-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QouvvCPdx3j/5T+C68Yx09geFMs+pYPAITYAfOKd7zRckF3YE+XXZqY8dro/KPYI OZmrROQbaliGoVCfHjBsIw== 0001011438-02-000249.txt : 20020415 0001011438-02-000249.hdr.sgml : 20020415 ACCESSION NUMBER: 0001011438-02-000249 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020401 FILER: COMPANY DATA: COMPANY CONFORMED NAME: 99 CENTS ONLY STORE CENTRAL INDEX KEY: 0001011290 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-VARIETY STORES [5331] IRS NUMBER: 952411605 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-11735 FILM NUMBER: 02595129 BUSINESS ADDRESS: STREET 1: 4000 EAST UNION PACIFIC AVE CITY: CITY OF COMMERCE STATE: CA ZIP: 90023 BUSINESS PHONE: 2139808145 MAIL ADDRESS: STREET 1: 4000 EAST UNION PACIFIC AVENUE CITY: CITY OF COMMERCE STATE: CA ZIP: 90023 10-K 1 form_10-k.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 (MARK ONE) |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001 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 Identification No.) of Incorporation or Organization) 4000 UNION PACIFIC AVENUE, 90023 CITY OF COMMERCE, CALIFORNIA (zip code) (Address of Principal Executive Offices) Registrant's telephone number, including area code: (323) 980-8145 Securities registered pursuant to Section 12(b) of the Act: COMMON STOCK, NO PAR VALUE NEW YORK STOCK EXCHANGE Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Security Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the last 90 days. Yes |X| No |_| Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |_| The aggregate market value of Common Stock held by non-affiliates of the Registrant on March 25, 2002 was $1,924,659,968 based on a $27.61 closing price for the Common Stock on such date. For purposes of this computation, all executive officers and directors have been deemed to be affiliates. Such determination should not be deemed to be an admission that such executive officers and directors are, in fact, affiliates of the Registrant. Indicate the number of shares outstanding of each of the issuer's classes of stock as of the latest practicable date. Common Stock, No Par Value, 69,708,800 Shares as of March 25, 2002 Portions of Part III of this report have been incorporated by reference from the Company's Proxy Statement for the 2002 Annual Shareholders meeting. TABLE OF CONTENTS Part I PAGE ---- Item 1. Business...................................................... 3 Item 2. Properties.................................................... 13 Item 3. Legal Proceedings............................................. 13 Item 4. Submission of Matters to a Vote of Security Holders........... 13 Part II Item 5. Market for Registrant's Common Stock and Related Stockholder Matters........................................ 14 Item 6. Selected Financial Data....................................... 15 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................. 17 Item 7A. Quantitative and Qualitative Disclosures About Market Risk.... 32 Item 8. Financial Statements and Supplementary Data................... 33 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........................ 50 Part III Item 10. Directors and Executive Officers of the Registrant............ 50 Item 11. Executive Compensation........................................ 50 Item 12. Security Ownership of Certain Beneficial Owners and Management................................................. 50 Item 13. Certain Relationships and Related Transactions................ 50 Part IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K........................................ 51 Page 2 SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION This Report contains statements that constitute "forward-looking statements" within the meaning of Section 21E of the Exchange Act and Section 27A of the Securities Act. The words "expect," "estimate," "anticipate", "predict," "believe" and similar expressions and variations thereof are intended to identify forward-looking statements. Such statements appear in a number of places in this filing and include statements regarding the intent, belief or current expectations of 99 Cents Only Stores (the " Company"), its directors or officers with respect to, among other things (a) trends affecting the financial condition or results of operations of the Company and (b) the business and growth strategies of the Company. The shareholders of the Company are cautioned not to put undue reliance on such forward-looking statements. Such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and actual results may differ materially from those projected in this Report, for the reasons, among others, discussed in the 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 Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K filed by the Company. PART I ITEM 1. BUSINESS 99 Cents Only Stores (the "Company") is a leading deep-discount retailer of primarily name-brand, consumable general merchandise. The Company's stores offer a wide assortment of regularly available consumer goods as well as a broad variety of first-quality, close-out merchandise. In 2001, a majority of the Company's product offerings were comprised of recognizable name-brand merchandise and were regularly available for reorder. The Company provides customers significant value on their everyday household needs and an exciting shopping experience in customer-service-oriented stores, which are attractively merchandised, brightly lit and well-maintained. The Company believes that its name-brand focus, along with a product mix emphasizing value-priced food and beverage and other everyday household items, increases the frequency of consumer visits and impulse purchases and reduces the Company's exposure to seasonality and economic cycles. The Company believes its format appeals to value-conscious customers in all socio-economic groups and results in a high volume of sales. As of March 28, 2002, the Company operated 132 retail stores, 112 in Southern California, eight in Central California, six in Las Vegas, Nevada and six in Phoenix, Arizona. These stores have an average size of approximately 20,000 square feet. The Company's 99 Cents Only Stores generated average net sales per estimated saleable square foot of $319, which the Company believes is among the highest in the deep-discount convenience store industry, and average net sales per store of $4.6 million for stores open the full year in 2001. The Company opened its first 99 Cents Only Store in 1982 and believes that it operates the nation's oldest existing single price point general merchandise chain. The Company competes in the deep-discount industry, which is one of the fastest growing retail sectors in the United States. In line with the Company's business strategy, the Company has significantly increased its rate of store expansion over the last five fiscal years. The Company expanded its 99 Cents Only Stores from 36 stores and 332,100 estimated saleable square feet at December 31, 1995 to 123 stores and 1,892,949 estimated saleable square feet at December 31, 2001, representing a compound annual growth rate ("CAGR") of 23% and 34%, respectively. The Company believes that its attractive store-level economics facilitates its expansion. Historically, the Company's 99 Cents Only Stores have been profitable within their first year of operation. In the first quarter of 2002, the Company opened nine stores and plans to open an additional 22 net new stores during the remainder of the year. The Company intends to continue its planned store expansion over Page 3 the next several years at a targeted growth rate of approximately 25% per year. The Company estimates that the Southern and Central California market and the Nevada and Arizona markets have the potential for over 250 99 Cents Only Stores. The Company intends to continue to expand in both Arizona and Nevada in 2002 and believes that the Arizona and Nevada markets have the potential for 35 and 15 99 Cents Only Stores, respectively. The Company also sells merchandise through its Bargain Wholesale division at prices generally below normal wholesale levels to local, regional, and national discount, drug and grocery store chains and independent retailers, distributors and exporters. Bargain Wholesale complements the Company's retail operations by allowing the Company to purchase in larger volumes at more favorable pricing, to be exposed to a broader selection of opportunistic buys and to generate additional sales with relatively small incremental increases in operating expenses, contributing to strong overall operating margins for the Company. Bargain Wholesale represented 9.7% of the Company's net sales in 2001. INDUSTRY The Company participates primarily in the deep-discount retail industry, with its 99 Cents Only Stores. Deep discount retail is distinguished from other retail formats by the purchase of close-out and other special-situation merchandise at prices substantially below original wholesale cost, and the subsequent sale of this merchandise at prices significantly below regular retail. This results in a continually changing selection of specific brands of products. The deep-discount retail industry is one of the fastest growing retail sectors in the United States. The sale of close-out or special-situation merchandise develops in response to the need of manufacturers, wholesalers and others to distribute merchandise outside their normal channels. Close-out or special-situation merchandise becomes available for a variety of reasons, including a manufacturer's over-production, discontinuance due to a change in style, color, size, formulation or packaging, the inability to move merchandise effectively through regular channels, reduction of excess seasonal inventory, discontinuation of test-marketed items and the financial needs of the manufacturer. Many deep-discount retailers also sell merchandise that can be purchased from a manufacturer or wholesaler on a regular basis. Although this merchandise can usually be purchased at less than original wholesale and sold below normal retail, the discount, if any, is generally less than with close-out merchandise. Deep-discount retailers sell regularly available merchandise to ensure a degree of consistency in their product offerings and to establish themselves as a reliable source of basic goods. BUSINESS STRATEGY The Company's goal is to continue to provide significant value to its customers on a wide variety of consumable merchandise in an exciting store environment. The Company's strategies to achieve this goal include the following: FOCUS ON "NAME-BRAND" CONSUMABLES. The Company strives to exceed its customers' expectations of the range and quality of name-brand consumable merchandise that can be purchased for 99 cents. During 2001, the Company purchased merchandise from more than 999 suppliers, including Colgate-Palmolive Company, The Dial Corp., Eveready Battery Company Inc., General Electric Company, Gerber Products Company, Hershey Foods Corp., Johnson & Johnson, Kraft General Foods, Inc., Lever Brothers Company, Mattel Inc., The Mead Corporation, Nabisco Inc., Nestle, The Pillsbury Company, The Procter & Gamble Company, Revlon Inc. and SmithKline Beecham Corporation. BROAD SELECTION OF REGULARLY AVAILABLE MERCHANDISE. The Company's retail stores offer consumer items in each of the following staple product categories: food including frozen and deli items, beverages, health and beauty aids, household products (cleaning supplies, paper goods, etc.), housewares (glassware, kitchen items, etc.), hardware, stationary and party goods, seasonal goods, baby products and toys, giftware, pet Page 4 products and clothing. The Company ensures that its merchandise offering is complete by supplementing its name-brand merchandise with private-label items. By consistently offering a wide selection of basic household consumable items, the Company encourages customers to shop at the stores for their everyday household needs, leading to a high frequency of customer visits. ATTRACTIVELY MERCHANDISED AND WELL-MAINTAINED STORES. The Company strives to provide its customers an exciting shopping experience in customer-service-oriented stores which are attractively merchandised, brightly lit and well-maintained. The Company's stores are merchandised and laid out in a "supermarket" format with items in the same category grouped together. In addition, the shelves are restocked as needed during the day. By offering merchandise in an attractive, convenient and familiar environment, the Company believes its stores appeal to a wide demographic of customers. STRONG LONG-TERM SUPPLIER RELATIONSHIPS. The Company believes that it has developed a reputation as a leading purchaser of name-brand, re-orderable and