operating margin was 12.2% for the 2002 period versus 11.9% for the 2001 period. OTHER INCOME (EXPENSE): Other income (expense) includes interest income on the Company's marketable securities and interest income under a lease agreement with Universal. Interest income decreased $0.8 million, or 35.0%, to $1.6 million for the 2002 period from $2.4 million for the 2001 period. The decrease in net interest income between 2002 and 2001 was primarily due to lower interest earned on short-term and long-term marketable securities because of interest rate declines over the past year. At June 30, 2002, the Company held $117.0 million in short-term investments and $35.0 million in long-term investments. The Company's short-term and long-term investments are comprised primarily of investment grade federal bonds, municipal bonds and commercial paper. The Company generally holds investments until maturity. In each of the 2002 and 2001 periods, the Company recorded $0.7 million of rent income under a lease agreement with Universal. PROVISION FOR INCOME TAXES: The provision for income taxes was $16.7 million for the 2002 period compared to $13.3 million for the 2001 period. The effective rate of the provision for income taxes was approximately 39.1% for the 2002 period and 38.9% for the 2001 period. This variance results from available tax credits and tax-free interest income earned. NET INCOME: As a result of the items discussed above, net income increased $5.1 million, or 24.4%, to $26.0 million, or $0.37 per diluted share for the 2002 period, from $20.9 million, or $0.30 per diluted share, for the 2001 period. Net income as a percentage of sales was 7.9% for the 2002 period and 8.0% for the 2001 period. LIQUIDITY AND CAPITAL RESOURCES Since inception, the Company has funded its operations principally from cash provided by operations, and has not generally relied upon external sources of financing. The Company's capital requirements result primarily from purchases of inventory, expenditures related to store openings and working capital requirements for new and existing stores. The Company takes advantage of close-out and other special situation opportunities which frequently result in large volume purchases, and as a consequence, its cash requirements are not constant or predictable during the year and can be affected by the timing and size of its purchases. Net cash provided by operations during the six months ended June 30, 2002 was $13.5 million, primarily consisting of $26.0 million of net income adjusted for non-cash items. Net cash provided by operations during the six months ended June 30, 2001 was $17.7 million, primarily consisting of $20.9 million of net income adjusted for non-cash items. In the six months ended June 30, 2002, the Company used $8.5 million for working capital. Net cash used for working capital and other activities primarily reflects an increase in inventory of $12.2 million, payment on accounts payable of $7.7 million and payment of $1.7 million due to shareholders as a result of the tax benefit of the sale of Universal Page 12 and other related transactions with Universal. Net cash used in investing activities during the six months ended June 30, 2002 and 2001 was $22.6 million and $29.1 million, respectively. Net cash used in investing activities for the 2002 period reflects $19.0 million used for capital expenditures, including $14.6 million used to open new stores. Net cash used in investing activities for the 2001 period reflects $17.8 million used for capital expenditures, including $11.1 million used to open new stores. The increase in net cash used in investing activities primarily is due to the purchase of marketable securities, which increased to $15.5 million for the 2002 period from $11.3 million for the 2001 period. Net cash provided by financing activities during the six months ended June 30, 2002 and 2001 was $9.0 million and $2.6 million, respectively, each of which represents the proceeds from the exercise of non-qualified stock options. The Company does not maintain any credit facilities with any bank. However, the Company has pledged a $5.1 million FNMA bond with the State of California Department of Industrial Relations as security for self-insured workers compensation. The Company plans to open new 99 Cents Only Stores at a targeted annual rate of 25%. The average investment per new store opened in 2002, including leasehold improvements, furniture, fixtures and equipment, inventory and pre-opening expenses, is approximately $660,000. The Company does not capitalize pre-opening expenses. The Company's cash requirements for new store openings are expected to total approximately $35.0 million in 2002, which includes the acquisition of properties. The Company's total planned expenditure in 2002 for additions to fixtures and leasehold improvements of existing stores, as well as for distribution, systems, expansion and replacement equipment is approximately $10.0 million. The Company believes that its total capital expenditure requirements for 2002 (including new store openings) will be approximately $45.0 million. The Company intends to fund its liquidity requirements for 2002 out of net cash provided by operations, short-term investments and cash on hand. RISK FACTORS TERRORISM AND THE UNCERTAINTY OF WAR MAY HAVE AN ADVERSE EFFECT ON OUR OPERATING RESULTS Terrorism attacks, such as the attacks that occurred in New York and Washington D.C. on September 11, 2001, the response by the United States initiated on October 7, 2001 and other acts of violence or war