close-out merchandise at discount prices through its ability to make immediate buying decisions, experienced buying staff, willingness to take on large volume purchases and take possession of merchandise immediately, ability to pay cash or accept abbreviated credit terms, reputation for prompt payment, commitment to honor all issued purchase orders and willingness to purchase goods close to a target season or out of season. The Company's relationship with its suppliers is further enhanced by its ability to minimize channel conflict for the manufacturer by quickly selling name-brand merchandise without, if requested by the supplier, advertising or wholesaling the item. Additionally, the Company believes its well-maintained, attractively merchandised stores have contributed to a reputation among suppliers for protecting their brand image. COMPLEMENTARY BARGAIN WHOLESALE OPERATION. Bargain Wholesale complements the Company's retail operations by allowing the Company to purchase in larger volumes at more favorable pricing, to be exposed to a broader selection of opportunistic buys and to generate additional sales with relatively small incremental increases in operating expenses, contributing to strong overall operating margins for the Company. Net sales in the Company's Bargain Wholesale division grew from $44.8 million in 1997 to $56.3 million in 2001, primarily due to an increased focus on large domestic and international accounts and expansion into new geographic markets. The Company maintains showrooms in New York City and Chicago to support its Bargain Wholesale operation. ADHERENCE TO DISCIPLINED COST CONTROLS AND SAVVY PURCHASING. The Company is able to provide its customers with significant value while maintaining strong operating margins through an adherence to a disciplined cost control program. The Company purchases merchandise at substantially discounted prices as a result of its buyers' knowledge, experience and negotiating ability and its established reputation among its suppliers. The Company applies this same approach to its relationships with other vendors and strives to maintain a lean operating environment focused on increasing net income. FOCUS ON LARGER STORES IN CONVENIENT LOCATIONS. The Company's 99 Cents Only Stores are conveniently located in freestanding buildings, neighborhood shopping centers (anchored by 99 Cents Only Stores or co-anchored with a supermarket and/or a drug store) or downtown central business districts where consumers are more likely to do their regular household shopping. The Company's 132 existing 99 Cents Only Stores average approximately 20,000 gross square feet. From January 1, 1997 through December 31, 2001, the Company has opened 87 new stores with an average of approximately 20,000 gross square feet and currently targets new store locations between 15,000 and 25,000 gross square feet. The Company's larger 99 Cents Only Stores allow it to more effectively display a wider assortment of merchandise, carry deeper stock positions and provide customers with a more inviting and convenient environment that encourages customers to shop longer and buy more. The Company's decision to target larger stores reflects higher average annual net sales per store and operating income typically achieved by these stores. EXPERIENCED MANAGEMENT TEAM AND DEPTH OF EMPLOYEE OPTION GRANTS. 99 Cents Only Stores' management team has many years of retail experience and has demonstrated its Page 5 skills through a proven track record of financial performance. The Company's management strongly believes that employee ownership of the Company's stock helps build employee pride in the stores, which significantly contributes to the success of the Company and its operations. Accordingly, all members of the Company's management (other than David Gold, the Company's Chief Executive Officer, Howard Gold, Senior Vice President of Distribution, Jeff Gold, Senior Vice President of Real Estate and Information Systems, Eric Schiffer, President and Karen Schiffer, Senior Buyer) and all employees with tenure of more than six months with the Company receive an annual grant of stock options. As of December 31, 2001, the Company's employees held options to purchase an aggregate of 5,193,169 shares, or 7.4% of the fully diluted shares of Common Stock outstanding. GROWTH STRATEGY Management believes that future growth will primarily result from new store openings facilitated by the following: THE WESTERN UNITED STATES HAS SIGNIFICANT POTENTIAL FOR GROWTH. The Company's 99 Cents Only Stores are located primarily in Southern and Central California, Nevada and Arizona. By focusing its near-term growth in its current market, the Company can leverage its brand awareness in the region and take advantage of its existing warehouse and distribution facility, regional advertising and other management and operating efficiencies. The Company has plans to open at least 31 net new 99 Cents Only Stores in 2002. The 2002 store additions will be located in Southern and Central California, Las Vegas, Nevada and Phoenix, Arizona. The Company will have opened nine new stores in the first three months of 2002, six stores in California, one in Las Vegas, Nevada and two in Phoenix, Arizona. The Company plans to open an additional 22 net new stores during the remainder of 2002. The Company has secured sites for seven additional store locations and has signed twelve letters of intent to lease prospective store sites. Generally, the Company expects that at least 50% of the letters of intent will become store sites. The Company intends to continue its planned store expansion over the next several years at a targeted rate of approximately 25% per year. The Company estimates that the Southern and Central California market, the Clark County, Nevada area, and Phoenix, Arizona, have the potential for over 250, 99 Cents Only Stores. PORTABLE FORMAT FACILITATES GEOGRAPHIC EXPANSION. The Company believes that its concept of consistently offering a broad selection of name-brand consumables, at value pricing, in a convenient store format is portable to most other densely populated areas of the country. In November 1999, the Company opened its first 99 Cents Only Stores outside the state of California in Las Vegas, Nevada and opened additional stores both in Las Vegas, Nevada and Phoenix, Arizona in 2001. ACQUISITIONS. The Company considers lease acquisition opportunities as they are presented to the Company and may make acquisitions of a chain, or chains, of clustered retail sites in densely populated regions, primarily for the purpose of acquiring favorable lease locations. RETAIL OPERATIONS The Company's retail stores offer customers a wide assortment of regularly available consumer goods, as well as a broad variety of first-quality, close-out merchandise, generally at a significant discount from normal retail. All merchandise sold in the Company's 99 Cents Only Stores retail stores sells for 99 cents per item or two or more items for 99 cents. The Company strives to exceed its customers' expectations of the range and quality of name-brand consumables that can be purchased for 99 cents. Page 6 The following table sets forth relevant information with respect to the growth of the Company's existing 99 Cents Only Store operations (dollar amounts in thousands, except sales per square foot):
YEAR ENDED DECEMBER 31, 1997 1998 1999 2000 2001 -------- -------- -------- -------- -------- 99 Cents Only Stores, net retail sales.......................... $186,024 $238,868 $312,306 $402,071 $522,019 99 Cents Only Stores annual net sales growth rate................. 29.9% 28.4% 30.7% 28.7% 29.8% 99 Cents Only Stores store count at beginning of year.................. 43 53 64 78 98 New stores............................ 10 13 18 20 26 Stores closed......................... - 2(a) 4(a) - 1(a) Total store count at year-end......... 53 64 78 98 123 Average 99 Cents Only Stores net sales per store open the full year(b).......................... $3,750 $4,147 $4,433 $4,487 $4,647 Estimated saleable square footage at year-end for 99 Cents Only Stores.. 631,500 822,900 1,102,369 1,424,280 1,892,949 Average net sales per estimated saleable square foot(b)............... $354 $335 $332 $318 $319 Change in comparable 99 Cents Only Stores net sales...................... 1.5% 4.3% 6.1% 2.0% 5.9% (a) Stores closed due to relocation to a larger nearby site. (b) For stores open for the entire fiscal year for 99 Cents Only Stores.
MERCHANDISING. All of the Company's stores offer a broad variety of first-quality, name-brand and other close-out merchandise as well as a wide assortment of regularly available consumer goods. The Company also carries a line of private label consumer products made exclusively for the Company. The Company believes that the success of its 99 Cents Only Stores concept arises from the value inherent in selling primarily name-brand consumables, most of which retail elsewhere from $1.19 to $9.99, for only 99 cents per item or group of items. Each store typically carries over five thousand different stock keeping units (SKU). The merchandise sold in the Company's stores primarily consists of a wide variety of basic consumer items such as food, including frozen and deli, beverages, health and beauty aids and household products (cleaning supplies, paper goods, etc.). The stores also carry house-wares (glassware, kitchen items, etc.), hardware, stationary and party goods, seasonal goods, baby products and toys, giftware, pet products and clothing. While each of the Company's stores regularly carry a variety of basic household consumer items, the stores differ from typical discount retail stores in that they do not continuously stock complete lines of merchandise. Although a majority of the merchandise purchased by the Company is available for reorder, the mix of specific brands of merchandise frequently changes, depending upon the availability of close-out and other special-situation merchandise at suitable prices. Since commencing its closeout purchasing strategy in 1976, the Company has not experienced difficulty in obtaining name brand closeouts as well as re-orderable merchandise at attractive prices. Management believes that continuously changing specific name-brands found in its stores from one week to the next encourages impulse and larger volume purchases, results in customers shopping more frequently and helps to create a sense of urgency, awareness and excitement. Unlike many discount retailers, the Company rarely imposes limitations on the quantity of specific items that may be purchased by a single consumer. The Company targets value-conscious consumers from a wide range of socio-economic backgrounds with diverse demographic characteristics. Purchases are by cash, credit or Page 7 debit card. The Company's stores do not accept checks or manufacturers' coupons. The Company's stores are open every day with opening hours designated to meet the needs of family consumers. The Company advertises that its stores are open "9:00 a.m. to 9:00 p.m., 9 days a week." STORE SIZE, LAYOUT AND LOCATIONS. As of March 28, 2002, the Company had 132, 99 Cents Only Stores. The stores include 112 locations in Southern California, eight stores in Central California, six stores located in Las Vegas, Nevada and six stores in Phoenix, Arizona. The stores average approximately 20,000 gross square feet. Since January 1, 1997, the Company has opened 87 new stores that average over 20,000 gross square feet and currently targets new store locations between 15,000 and 25,000 gross square feet. The Company's larger 99 Cents Only Stores allow it to more effectively display a wider assortment of merchandise, carry deeper stock positions and provide customers with a more inviting and convenient environment that encourages customers to shop longer and buy more. The Company's decision to target larger stores reflects higher average annual store revenues typically achieved by these stores. The Company's stores are conveniently located in freestanding buildings, neighborhood shopping centers (anchored by 99 Cents Only Stores, a supermarket and/or a drug store) or downtown central business districts where consumers are more likely to do their regular household shopping. The Company's stores are attractively merchandised, brightly lit, well-maintained, "destination" locations. The layout of each of the Company's stores is customized to the actual size and configuration of the individual location. The interior of each store is, however, designed to reflect a uniform format, like a typical supermarket, featuring attractively displayed products in windows, consistent merchandise display techniques, bright lighting, lower shelving height that allows unobstructed visibility throughout the store, distinctive color scheme, interior and exterior signage and customized check-out counters, floors, price tags, shopping carts and shopping bags. The Company emphasizes a strong visual presentation in all key traffic areas of the store. Merchandising displays are maintained throughout the day, change frequently and often incorporate seasonal themes. The Company believes that due to the continuously changing brand-names, the lower shelving height and the absence of aisle description signs, the typical customer tends to shop the whole store. The Company leases 106 of its 123 99 Cents Only Stores retail locations in operation at December 31, 2001. The Company typically seeks leases with an initial five-year to ten-year term and with one or more five-year renewal options. See "Item 2 Properties." The Company identifies potential sites through a network of contacts within the brokerage and real estate communities, information provided by vendors, customers and employees and through the efforts of the Company's real estate department. Most leases have renewal options ranging from three to ten years. As part of its strategy to expand retail operations, the Company has, at times, opened 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 effect on comparable stores net sales as some customers migrated from the existing store to the close-by larger new store. Except for 11 relocations to larger stores, the Company has never closed one of its 99 Cents Only Stores. STORE MANAGEMENT. Substantially all merchandise decisions with respect to pricing and advertising are made at the Company's headquarters. The Company employs 24 district managers and two regional managers responsible for store operations. Each district manager is responsible for up to seven stores. Reporting to each district manager is one merchandising supervisor responsible for store merchandising in that district. The store managers also report to the district manager. These district managers are supervised by the two regional managers that report to the Company's Vice President of Retail Page 8 Operations. District managers visit each store in their district at least twice a week and focus on the implementation of the Company's policies, operations and merchandising philosophy. District managers also help train store management and assist store management with scheduling. The Vice President of Retail Operations also supervises a cashier's training school located at the Company's corporate offices. Each merchandising supervisor and his crew (usually six to ten experienced stock people) visit each of the stores at least once a week and help the store managers to maintain and improve the appearance of the sales floor, move merchandise sections, organize the stockroom and train store personnel. Typically the Company's stores are staffed with a manager and two or three assistant managers. Store managers are responsible for assessing their respective store's stocking needs and ordering accordingly. ADVERTISING. Advertising expenditures were $2.4 million, $2.7 million and $3.4 million for 1999, 2000 and 2001, respectively, or 0.7%, 0.6% and 0.6% of net sales, respectively. The Company manages its advertising without the assistance of an outside agency. The Company allocates the majority of its advertising budget to newspaper and radio advertising. The Company's advertising strategy emphasizes the offering of nationally recognized, name-brand merchandise at significant savings. The Company minimizes its advertising expenditures by an efficient implementation of its advertising program combined with word-of-mouth publicity, locations with good visibility and efficient signage. Because of the Company's distinctive grand opening promotional campaign, which includes the sale of nine televisions for 99 cents each and nine microwave ovens for 99 cents each, grand openings often attract long lines of customers and receive media coverage. The Company believes that one of its biggest challenges is attracting affluent customers to shop its stores. The Company also uses a direct mail campaign for new customers who are homeowners in more upscale neighborhoods. The Company believes the direct mail campaign has been successful in attracting new customers. BARGAIN WHOLESALE In 2001, Bargain Wholesale sold merchandise to over 999 customers, including other wholesalers, small local retailers, large regional and national retailers and exporters. During 2001, no single customer accounted for more than 8.3% of Bargain Wholesale's net sales. The Company advertises its wholesale operations primarily through direct mail. The Company plans to continue to expand its wholesale operations by continuing its focus on the needs of large domestic and international accounts, expansion into new geographic markets, increasing its marketing and promotional programs, increasing the number of trade shows at which it exhibits, focusing on its showrooms in Chicago and New York City, enhancing customer service and aggressively contacting its customers on a more frequent basis through telephone, facsimile and mail. The Company's wholesale product line is substantially similar to its retail product line, although the Company has seen strong growth in re-orderable and private label merchandise within its wholesale operations. Bargain Wholesale continues to provide merchandise for the "dollar" promotional aisles of certain supermarkets and drugstores. The Company offers 15-day payment terms to its Bargain Wholesale customers who meet the Company's credit standards. Customers located abroad, certain smaller customers or others who do not meet the Company's credit standards must pay cash upon pickup or before shipment of merchandise. Bargain Wholesale complements the Company's retail operations by allowing the Company to purchase in larger volumes at more favorable pricing, to be exposed to a broader selection of opportunistic buys and to generate additional net sales with relatively small incremental increases in operating expenses contributing to strong overall margins for the Company. Bargain Wholesale also allows the Company to purchase goods which it would not otherwise purchase for distribution through its 99 Cents Only Stores and provides the Company with a channel by which it may distribute merchandise at prices other than 99 cents. Bargain Wholesale conducts its wholesale operations through its 15,000 square foot product showroom located at the Company's warehouse and distribution facility. The Page 9 Company's showrooms in New York and Chicago also continue to support Bargain Wholesale's operations. PURCHASING The Company's purchasing department staff consists of thirteen buyers managed by the Company's Vice President of Purchasing. The Company's Chief Executive Officer also participates in the Company's purchasing activities. The Company's buyers purchase for 99 Cents Only Stores and Bargain Wholesale. The Company believes a primary factor contributing to its success is its ability to identify and take advantage of opportunities to purchase merchandise with high customer interest at lower than regular wholesale prices. The Company purchases most of its merchandise directly from the manufacturer. The Company's other sources of merchandise include wholesalers, manufacturers' representatives, importers, barter companies, auctions, professional finders and other retailers. The Company develops new sources of merchandise primarily by attending industry trade shows, advertising, marketing brochures and referrals. The Company has no continuing contracts for the purchase of merchandise and must continuously seek out buying opportunities from both its existing suppliers and new sources. No single supplier accounted for more than 2.3% of the Company's total purchases in 2001. During 2001, the Company purchased merchandise from more than 999 suppliers, including Colgate-Palmolive Company, The Dial Corp., Eveready Battery Company Inc., General Electric Company, Gerber Products Company, The Gillette Company, Hershey Foods Corp., Johnson & Johnson, Kraft General Foods Inc., Lever Brothers Company, Mattel Inc., The Mead Corporation, Nabisco Inc., Nestle, The Pillsbury Company, The Procter & Gamble Company, Revlon Inc. and SmithKline Beecham Corporation. Many of these companies have been supplying products for the Company in excess of four years. A significant portion of the merchandise purchased by the Company in 2001 was close-out or special-situation merchandise. The Company has developed strong relationships with many manufacturers and distributors who recognize that their special-situation merchandise can be moved quickly through the Company's retail and wholesale distribution channels. The sale of closeout or special-situation merchandise develops in response to the need of manufacturers, wholesalers and others to distribute merchandise outside their normal channels. The Company's buyers search continuously for close-out opportunities. The Company's experience and expertise in buying merchandise has enabled it to develop relationships with many manufacturers that often offer some or all of their close-out merchandise to the Company prior to attempting to sell it through other channels. The key elements to these supplier relationships include the Company's (i) ability to make immediate buy decisions, (ii) experienced buying staff, (iii) willingness to take on large volume purchases and take possession of merchandise immediately, (iv) ability to pay cash or accept abbreviated credit terms, (v) reputation for prompt payment, (vi) commitment to honor all issued purchase orders and (vii) willingness to purchase goods close to a target season or out of season. The Company's relationship with its suppliers is further enhanced by its ability to minimize channel conflict for the manufacturer by quickly selling name-brand merchandise without, if requested by the supplier, advertising or wholesaling the item. The Company believes this reputation along with its well-maintained, attractively merchandised stores have contributed to a reputation among suppliers for protecting their brand image. In 2001, re-orderable merchandise accounted for a majority of the Company's purchases. The Company's strong relationships with many manufacturers and distributors, along with its ability to purchase in large volumes, also enable the Company to purchase re-orderable name-brand goods at discounted wholesale prices. The Company focuses its purchases of re-orderable merchandise on a limited number of SKUs, which allows the Company to make purchases in large volumes. The Company is continuously developing new private label consumer products to broaden the assortment of merchandise that is consistently available. The Company also has an in-house import operation, which primarily purchases re-orderable merchandise. The Company imports products from various European, South American and Asian countries with Page 10 the single largest supplier coming from Europe. Merchandise directly imported by the Company accounted for approximately 3.2% of total merchandise purchased in 2001. The Company primarily imports merchandise in product categories, which are not brand sensitive to consumers such as kitchen items, house-wares, toys, seasonal products, pet-care and hardware. WAREHOUSING AND DISTRIBUTION The Company owns an 880,000 square feet, single level warehouse and distribution facility located on approximately 23 acres in the City of Commerce, California. The Company's headquarters are located in this facility. The Company also leases an additional 80,000 square foot of warehouse storage space adjacent to its main distribution facility and 15,000 square feet of deli and frozen product storage space. All of the three sites are located near downtown Los Angeles and have close access to the Southern California freeway and rail systems and the ports of Los Angeles and Long Beach. The main distribution facility has 129 dock doors available for receiving or shipping, over 25 dock levers and, new racking with over 10,000 pallet positions. Most of the Company's merchandise is shipped by truck directly from manufacturers and other suppliers to the Company's warehouse and distribution facility. As part of its distribution network, the Company owns a fleet of 64 tractors and 128 trailers, which are primarily used to deliver merchandise to its stores. Full truck deliveries are made from its distribution center to each store typically three times a week. Product is delivered to a store the day after the store places a scheduled order. The Company optimizes the utilization of its fleet by a combination of filling outbound trucks to capacity and instituting a backhaul program whereby products are picked up from suppliers in conjunction with deliveries