may affect the market on which our common stock will trade, the markets in which we operate and our profitability. Further terrorist attacks on the United States or United States businesses may occur. The potential near-term and long-term effects these attacks may have for our customers, the market for our common stock, the market for our products and the United States economy are uncertain. The consequence of any terrorist attack, or any armed conflicts which may result, are unpredictable, and we may not be able to foresee events that could have an adverse effect on our markets or our business. INFLATION MAY AFFECT OUR ABILITY TO SELL MERCHANDISE AT THE 99 CENTS PRICE POINT The Company's ability to provide quality merchandise at the 99 cents price point is subject to certain economic factors which are beyond the Company's control, including inflation. Inflation could have a material adverse effect on the Company's business and results of operations, especially given the constraints on the Company to pass on any incremental costs due to price increases or other factors. The Company believes that it will be able to respond to ordinary price increases resulting from inflationary pressures by adjusting the number of items sold at the single price point (e.g., two items for 99 cents instead of three items for 99 cents) and by changing its selection of merchandise. Nevertheless, a sustained trend 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 Page 13 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 1999, 2000 and 2001, we opened eighteen, twenty and twenty-six 99 Cents Only Stores, respectively (fourteen, twenty and twenty-five stores, respectively, net of relocated stores). As of June 30, 2002, we opened sixteen stores and expect to open at least 15 additional stores in the remainder of 2002. 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 we will improve our results of operations when we open new stores. A variety of factors, including store location, store size, rental terms, the level of store sales and the level of initial advertising influence if and when a store becomes profitable. Assuming that our planned expansion occurs as anticipated, our store base will include a relatively high proportion of stores with relatively short operating histories. We cannot assure you that our new stores will achieve the sales per saleable square foot and store-level operating margins currently achieved at our existing stores. If our new stores on average fail to achieve these results, our planned expansion could produce a decrease in our overall sales per saleable square foot and store-level operating margins. Increases in the level of advertising and pre-opening expenses associated with the opening of new stores could also contribute to a decrease in our operating margins. Finally, the opening of new stores in existing markets has in the past and may in the future reduce retail sales of existing stores in those markets, negatively affecting comparable store sales. OUR OPERATIONS ARE CONCENTRATED IN SOUTHERN CALIFORNIA All but 17 of our 99 Cents Only Stores are currently located in California. The Company operates seven stores in Las Vegas, Nevada and ten stores in Arizona. Accordingly, our results of operations and financial condition largely 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. If retail spending declines again due to another economic slow-down or recession in Southern California, we cannot assure you that our operations will not be negatively impacted. 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. 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 Page 14 merchandise consists of closeouts and other irreplaceable products. Although we maintain standard property and business interruption insurance, we do not have earthquake insurance on our properties. Although we try to limit our risk of exposure to potential product liability claims, we do not know if the limitations in our agreements are enforceable. We maintain insurance covering damage from use of our products. If any product liability claim is successful and large enough, our business could suffer. WE DEPEND UPON OUR RELATIONSHIPS WITH OUR SUPPLIERS AND THE AVAILABILITY OF CLOSE-OUT AND SPECIAL-SITUATION MERCHANDISE Our success depends in large part on our ability to locate and purchase quality close-out and special-situation merchandise at attractive prices. This helps us maintain a mix of name-brand and other merchandise at the 99 cents price point. We cannot be certain that such merchandise will continue to be available in the future. Further, we may not be able to find and purchase merchandise in quantities necessary to accommodate our growth. Additionally, our suppliers sometimes restrict the advertising, promotion and method of distribution of their merchandise. These restrictions in turn may make it more difficult for us to quickly sell these items from our inventory. Although we believe our relationships with our suppliers are good, we do not have long-term agreements with any supplier. As a result, we must continuously seek out buying opportunities from our existing suppliers and from new sources. We compete for these opportunities with other wholesalers and retailers, discount and deep-discount chains, mass merchandisers, food markets, drug chains, club stores and various privately-held companies and individuals. Although we do not depend on any single supplier or group of suppliers and believe we can successfully compete in seeking out new suppliers, a disruption in the availability