to stores in the same general area. Backhauls accounted for approximately half of all merchandise picked up by the Company's trucks. The Company also uses its own vehicles to pick up certain shipments at local ports and rail yards. The size of the Company's distribution center allows storage of bulk one-time close-out purchases and seasonal or holiday items without incurring additional costs. The Company believes that its current warehouse and distribution facilities will be able to support distribution to approximately 200 stores in California and areas within a 450 mile radius. There can be no assurance that the Company's existing warehouse will provide adequate storage space for the Company's long-term storage needs. INFORMATION SYSTEMS In 2001, the Company installed a financial, accounting, human resource and payroll system utilizing an INFORMIX database to run on an IBM UNIX operating system. The Company also operates a separate IBM UNIX based in-house developed inventory control system. The Company's store ordering system was upgraded in 2000 and 2001 utilizing a radio frequency hand held scanning device. This system also is a customized system and has improved the overall order processing turn around time as well as improving the inventory availability to the stores. This system is processed from a back office PC system at each retail location. The Company has installed a Wide Area Network (WAN) to improve voice and data communications among the stores, the warehouse and the administrative functions. In 2001, the Company started the roll-out of its Point of Sale System (POS) to all 99 Cents Only Stores and completed the roll-out in February of 2002. It is expected that the system will expedite the customer check-out process and provide product category sales data necessary to better service the Company's customers. The Company's Information Systems staffing is comprised of 15 employees. The Company believes that its management information systems and inventory control systems along with the initiatives indicated above will be adequate to support the Company's current needs. The Company intends to continue to enhance its systems to support its future planned store growth and to take advantage of new proven technology. COMPETITION The Company faces competition in both the acquisition of inventory and sale of merchandise from other wholesalers, discount stores, single price point merchandisers, Page 11 mass merchandisers, food markets, drug chains, club stores and other retailers. Industry competitors also include a large number of privately held companies and individuals. In some instances these competitors are also customers of the Company's Bargain Wholesale division. There is increasing competition with other wholesalers and retailers, including other deep-discount retailers, for the purchase of quality close-out and other special-situation merchandise. Some of these competitors have substantially greater financial resources and buying power than the Company. The Company's ability to compete will depend on many factors including the success of its purchase and resale of such merchandise at lower prices than the competition. The Company may face intense competition in the future from new entrants in the deep-discount retail industry, among others, that could have an adverse effect on the Company's business and results of operations. EMPLOYEES At December 31, 2001, the Company had 5,674 employees: 4,997 in its retail operation, 452 in its warehouse and distribution facility, 205 in its corporate offices and 20 in its Bargain Wholesale division. None of the Company's employees is party to a collective bargaining agreement. The Company considers relations with its employees to be good. The Company offers certain benefits, including health insurance, 401(k) benefits to its full time employees and an executive deferred compensation plan. All members of management (other than David Gold, the Company's Chief Executive Officer, Howard Gold, Senior Vice President of Distribution, Jeff Gold, Senior Vice President of Real Estate and Information Systems, Eric Schiffer, President and Karen Schiffer, Senior Buyer) and all full-time employees, hired before January 1, 2002 receive an annual grant of stock options. TRADEMARKS AND SERVICE MARKS "99 Cents Only Stores" and "99 Cents" are registered service marks of the Company and are listed on the United States Patent and Trademark Office Principal Register. "Bargain Wholesale" is a service mark used by the Company. Management believes that the Company's trademarks, service marks and trade names are an important but not critical element of the Company's merchandising strategy. ENVIRONMENTAL MATTERS Under various federal, state and local environmental laws and regulations, a current or previous owner or occupant of real property may become liable for the costs of removal or remediation of hazardous substances at such real property. Such laws and regulations often impose liability without regard to fault. As of March 28, 2002 the Company leased 113 of its 132 existing stores and the Company owned its warehouse and distribution facilities (where its executive offices are located). The Company also owns a warehouse facility in Eagan, Minnesota that is currently leased to Universal International. In connection with such properties, the Company could be held liable for the costs of remedial actions with respect to hazardous substances. In addition, the Company operates one underground diesel storage tank and one above-ground propane tank at its warehouse and distribution facility. Although the Company has not been notified of, and is not otherwise aware of, any specific current environmental liability, claim or non-compliance, there can be no assurance that the Company will not be required to incur redemption or other costs in the future in connection with its leased properties or its storage tanks or otherwise. In the ordinary course of its business, the Company from time to time handles or disposes of ordinary household products that are classified as hazardous materials under various federal, state and local environmental laws and regulations. The Company has adopted policies regarding the handling and disposal of these products, and has implemented a training program for employees on hazardous material handling and disposal. There can be no assurance, however, that such policies or training will be successful in assisting the Company in avoiding violations of environmental laws and regulations relating to the handling and disposal of such products in the future. Page 12 ITEM 2. PROPERTIES As of March 28, 2002, the Company leased 113 of its 132 store locations. The Company currently leases 12 store locations and a parking lot associated with one of these stores from the Gold Family. Our annual rental expense for these facilities totaled approximately $1.9 million, $1.9 million and $1.9 million in 1999, 2000 and 2001, respectively. Management believes that the Company's stable operating history, excellent credit history and ability to generate substantial customer traffic give the Company significant leverage when negotiating lease terms. Most of the Company's leases provide for fixed rents, subject to periodic adjustments. Certain of the Company's store leases contain provisions that grant the Company a right of first refusal to acquire the subject site. The following table sets forth, as of December 31, 2001, information relating to the expiration dates of the Company's current retail stores leases:
EXPIRING EXPIRING EXPIRING EXPIRING 2003 2004-2006 2007-2009 2010 AND BEYOND 5(a) 47 29 25 (a) Includes two stores leased on a month-to-month basis.
The Company has purchased 17 locations, one opened in 1996, two in 1997, one in 1998, three in 1999, three in 2000, six in 2001 and one existing store. The Company also has escrow deposits on 5 additional locations for future openings. The Company owns its main warehouse, distribution and executive office facility, located in the City of Commerce, California. The Company had been leasing this facility since December 1993. At that time, the Company entered into a seven year, triple net lease agreement with a purchase option, which was accounted for on the Company's financial statements as a capitalized lease obligation. The lease included the Company's initial payment of $2.75 million and eighty-four monthly payments of $70,000. As part of the lease agreement, the Company received $500,000 in 1993 and $1.0 million in 1994 to apply to renovation costs. The facility's fire prevention and lighting systems were completely upgraded. A state-of-the-art sprinkler system, hundreds of new smoke-vents (skylights) and energy efficient lighting with motion detectors were installed. The Company exercised its option to purchase the building in December 2000 for $10.5 million. The Company funded the acquisition of this facility from its investments in marketable securities. The Company also leases an additional 80,000 square feet of warehouse storage space adjacent to its main distribution facility and 15,000 square feet of deli and frozen product storage space which is also located in the vicinity. ITEM 3. LEGAL PROCEEDINGS The Company is periodically subject to legal actions, which arise in the ordinary course of its business. The Company does not believe that any pending action is material to its results of operations or financial condition. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. Page 13 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock is traded on the New York Stock Exchange under the symbol "NDN." The following table sets forth, for the calendar periods indicated, the high and low closing prices per share of the Common Stock as reported by the New York Stock Exchange. All stock prices have been restated to reflect a four-for-three stock split effected in the form of a stock dividend to be distributed on April 3, 2002.
PRICE RANGE HIGH LOW 2000: First Quarter.......................... $19.63 $11.63 Second Quarter......................... 21.54 17.01 Third Quarter.......................... 27.66 19.72 Fourth Quarter......................... 25.10 10.26 2001: First Quarter.......................... $19.93 $13.35 Second Quarter......................... 23.04 16.28 Third Quarter.......................... 27.38 20.03 Fourth Quarter......................... 29.86 23.52 2002: First Quarter through March 28, 2002... $28.76 $24.87
The closing price as reported on March 25, 2002 on the New York Stock Exchange is set forth on the cover page of this Form 10-K. As of March 28, 2002, the Company had approximately 13,642 holders of the Common Stock including 472 shareholders of record. The Company has not paid any cash dividends with respect to the Common Stock. The Company presently intends to retain future earnings to finance its development and expansion and therefore does not anticipate the payment of any cash dividends in the foreseeable future. Payment of future dividends, if any, will depend upon future earnings and capital requirements of the Company and other factors, which the Board of Directors considers appropriate. The Company's 1996 Stock Option Plan is a fixed plan, which provides for the granting of non-qualified and incentive options to purchase up to 9,250,500 shares of common stock. Options may be granted to officers, employees, directors and consultants. Grants may be at fair market value at the date of grant or at a price determined by the compensation committee consisting of three outside members of the board of directors (the "Committee"). Options vest over a three-year period, one-third one year from the date of grant and one third per year thereafter. Options expire ten years from the date of grant. Page 14 ITEM 6. SELECTED FINANCIAL DATA The following table sets forth, selected financial and operating data of the Company for the periods indicated. The following selected statement of income data for each of the three years ended December 31, 1999, 2000, and 2001, and the balance sheet data as of December 31, 2000 and 2001 are derived from the financial statements and the notes thereto included elsewhere herein audited by Arthur Andersen LLP, independent public accountants, as set forth in their report also included elsewhere herein. The selected statements of income data for the years ended December 31, 1997 and 1998, and the balance sheet data as of December 31, 1997, 1998 and 1999 are derived from financial statements audited by Arthur Andersen LLP not included herein. The following information should be read in conjunction with "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Item 8. Financial Statements and Supplementary Data" of the Company and notes thereto included elsewhere in this report.