of merchandise at attractive prices could impair our business. WE PURCHASE IN LARGE VOLUMES AND OUR INVENTORY IS HIGHLY CONCENTRATED To obtain inventory at attractive prices, we take advantage of large volume purchases, close-outs and other special situations. As a result, our inventory levels are generally higher than other discount retailers. At December 31, 1999, 2000 and 2001, we recorded net inventory of $53.9 million, $63.7 million and $66.5 million, respectively. We periodically review the net realizable value of our inventory and make adjustments to its carrying value when appropriate. The current carrying value of our inventory reflects our belief that we will realize the net values recorded on our balance sheet. However, we may not be able to do so. If we sell large portions of our inventory at amounts less than their carrying value or if we write down a significant part of our inventory, our cost of sales, gross profit, operating income and net income could suffer greatly during the period in which such event or events occur. 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; Page 15 - increases in operating costs; - increases in employee health care costs; - increases in prevailing wage levels; and - decreases in consumer confidence levels. In January 2001, California enacted a minimum wage increase of $0.50 per hour with an additional $0.50 increase required in January 2002. In 2001, annual payroll expenses increased less than 1.0% for the first year the minimum wage increase was in effect. We expect a similar increase for the year 2002. Because we provide consumers with merchandise at a 99 cents fixed price point, we typically cannot pass on cost increases to our customers. However the Company believes that the increased minimum wage will result in incremental customer spending in our stores. WE FACE RISKS ASSOCIATED WITH INTERNATIONAL SALES AND PURCHASES Although international sales historically have not been important to our net sales, they have contributed to historical growth in Bargain Wholesale's net sales. In addition, some of the inventory we purchase is manufactured outside the United States. There are many risks associated with doing business internationally. Our international transactions may be subject to risks such as: - political instability; - currency fluctuations; - exchange rate controls; - changes in import and export regulations; and - changes in tariff and freight rates. The United States and other countries have also proposed various forms of protectionist trade legislation. Any resulting changes in current tariff structures or other trade policies could lead to fewer purchases of our products and could adversely affect our international operations. WE COULD ENCOUNTER RISKS RELATED TO TRANSACTIONS WITH OUR AFFILIATES We currently lease 12 of our 99 Cents Only Stores and a parking lot for one of these stores from certain members of the Gold family and their affiliates. Our annual rental expense for these facilities totaled approximately $1.9 million in each of 1999, 2000 and 2001. Through June 30, 2002, the Company recorded $1.1 million in rental expense associated with these properties. We believe that our lease terms are just as favorable to us as they would be for an unrelated party. Under our current policy, we enter into real estate transactions with our affiliates only for the renewal or modification of existing leases and on occasions where we determine that such transactions are in our best interests. Moreover, the independent members of our Board of Directors must unanimously approve all real estate transactions between the Company and our affiliates. They must also determine that such transactions are equivalent to a negotiated arm's-length transaction with a third party. We cannot guarantee that we will reach agreements with the Gold family on renewal terms for the properties we currently lease from them. Also, even if we agree to such terms, we cannot be certain that our independent directors will approve them. If we fail to renew one of these leases, we could be forced to relocate or close the leased store. Any relocations or closures we experience will be costly and could adversely affect our business. WE RELY HEAVILY ON OUR MANAGEMENT TEAM Our success depends substantially on David Gold and Eric Schiffer, our Chief Executive Officer and President, respectively. We also rely on the continued service of our executive officers and other key management, 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. Page 16 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 2000 and 2001, we generated approximately 29.6% and 29.9%, respectively, of our net sales and approximately 32.7% and 35.3%, respectively, of our operating income during the fourth quarter. If for any reason the Company's net sales were to fall below norms during the fourth quarter it could have an adverse impact on our profitability and impair our results of operations for the entire year. Adverse weather conditions or other disruptions during the peak holiday season could also affect our net sales and profitability for the year. In addition to seasonality, many other factors may cause our results of operations to vary significantly from quarter to quarter. Some of these factors are beyond our control. These factors include: - the number of new stores and timing of new store openings; - the level of advertising and pre-opening expenses associated with new stores; - the integration of new stores into our operations; - general economic health of the deep-discount retail industry; - changes in the mix of products sold; - unexpected increases in shipping costs; - ability to successfully manage our inventory levels; - changes in our personnel; - fluctuations in the amount of consumer spending; - 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. As of June 30, 2002, we lease all but 17 of our stores. In December 2000, the Company exercised its option to purchase its main warehouse and distribution facility (where our executive offices are located) for $10.5 million. 