YEAR ENDED DECEMBER 31, 1997 1998 1999 2000 2001 --------- --------- --------- --------- --------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND OPERATING DATA) Statements of Income Data: Net sales: 99 Cents Only Stores................. $186,024 $238,868 $312,306 $402,071 $522,019 Bargain Wholesale(e)................. 44,831 53,202 47,652 49,876 56,250 --------- --------- --------- --------- --------- Total Sales......................... 230,855 292,070 359,958 451,947 578,269 Cost of sales............................ 146,797 183,044 218,496 275,395 350,421 --------- --------- --------- --------- --------- Gross profit............................. 84,058 109,026 141,462 176,552 227,848 Selling, general and administrative expenses: Operating expenses................... 49,850 62,424 80,089 107,981 141,544 Depreciation and amortization........ 2,989 4,506 5,927 8,666 12,354 --------- --------- --------- --------- --------- Total operating expenses............ 52,839 66,930 86,016 116,647 153,898 Operating income......................... 31,219 42,096 55,446 59,905 73,950 Other (income) expense, net.............. (855) (1,428) (1,059) (3,617) (5,931) --------- --------- --------- --------- --------- Income from continuing operations before provision for income taxes........ 32,074 43,524 56,505 63,522 79,881 Provision for income taxes............... 13,124 17,032 22,367 24,664 31,438 --------- --------- --------- --------- --------- Income from continuing operations........ $18,950 $26,492 $34,138 $38,858 $48,443 --------- --------- --------- --------- --------- Income (loss) from discontinued operation net of income tax provision of $910 in 1998 and income tax benefit of $2,111 and $700 in 1999 and 2000 respectively....... - 201 (3,167) (1,050) - Loss on disposal of discontinued operation including a provision of $1,200 for operating losses during phase-out period, net of income tax benefit of $2,613........................ - - (9,000) - - --------- --------- --------- --------- --------- Net Income............................... $18,950 $26,693 $21,971 $37,808 $48,443 ========= ========= ========= ========= ========= Page 15 (CONTINUED FROM PREVIOUS PAGE) AS OF DECEMBER 31, 1997 1998 1999 2000 2001 --------- --------- --------- --------- --------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND OPERATING DATA) Earnings per common share from continuing operations (d): Basic................................. $0.31 $0.41 $0.51 $0.58 $0.70 Diluted................................ $0.30 $0.40 $0.50 $0.56 $0.69 Earnings (loss) per common share from discontinued operations(d): Basic.................................. - - ($0.05) ($0.02) - Diluted................................ - - ($0.05) ($0.02) - Earnings (loss) per common share from disposal of discontinued operations(d): Basic.................................. - - ($0.13) - - Diluted................................ - - ($0.13) - - Earnings per common share (d): Basic.................................. $0.31 $0.42 $0.33 $0.56 $0.70 Diluted................................ $0.30 $0.41 $0.32 $0.55 $0.69 Weighted average number of common shares outstanding: Basic.................................. 61,793 64,075 66,487 67,650 68,815 Diluted................................ 62,504 65,486 67,954 68,945 70,009 COMPANY OPERATING DATA: Sales Growth 99 Cents Only Stores................... 29.9% 28.4% 30.7% 28.7% 29.8% Bargain Wholesale(e)................... 10.7 18.7 (10.4) 4.7 12.8 Total Company sales.................... 25.7 26.5 23.2 25.6 28.0 Gross margin............................... 36.4 37.3 39.3 39.1 39.4 Operating margin........................... 13.5 14.4 15.4 13.3 12.8 Income from continuing operations:......... 8.2 9.1 9.5 8.6 8.4 RETAIL OPERATING DATA(A): 99 Cents Only Stores at end of period...... 53 64 78 98 123 Change in comparable stores Net sales (b).............................. 1.5% 4.3% 6.1% 2.0% 5.9% Average net sales per store open the full year.............................. $3,750 $4,147 $4,433 $4,487 $4,647 Average net sales per estimated saleable square foot(c).................... $354 $335 $332 $318 $319 Estimated saleable square footage at year end................................ 631,500 822,900 1,102,369 1,424,280 1,892,949 Page 16 (CONTINUED FROM PREVIOUS PAGE) AS OF DECEMBER 31, 1997 1998 1999 2000 2001 --------- --------- --------- --------- --------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND OPERATING DATA) Balance Sheet Data: Working capital........................ $60,791 $81,439 $105,637 $166,779 $194,302 Total assets........................... 119,443 194,167 224,015 277,285 352,158 Capital lease obligation, including current portion........................ 8,709 8,005 7,251 - 1,677 Total shareholders' equity............. $96,308 $164,365 $195,540 $253,533 $319,643 (a) Includes retail operating data solely for the Company's 99 Cents Only Stores. (b) Change in comparable stores net sales compares net sales for all stores open at least 15 months. (c) Computed based upon estimated total saleable square footage of stores open for the entire period. (d) All earnings per share amounts have been restated to reflect the adoption of SFAS No. 128, "Earnings per Share," effective December 15,1997 and the four-for-three stock split to be distributed on April 3, 2002. (e) In 1998, Bargain Wholesale sales includes $12.0 million inter-company sales to Universal billed at cost. In 2001 Bargain Wholesale sales include $4.7 million of sales to Universal billed at a 10% mark-up.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following management's discussion and analysis should be read in connection with "Item 6. Selected Financial Data," and "Item 8. Financial Statements and Supplementary Data." GENERAL 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 March 28, 2002, operated a chain of 132 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 nine stores through March 28, 2002 (three stores in Southern California, three in Central California, one in Las Vegas, Nevada and two in Phoenix, Arizona). The Company plans to open an additional 22 net new stores during the remainder of the year, including stores in Las Vegas, Nevada and Phoenix, Arizona. The Company has secured sites for seven additional store locations. Bargain Wholesale sales over the three years ended December 31, 2001 were 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. Page 17 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. During the three years in the period ending December 31, 2001, average net sales per estimated saleable square foot (computed on 99 Cents Only Stores open for a full year) declined from $332 per square foot to $319 per square foot. This trend reflects the Company's determination to target larger locations for new store development. Existing stores average approximately 20,000 gross square feet. Since January 1, 1999 through December 31, 2001, the Company opened 64 new stores (including four relocations in 1999 and one relocation in 2001) that average approximately 20,000 gross square feet. The Company currently targets new store locations between 15,000 and 25,000 gross square feet. Although it is the Company's experience that larger stores generally have lower average net sales per square foot than smaller stores, larger stores generally achieve higher average annual store revenues and operating income. 99 Cents Only Stores has increased its net sales, operating income and income from continuing operations in each of the last five years. In 2001, it had net sales of $578.3 million, operating income of $74.0 million and income from continuing operations of $48.4, representing a 28.0%, 23.4% and 24.7% increase over 2000, respectively. From 1997 through 2001, the Company had a CAGR in net sales, operating income and income from continuing operations of 25.8%, 24.1% and 26.4%, respectively. 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, $1.9 million and $1.9 million in 1999, 2000 and 2001, 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. 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: 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 Page 18 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 form the use of the asset and its eventual disposition. Changes in market conditions can impact estimated future cash flows from use of these assets and additional impairments may be required should such changes occur. Self-insurance reserves: The Company is self-insured in relation to worker's compensation claims. The Company carries excess worker's compensation insurance, which covers any 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. UNIVERSAL INTERNATIONAL In December 1999, the Company determined it would be in its best interest, and that of its shareholders, to focus its efforts on increasing the growth rate of 99 Cents Only Stores. In conjunction with its revised growth strategy, the Company decided to sell its Universal International, Inc. and Odd's-n-End's, Inc. subsidiaries (together "Universal"). Universal operated a multi-price point variety chain, with 65 stores located in the Midwest, Texas and New York, under the trade names Only Deals and Odd's-N-End's. Among other factors, the Company also considered its successful opening of its first 99 Cents Only Store outside the state of California, in Las Vegas, Nevada. Given the success to date of the Las Vegas, Nevada stores, the Company believes that the 99 Cents Only Stores concept is portable to areas outside the state of California. As a result, the Company has focused greater management resources to increase its store growth rate and expand more rapidly in Nevada and into Arizona. The Company also adopted a definitive plan to sell Universal within one year, as set forth by guidelines for the accounting treatment of discontinued operations. The Company engaged an investment-banking firm to evaluate and identify potential buyers for the Universal business and expected to sell Universal within the one-year time frame. The investment banking firm's marketing process focused upon selling the business as a going concern. From June 2000 through August 2000, sales presentations were delivered to both strategic buyers and financial buyers. This process did not generate the expected interest level from potential buyers that had been anticipated. The highest offer for the Universal business was significantly less than the Company's expectations. As a result of the difficulties encountered in trying to sell Universal and the necessity to complete the process by December 31, 2000, it was decided by the Board of Directors to be in the Company's and the shareholders' best interest to sell Universal for the Company's carrying value as of the close of business on September 30, 2000 to Universal Deals, Inc. and Universal Odd's-n-End's, Inc., both of which are owned 100% by David and Sherry Gold, both significant shareholders of 99 Cents Only Stores. Mr. Gold is also Chairman and CEO of 99 Cents Only Stores. The sale was effective as of the close of business on September 30, 2000. The purchase price for Universal was paid in cash and was equal to the Company's carrying book value of the assets of Universal at September 30, 2000 or $33.9 million. The net assets at September 30, 2000 included $29.2 million in inventory, net fixed assets of $7.6 million and $0.6 million of other assets. These assets were offset by $3.5 million of accounts payable, accrued and other liabilities. In connection with this transaction, 99 Cents Only Stores provided certain ongoing administrative services to Universal in 2000 and 2001 pursuant to a service agreement for a management fee of 6% of Universal sales revenues. During fiscal year 2000, the Company recorded an additional net loss from discontinued operations of $1.1 million, net of tax benefit of $0.7 million, for operating losses incurred through the date of sale, in excess of the amounts originally provided in 1999. In the fourth quarter of 2000, the Company received $1.3 Page 19 million in management fees under the service agreement with Universal. The Company also received $0.4 million in lease payments for rental of a distribution facility to Universal. During 2001, the Company received $3.7 million in fees under the service agreement, $1.4 million in lease payments and sold $4.7 million in merchandise at a 10% mark-up. Subsequent to December 31, 2001, Universal ceased operations and closed its business. It is expected that Universal will terminate its service agreement and lease arrangement with 99 Cents Only Stores some time during the first half of 2002. CONTRACTUAL OBLIGATIONS, COMMITMENTS AND CONTINGENCIES CONTRACTUAL OBLIGATIONS The following table summarizes our consolidated contractual obligations as of December 31, 2001. These should be read in conjunction with "Note 8 Commitments and Contingencies"
THERE- Contractual Obligations 2002 2003 2004 2005 2006 AFTER TOTAL ------- ------- ------- ------- ------- ------- -------- Cap. Lease Obligations $169 $169 $169 $169 $169 $1,568 $2,413 Opr. Lease Obligations 18,284 18,319 17,116 14,517 11,837 32,434 112,507 ------- ------- ------- ------- ------- ------- -------- $18,453 $18,488 $17,285 $14,686 $12,006 $34,002 $114,920 ======= ======= ======= ======= ======= ======= ========
LEASE COMMITMENTS The Company leases various facilities under operating lease except for two, which were classified as capital leases and will expire at various dates through 2017. Some of the lease agreements contain renewal options and/or provide for scheduled increases or increases based on the Consumer Price Index. Total minimum lease payments under each of these lease agreements, including scheduled increases, are charged to operations on a straight-line basis over the life of each respective lease. Certain leases require the payment of property taxes, maintenance and insurance. Rental expense charged to operations in 1999, 2000 and 2001 was approximately $11.0 million, $15.6 million and $19.4 million, respectively. The Company typically seeks leases with an initial five-year to ten-year term and with one or more five-year renewal options. See "Item 2 Properties." Most leases have renewal options ranging from three to ten years. COMMITMENTS AND CONTINGENCIES None Page 20 The following table sets forth for the periods indicated, certain selected income statement data, including such data as a percentage of net sales:
YEARS ENDED DECEMBER 31, 1999 2000 2001 ----------------- ------------------- ------------------ (Amounts in thousands) Net Sales: 99 Cents Only Store.................. $312,306 86.8% $402,071 89.0% $522,019 90.3% Bargain Wholesale.................... 47,652 13.2 49,876 11.0 56,250 9.7 -------- ------ -------- ------ -------- ----- Total................................ 359,958 100.0 451,947 100.0 578,269 100.0 Cost of sales........................ 218,496 60.7 275,395 60.9 350,421 60.6 -------- ------ -------- ------ -------- ----- Gross Profit......................... 141,462 39.3 176,552 39.1 227,848 39.4 Selling, general and administrative expenses: Operating expenses................... 80,089 22.3 107,981 23.9 141,544 24.5 Depreciation and amortization........ 5,927 1.6 8,666 1.9 12,354 2.1 -------- ------ -------- ------ -------- ----- Total................................ 86,016 23.9 116,647 25.8 153,898 26.6 Operating Income..................... 55,446 15.4 59,905 13.3 73,950 12.8 Other (income) expense, net.......... (1,059) (0.3) (3,617) (0.8) (5,931) (1.0) -------- ------ -------- ------ -------- ----- Income from continuing operations before provision for income taxes.... 56,505 15.7 63,522 14.1 79,881 13.9 Provision for income taxes........... 22,367 6.2 24,664 5.5 31,438 5.4 -------- ------ -------- ------ -------- ----- Income from continuing operations.... 34,138 9.5 38,858 8.6 48,443 8.4 Income (loss) from discontinued operation, net of income tax benefit of $2,111 and $700 in 1999 and 2000........................ (3,167) (0.9) (1,050) (0.2) - - Loss from disposal of discontinued operations including a provision of $1,200 for operating losses during the phase-out, net of income tax benefit of $2,613......... (9,000) (2.5) - - - - -------- ------ -------- ------ -------- ----- Net Income........................... $21,971 6.1% $37,808 8.4% $48,443 8.4% ======== ====== ======== ====== ======== =====
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000 NET SALES. Total net sales increased $126.4 million, or 28.0%, from $451.9 million in 2000 to $578.3 million in 2001. 99 Cents Only Stores net sales increased approximately $119.9 million, or 29.8%, from $402.1 million in 2000 to $522.0 million in 2001. Bargain Wholesale net sales increased approximately $6.4 million, or 12.8%, from $49.9 million in 2000 to $56.3 million in 2001. The increase in 99 Cents Only Stores net sales was attributed to the net effect of 25 net new stores opened in 2001 and the full year effect of 20 stores opened in 2000. Comparable stores net sales increased 5.9% from 2000 to 2001. Net sales in 2002 are expected to be favorably impacted by the full year effect of the 25 net new stores opened in 2001 (constituting an increase in 469,000 saleable square feet) and the estimated 32 new 99 Cents Only Stores expected to be opened in 2002. The increase in Bargain Wholesale net sales was primarily attributed to $4.7 million in shipments to Universal. GROSS PROFIT. Gross profit, which consists of total net sales, less cost of sales, increased approximately $51.2 million, or 29.0%, from $176.6 million in 2000 to $227.8 million in 2001. The increase in gross profit dollars was primarily due to higher sales volume. As a percentage of net sales, gross profit was 39.4% in 2001 versus 39.1% in 2000. This 0.3% variation results from the ratio of retail versus wholesale sales. The Page 21 retail gross margin increased to 41.6% of sales in 2001 versus 41.3% in 2000. This was due to product cost and mix factors. The wholesale margin was 19.3% in 2001 versus 21.0% in 2000. This change results from the $4.7 million in shipments to Universal at a contract margin of 10%. SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expenses ("SG&A"), which include operating expenses and depreciation and amortization, increased $37.3 million, or 32.0%, from $116.6 million in 2000 to $153.9 million in 2001. The increase over 2000 is associated with year 2001 new store growth and the full year effect of 2000 new stores additions and an incremental provision for workers compensation of $1.8 million. SG&A increased as a percentage of net sales from 25.8% in 2000 to 26.6% in 2001. The increase in SG&A expenses in 2001 were offset by $3.7 million in management fees from Universal (see Universal International above). The increases in SG&A in 2001 were directly attributable to 25 net new store openings and to increases in utility costs, minimum wage increases and the additional field and corporate support staff hired to support the future new store growth and expansion outside of the state of California. Additional key staff positions were filled in retail management, information systems, real estate, distribution, human resources and buying. OPERATING INCOME. Operating income increased $14.1 million, or 23.5%, from $59.9 million in the 2000 period to $74.0 million in 2001. Operating income as a percentage of net sales was 13.3% in 2000 and 12.8% in 2001 primarily due to the increase in the operating costs discussed above. OTHER (INCOME) EXPENSE. Other (income) expense relates primarily to the interest income on the Company's marketable securities, net of interest expense on the Company's capitalized leases. Interest expense was $0.7 million in 2000 and $0.1 in 2001. The Company had no bank debt during 2001 or 2000. Interest income earned on the Company's marketable securities was $4.6 million in 2001 and $4.0 million in 2000. At December 31, 2001, the Company held $147.6 million in short-term investments and $0.5 million in long-term investments. The Company's short-term investments are comprised primarily of investment grade federal and municipal bonds and commercial paper, all with short-term maturities. The Company generally holds investments until maturity. Also included in 2001 and 2000 is $1.4 million and $0.4 million respectively, of income under a lease agreement with Universal for a distribution facility. PROVISION FOR INCOME TAXES. The provision for income taxes in 2001 was $31.4 million, or 5.4% of net sales, compared to $24.7 million, or 5.5% of net sales in 2000. The effective combined federal and state rates of the provision for income taxes were 39.4% and 38.8% in 2001 and 2000, respectively. The effective combined federal and state rates are less than the statutory rates in each period due to the benefit of certain tax-exempt interest and welfare to work tax credits. See Note 4 of "Notes to Financial Statements." INCOME FROM CONTINUING OPERATIONS. As a result of the items discussed above, net income from continuing operations increased $9.5 million, or 24.4%, from $38.9 million in 2000 to $48.4 million in 2001. Income from continuing operations as a percentage of net sales was 8.4% in 2001 and 8.6% in 2000. DISCONTINUED OPERATIONS. The Board of Directors approved the sale of Universal for an amount equal to the carrying value of the Company's investment, $33.9 million, as of the close of business on September 30, 2000 (see "Recent Developments" above). The Company recorded an additional loss from discontinued operations of $1.1 million, net of tax benefit of $0.7 million, for Universal and Odd's-n-End's operating losses incurred through the date of sale, in excess of the amounts originally provided in 1999. YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999 NET SALES. Total net sales increased $91.9 million, or 25.6%, from $360.0 million in 1999 to $451.9 million in 2000. 99 Cents Only Stores net sales increased approximately $89.8 million, or 28.8%, from $312.3 million in 1999 to $402.1 million in 2000. Bargain Page 22 Wholesale net sales increased approximately $2.2 million, or 4.6%, from $47.7 million in 1999 to $49.9 million in 2000. The increase in 99 Cents Only Stores net sales was attributed to the effect of 20 net new stores opened in 2000 and the full year effect of 14 net new stores opened in 1999. Comparable stores net sales increased 2.0% from 1999 to 2000. The increase in Bargain Wholesale net sales was primarily attributed to an increased focus on large international and domestic accounts and expansion into new geographic markets. GROSS PROFIT. Gross profit, which consists of total net sales, less cost of sales, increased approximately $35.1 million, or 24.8%, from $141.5 million in 1999 to $176.6 million in 2000. The increase in gross profit dollars was primarily due to higher sales volume. As a percentage of net sales, gross profit was 39.1% in 2000 versus 39.3% in 1999. This 0.2% variation results from product cost and mix factors. SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expenses ("SG&A"), which include operating expenses and depreciation and amortization, increased $30.6 million, or 35.6%, from $86.0 million in 1999 to $116.6 million in 2000. The increase over 1999 is associated with year 2000 new store growth and the full year effect of 1999 new stores. SG&A increased as a percentage of net sales from 23.9% in 1999 to 25.8% in 2000. The increase in SG&A expenses is directly attributable to 20 net new store openings and to the additional field and corporate support staff hired to support the future new store growth and expansion outside of the state of California. Key staff positions were added in risk management, information systems, real estate, distribution, human resources and buying. This increase was offset by $1.3 million in management fees from Universal. OPERATING INCOME. Operating income increased $4.5 million, or 8.1%, from $55.4 million in the 1999 period to $59.9 million in 2000. Operating income as a percentage of net sales was 15.4% in 1999 versus 13.3% in 2000 primarily due to the increase in the operating costs discussed above. OTHER (INCOME) EXPENSE. Other (income) expense relates primarily to the interest income on the Company's marketable securities, net of interest expense on the Company's capitalized warehouse lease. Interest expense was $0.7 million in 2000 and in 1999. The Company had no bank debt during 2000 or 1999. Interest income earned on the Company's marketable securities was $4.0 million in 2000 and $1.8 million in 1999. At December 31, 2000, the Company held $109.4 million in short-term investments and $2.9 million in long-term investments. The Company's short-term investments are comprised primarily of investment grade federal and municipal bonds and commercial paper, all with short-term maturities. The Company generally holds investments until maturity. Also included in 2000 is $0.4 million of income under a lease agreement with Universal for a distribution facility. PROVISION FOR INCOME TAXES. The provision for income taxes in 2000 was $24.7 million, or 5.5% of net sales, compared to $22.4 million, or 6.2% of net sales in 1999. The effective combined federal and state rates of the provision for income taxes were 38.8% and 39.6% in 2000 and 1999, respectively. The effective combined federal and state rates are less than the statutory rates in each period due to the benefit of certain tax-exempt interest and welfare to work tax credits. See Note 4 of "Notes to Financial Statements." INCOME FROM CONTINUING OPERATIONS. As a result of the items discussed above, net income from continuing operations increased $4.9 million, or 14.4%, from $34.1 million in 1999 to $39.0 million in 2000 before a charge of $1.1 million from the discontinued operation. Income from continuing operations as a percentage of net sales was 8.6% in 2000 and 9.5% in 1999. DISCONTINUED OPERATIONS. The Board of Directors approved the sale of Universal for an amount equal to the carrying value of the Company's investment, $33.9 million, as of the close of business on September 30, 2000 (see "Recent Developments" above). The