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. Moreover David Gold, our Chairman and Chief Executive Officer, and members of his immediate family and certain of their affiliates beneficially own 22,735,622, or 32.4% of shares outstanding. 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. Page 17 THE MARKET PRICE OF OUR STOCK COULD BE VOLATILE. The market price of our common stock has been subject to volatility and, in the future, the market price of our common stock may fluctuate substantially due to a variety of factors, including: o quarterly fluctuations in our operating income and earnings per share results; o economic conditions; o changes in earnings estimates by market research analysts; o conditions or trends in our industry; o sales of common stock by existing holders; o loss of key personnel; and o securities class actions or other litigation. The market price for our common stock may also be affected by our ability to meet analysts' expectations. Any failure to meet such expectations, even slightly, could have an adverse effect on the market price of our common stock. In addition, the stock market is subject to extreme price and volume fluctuations. This volatility has had a significant effect on the market prices of securities issued by many companies for reasons unrelated to the operating performance of these companies. In the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been instituted against that company. If similar litigation were instituted against us, it could result in substantial costs and a diversion of our management's attention and resources, which could have an adverse effect on our business, results of operations and financial condition. 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, 2002, the Company had $152.1 million in marketable securities maturing at various dates through February 2004. The Company's investments are comprised primarily of investment grade federal and municipal bonds and commercial paper. The Company generally holds investments until maturity, and therefore should not bear any interest risk due to early disposition. We do not enter into any derivative or interest rate hedging transactions. Any premium or discount recognized upon the purchase of an investment is amortized over the term of the investment. At June 30, 2002, the fair value of investments approximated the carrying value. Page 18 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 2002 Annual Meeting of Stockholders on June 5, 2002. A quorum of shareholders were present either in person or by proxy. There were four matters submitted to a vote of the shareholders. The first matter was the election of nine directors to hold office for a one-year term. All directors who were nominated were elected. The results of the election are set forth in the following table:
DIRECTOR VOTES FOR VOTES AGAINST -------- --------- ------------- William Christy 57,622,723 759,561 Lawrence Glascott 57,568,561 813,723 David Gold 52,225,632 6,126,625 Howard Gold 52,225,632 6,126,625 Jeff Gold 52,225,632 6,126,625 Marvin Holen 57,568,561 813,723 Eric Schiffer 51,859,833 6,522,451 Ben Schwartz 57,622,723 759,561 John Shields 57,622,723 759,561
The second proposal was to increase the number of authorized shares of common stock from 100 million shares to 200 million shares. This proposal was approved. VOTES FOR VOTES AGAINST ABSTENTIONS --------- ------------- ----------- 54,280,870 4,100,368 1,046 The third proposal was to amend the 1996 Stock Option Plan to increase the number of shares of common stock available for issuance under the plan from 12,334,367 shares to 17,000,000 shares. This proposal was approved. VOTES FOR VOTES AGAINST ABSTENTIONS --------- ------------- ----------- 42,772,748 15,597,082 12,453 The fourth matter was to consider and act upon a shareholder proposal that requested the Board of Directors to establish certain vendor standards to be inserted in the Company's purchase contracts with its vendors. This proposal was not approved. VOTES FOR VOTES AGAINST ABSTENTIONS --------- ------------- ----------- 4,835,027 45,931,250 8,156,006 Page 19 ITEM 5. OTHER INFORMATION None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. Exhibits 99.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 dated August 14, 2002. 99.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 dated August 14, 2002. b. Reports on Form 8-K (i) Current report on Form 8-K filed on July 25, 2002; Item 5 was reported. (ii) Current Report on Form 8-K filed on June 14, 2002; Item 4 was reported. (iii) Current Report on Form 8-K filed on April 18, 2002; Item 5 was reported. Page 20 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: August 14, 2002 /s/ Andrew A. Farina ----------------------------- Andrew A. Farina Chief Financial Officer (Duly Authorized Officer) Page 21 EXHIBIT INDEX 99.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes- Oxley Act of 2002 dated August 14, 2002. 99.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes- Oxley Act of 2002 dated August 14, 2002. Page 22