Company recorded an additional loss from discontinued operations of $1.1 million, net of tax benefit of $0.7 million, for Universal and Odd's-n-End's operating losses incurred through the date of sale, in excess of the amounts originally provided in 1999. Page 23 LIQUIDITY AND CAPITAL RESOURCES Since inception, the Company has funded its operations principally from cash provided by operations, and has not generally relied upon external sources of financing. The Company's capital requirements result primarily from purchases of inventory, expenditures related to new store openings and working capital requirements for new and existing stores. The Company takes advantage of close-out and other special-situation opportunities, which frequently result in large volume purchases, and as a consequence, its cash requirements are not constant or predictable during the year and can be affected by the timing and size of its purchases. Net cash provided by operations during 2000 and 2001 was $50.4 and $67.2 million, consisting primarily of $54.8 and $64.2 million of net income adjusted for non-cash items. In 2000, the Company used $4.4 million in working capital and other activities and in 2001, the Company provided $3.0 million in working capital and other activities. Net cash used in working capital and other activities primarily reflects the increases in inventories in the amount of $9.8 million and $2.8 million, respectively. Net cash used in investing activities during 2000 and 2001 was $55.0 and $87.4 million. Net cash used in investing activities represents the following: In 2000, the Company used $26.7 million (including $7.0 million used to purchase of distribution facility which is currently leased to Universal), the Company also used $1.5 million to repurchase 129 thousand shares of its outstanding stock under its stock repurchase program, the Company received $33.9 million for the sale of Universal and used $52.7 million for the purchase of short-term marketable securities. In 2001, the Company used $46.9 million for the purchase of property and equipment (including $8.7 million for the purchase of new store locations added in 2001 and $9.2 million for the purchase of properties for future openings), $4.7 million in investments in two partnerships for the purpose of obtaining leases on two store locations and $35.8 million for the purchase of short-term investments. The Company did not repurchase any of its shares under its stock repurchase program in 2001, which expired during the next year. Net cash provided by financing activities during 2000 and 2001 was $5.7 and $11.4 million, 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 maintains a surety bond of approximately $1.6 million 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 2001, including leasehold improvements, furniture, fixtures and equipment, inventory and pre-opening expenses, was approximately $660,000. The Company does not capitalize pre-opening expenses. The Company's cash needs for new store openings are expected to total approximately $35.0 million in 2002 including acquired properties. The Company's total planned expenditures in 2002 for additions to fixtures and leasehold improvements of existing stores as well as for distribution, systems, expansion and replacement will be approximately $10.0 million. The Company believes that its total capital expenditure requirements (including new store openings) will approximate $45.0 million in 2002. The Company intends to fund its liquidity requirements in 2002 out of net cash provided by operations, short-term investments and cash on hand. SEASONALITY AND QUARTERLY FLUCTUATIONS The Company has historically experienced and expects to continue to experience some seasonal fluctuations in its net sales, operating income and net income. The highest sales periods for the Company are the Christmas and Halloween seasons. A greater amount of the Company's net sales and operating and net income is generally realized during the fourth quarter. The Company's quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including the timing of certain holidays (e.g., Easter) and the timing of new store openings and the merchandise mix. Page 24 The following table sets forth, certain unaudited results of operations for each quarter during 2000 and 2001. The unaudited information has been prepared on the same basis as the audited financial statements appearing elsewhere in this report and includes all adjustments, which management considers necessary for a fair presentation of the financial data shown. The operating results for any quarter are not necessarily indicative of the results to be attained for any future period. All earnings per share amounts have been restated to reflect the four-for-three stock split to be distributed on April 3, 2002.
1ST 2ND 3RD 4TH 1ST 2ND 3RD 4TH QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31, 2000 2001 (AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) Net sales: 99 Cents Only Stores... $87,563 $96,407 $98,096 $120,005 $110,212 $122,522 $130,799 $158,486 Bargain Wholesale...... 13,239 11,540 11,336 13,761 14,758 13,852 13,223 14,417 Total................ 100,802 107,947 109,432 133,766 124,970 136,374 144,022 172,903 Gross profit.............. 39,502 41,615 42,440 52,995 48,071 53,179 56,271 70,327 Operating income.......... 12,722 14,410 13,173 19,600 14,605 16,465 16,763 26,117 Income from continuing operations................ 8,011 9,084 8,575 13,188 9,964 10,929 11,168 16,382 (Loss) from discontinued operations................ - - (1,050) - - - - - Net Income................ $8,011 $9,084 $7,525 $13,188 $9,964 $10,929 $11,168 $16,382 Earnings per common share from continuing operations: Basic.................. $0.12 $0.14 $0.13 $0.19 $0.14 $0.16 $0.16 $0.24 Diluted................ $0.12 $0.13 $0.12 $0.19 $0.14 $0.16 $0.16 $0.23 (Loss) per common share from discontinued operations: Basic.................. - - ($0.02) - - - - - Diluted................ - - ($0.01) - - - - - Net earnings per share: Basic.................. $0.12 $0.14 $0.11 $0.19 $0.14 $0.16 $0.16 $0.24 Diluted................ $0.12 $0.13 $0.11 $0.19 $0.14 $0.16 $0.16 $0.23 Shares Outstanding Basic.................. 66,789 67,279 68,051 68,399 68,403 68,506 68,995 69,325 Diluted................ 68,000 69,922 69,568 69,400 69,183 69,499 70,369 70,780 Percent of Net sales Net sales: 99 Cents Only Stores... 86.9% 89.3% 89.6% 89.7% 88.2% 89.8% 90.8% 91.7% Bargain Wholesale...... 13.1 10.7 10.4 10.3 11.8 10.2 9.2 8.3 Total............... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Gross profit.............. 39.2 38.6 38.8 39.6 38.5 39.0 39.1 40.7 Operating income.......... 12.6 13.3 12.0 14.7 11.7 12.1 11.7 15.1 Income from continuing operations................ 7.9% 8.4% 7.8% 9.9% 8.0% 8.0% 7.8% 9.5%
Page 25 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 SFAS 142, "Goodwill and Other Intangible Assets," which defines when and how goodwill and other intangible assets are amortized. These statements are effective as of January 1, 2002. Management does not expect that the adoption of SFAS 141 and SFAS 142 will 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" (SFAS143). 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 a material 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 is effective for the financial statements issued for fiscal years beginning after December 15, 2001 and interim periods with those fiscal years. Management does not expect that the adoption of SFAS 144 will have a material impact on the Company's financial position or results of operations. RISK FACTORS TERRORISM AND THE UNCERTAINTY OF WAR MAY HAVE ADVERSE EFFECT ON OUR OPERATING RESULTS. Terrorist 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 operations and profitability. Further terrorist attack on the United States or the United States business may occur. The potential near-term and long-term effects these markets may have for our customers, the market for our common stock, the markets 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 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 1999, 2000 and 2001, we opened eighteen, twenty and twenty six 99 Cents Only Stores, respectively (fourteen stores in 1999 and twenty five 2001, respectively, net of relocated stores). As of March 28, 2002, we opened nine stores and expect to open at least 22 additional stores in 2002. Page 26 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 twelve of our 99 Cents Only Stores are currently located in Southern and Central California. The Company currently has six stores in Las Vegas, Nevada and six 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. Recovery in these retail markets has continued since 1995. 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. 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 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 maintain standard property and business interruption insurance, we do not have earthquake insurance. 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. Page 27 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; - increases in operating costs; - increases in employee health care costs; Page 28 - 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. The Company believes that annual payroll expenses could increase approximately less than 1.0% over this two-year period as a result. 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 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; 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, $1.9 million and $1.9 million in 1999, 2000 and 2001, 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. Page 29 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. We lease all but 17 of our stores at December 31, 2001. 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 31,091,571 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 Page 30 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. Page 31 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to interest rate risk for its investments in marketable securities. At December 31, 2001, the Company had $148,099,000 in marketable securities maturing at various dates through January 2003. 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 with purchase of an investment is amortized over the term of the investment. At December 31, 2001, the fair value of investments approximated the carrying value. Page 32 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO FINANCIAL STATEMENTS 99 CENTS ONLY STORES Report of Independent Public Accountants.................................. 34 Balance Sheets as of December 31, 2000 and 2001........................... 35-36 Statements of Income for the years ended December 31, 1999, 2000 and 2001........................................................... 37 Statements of Shareholders' Equity for the years ended December 31 1999, 2000 and 2001..................................................... 38 Statements of Cash Flows for the years ended December 31, 1999, 2000 and 2001........................................................... 39 Notes to Financial Statements............................................. 40 Page 33 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS TO THE SHAREHOLDERS AND BOARD OF DIRECTORS OF 99 CENTS ONLY STORES: We have audited the accompanying balance sheets of 99 Cents Only Stores (a California Corporation) as of December 31, 2000 and 2001 and the related statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of 99 Cents Only Stores as of December 31, 2000 and 2001, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States. ARTHUR ANDERSEN LLP Los Angeles, California February 20, 2002 (Except for the matters discussed in Note 13, as to which the date is March 9, 2002) Page 34
99 CENTS ONLY STORES BALANCE SHEETS AS OF DECEMBER 31, 2000 AND 2001 (AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA) ASSETS 2000 2001 -------- -------- CURRENT ASSETS: Cash........................................................ $ 9,034 $ 232 Short-term investments...................................... 109,430 147,566 Accounts receivable, net of allowance for doubtful accounts of $113 and $165 as of December 31, 2000 and 2001, respectively...................................... 3,569 3,523 Income tax receivable....................................... - 1,384 Inventories................................................. 63,693 66,528 Other....................................................... 2,663 3,886 -------- -------- Total current assets...................................... 188,389 223,119 PROPERTY AND EQUIPMENT, at cost: Land........................................................ 17,781 20,715 Building and improvements................................... 17,357 24,007 Leasehold improvements...................................... 34,026 50,602 Fixtures and equipment...................................... 19,533 28,421 Transportation equipment.................................... 2,250 2,836 Construction in progress.................................... 5,091 17,856 -------- -------- Total properties, fixtures and equipment.................. 96,038 144,437 Accumulated depreciation and amortization................... (28,636) (40,798) -------- -------- Total net properties...................................... 67,402 103,639 OTHER ASSETS: Deferred income taxes....................................... 12,841 15,688 Long term investments in marketable securities.............. 2,867 533 Deposits.................................................... 308 296 Long term investments in partnerships....................... - 4,702 Other assets................................................ 5,478 4,181 -------- -------- Total other assets....................................... 21,494 25,400 -------- -------- TOTAL ASSETS................................................ $277,285 $352,158 ======== ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE BALANCE SHEETS. Page 35
99 CENTS ONLY STORES BALANCE SHEETS AS OF DECEMBER 31, 2000 AND 2001 (AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA) LIABILITIES AND SHAREHOLDERS' EQUITY 2000 2001 -------- -------- CURRENT LIABILITIES: Current portion of capital lease obligation..................... $ - $ 40 Accounts payable................................................ 12,622 15,244 Accrued expenses: Payroll and payroll-related.................................. 2,530 2,771 Sales tax.................................................... 2,802 3,011 Other........................................................ 340 562 Due to shareholders.......................................... - 1,655 Worker's compensation........................................ 2,764 5,534 Income taxes payable......................................... 552 - -------- -------- Total current liabilities................................. 21,610 28,817 LONG-TERM LIABILITIES: Deferred rent............................................... 2,142 2,061 Capital lease obligation, net of current portion............ - 1,637 -------- -------- Total non-current liabilities............................. 2,142 3,698 COMMITMENTS AND CONTINGENCIES: (Note 8) 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 68,407,520 at December 31, 2000 and 69,506,103 at December 31, 2001......................... 138,487 156,154 Retained earnings........................................... 115,046 163,489 -------- -------- Total shareholder's equity................................. 253,533 319,643 -------- -------- Total liabilities and shareholder's equity................. $277,285 $352,158 ======== ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE BALANCE SHEETS. Page 36
99 CENTS ONLY STORES STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) 1999 2000 2001 -------- -------- -------- NET SALES: 99 Cents Only Stores..................................... $312,306 $402,071 $522,019 Bargain Wholesale........................................ 47,652 49,876 56,250 -------- -------- -------- Total Sales............................................ 359,958 451,947 578,269 COST OF SALES............................................... 218,496 275,395 350,421 -------- -------- -------- Gross profit............................................. 141,462 176,552 227,848 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES: Operating expenses....................................... 80,089 107,981 141,544 Depreciation and amortization............................ 5,927 8,666 12,354 -------- -------- -------- Total SG&A............................................. 86,016 116,647 153,898 -------- -------- -------- Operating income......................................... 55,446 59,905 73,950 OTHER (INCOME) EXPENSE: Interest income.......................................... (1,805) (3,969) (4,583) Interest expense......................................... 746 712 92 Other.................................................... - (360) (1,440) -------- -------- -------- Total Other (Income) Expense........................... (1,059) (3,617) (5,931) -------- -------- -------- Income from continuing operations before Tax Provision.............................................. 56,505 63,522 79,881 PROVISION FOR INCOME TAX.................................... 22,367 24,664 31,438 -------- -------- -------- Income from continuing operations........................... 34,138 38,858 48,443 Income (loss) from discontinued operation net of income tax benefit of $2,111 and $700 in 1999 and 2000, respectively...................................... (3,167) (1,050) - Loss from disposal of discontinued operation including a provision of $1,200 for operating losses during the phase-out period, net of income tax benefit of $2,613................................ (9,000) - - -------- -------- -------- NET INCOME.................................................. $21,971 $37,808 $48,443 -------- -------- -------- EARNINGS PER COMMON SHARE FROM CONTINUING OPERATIONS: Basic.................................................... $0.51 $0.58 $0.70 Diluted.................................................. $0.50 $0.56 $0.69 EARNINGS (LOSS) PER COMMON SHARE FROM DISCONTINUED OPERATION: Basic.................................................... ($0.05) ($0.02) - Diluted.................................................. ($0.05) ($0.01) - (LOSS) PER COMMON SHARE FROM DISPOSAL OF DISCONTINUED OPERATION: Basic.................................................... ($0.13) - - Diluted.................................................. ($0.13) - - NET EARNINGS FOR COMMON SHARE: Basic.................................................... $0.33 $0.56 $0.70 Diluted.................................................. $0.32 $0.55 $0.69 WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING: Basic.................................................... 66,487 67,650 68,815 Diluted.................................................. 67,954 68,945 70,009
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. Page 37
99 CENTS ONLY STORES STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001 (AMOUNTS IN THOUSANDS) RETAINED SHARES AMOUNT EARNINGS ---------- ---------- --------- Common Stock BALANCE, December 31, 1998....................................... 65,960 $107,571 $56,794 Net income.................................................... - - 21,971 Tax benefit from exercise of stock options.................... - 4,229 - Proceeds from exercise of stock options....................... 874 4,975 - ---------- ---------- --------- BALANCE, December 31, 1999....................................... 66,834 $116,775 $78,765 Net income.................................................... - - 37,808 Tax benefit from exercise of stock options.................... - 8,223 - Proceeds from exercise of stock options....................... 1,684 12,961 - Compensation expense in connection with Cash-less exercise.......................................... 19 528 - Shares repurchased under stock Buyback program............................................. (129) - (1,527) ---------- ---------- --------- BALANCE, December 31, 2000....................................... 68,408 $138,487 $115,046 Net income.................................................... - - 48,443 Tax benefit from exercise of stock options.................... 6,205 - Proceeds from exercise of stock options....................... 1,098 11,462 - ---------- ---------- --------- BALANCE, December 31, 2001....................................... 69,506 $156,154 $163,489 ========== ========== =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. Page 38
99 CENTS ONLY STORES STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001 (AMOUNTS IN THOUSANDS) 1999 2000 2001 -------- -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income....................................................... $ 21,971 $ 37,808 $ 48,443 Adjustment to reconcile net income to net cash provided by operating activities: Loss from discontinued operations................................... 3,167 1,050 - Provision for loss on disposal of discontinued operation......................................... 9,000 - - Depreciation and amortization.................................... 5,927 8,666 12,354 Compensation expense for cash-less exercise of stock options..... - 528 - Tax benefit from exercise of non qualified employee stock options.................................................. 4,229 8,223 6,205 Benefit from deferred income taxes............................... (4,976) (1,523) (2,847) Changes in asset and liabilities associated with operating activities net of businesses acquired: Accounts receivable.............................................. (901) (213) 46 Inventories...................................................... (4,298) (9,761) (2,835) Other assets..................................................... (2,888) (1,525) 74 Deposits......................................................... (31) (94) 12 Due to Shareholders.............................................. - - 1,655 Accounts payable................................................. (3,316) 3,612 2,622 Accrued expenses................................................. 1,158 855 672 Accrued worker's compensation.................................... 723 669 2,770 Income taxes..................................................... (4,647) 5,226 (1,936) Deferred rent.................................................... 202 190 (81) Accrued interest................................................. 660 (3,350) - -------- -------- -------- Net cash provided by operating activities...................... 25,980 50,361 67,154 CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment.............................. (17,953) (26,646) (46,888) Purchases of short-term investments.............................. (13,011) (52,726) (35,802) Investments in Partnerships...................................... - - (4,702) Repurchase of Company stock...................................... - (1,527) - Net assets of discontinued operations............................ 6,048 (8,031) - Proceeds from sale of Universal International, Inc............... - 33,909 - -------- -------- -------- Net cash used in investing activities.......................... (24,916) (55,021) (87,392) CASH FLOWS FROM FINANCING ACTIVITIES: Payments of capital lease obligation............................. (754) (7,251) (26) Proceeds from exercise of stock options.......................... 4,975 12,961 11,462 Net cash provided by financing activities...................... 4,221 5,710 11,436 NET INCREASE (DECREASE) IN CASH..................................... 5,285 1,050 (8,802) CASH, beginning of period........................................... 2,699 7,984 9,034 -------- -------- -------- CASH, end of period................................................. $ 7,984 $ 9,034 $ 232 ======== ======== ======== NON CASH INVESTING AND FINANCING ACTIVITIES Asset acquired under capital lease......................................................... $1,703
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. Page 39 99 CENTS ONLY STORES NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2001 1. LINE OF BUSINESS 99 Cents Only Stores (the Company) is incorporated in the State of California. The Company retails various consumable products through its 98 and 123 stores at December 31, 2000 and 2001, respectively. The Company is also a wholesale distributor of various consumable products. 2. CONCENTRATION OF OPERATIONS IN SOUTHERN CALIFORNIA Most of the Company's retail stores are located in Southern California. In addition, the Company's current retail expansion plans anticipate that most new stores will be located in this geographic region. Consequently, the Company's results of operations and financial condition are dependent upon general economic trends and various environmental factors in California. The Company also has six stores in Las Vegas, Nevada and six stores in Arizona as of March 28, 2002. 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES USE OF ESTIMATES The preparation of the financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. INVENTORIES Inventories are priced at the lower of cost (first in, first out) or market. DEPRECIATION AND AMORTIZATION Property and equipment are amortized and depreciated on a straight-line basis over the following useful lives of the assets: Building and improvements............. 27.5 - 30 years Leasehold improvements................ Lesser of 5 years or remaining lease term Fixtures and equipment................ 5 years Transportation equipment.............. 3 years The Company follows the policy of capitalizing expenditures that materially increase asset lives and charging ordinary repairs and maintenance to operations as incurred. EARNINGS PER SHARE "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). Page 40 A reconciliation of the basic weighted average number of shares outstanding and the diluted weighted average number of shares outstanding for each of the three years in the period ended December 31, 2001 follows:
1999 2000 2001 ------- ------- ------- (AMOUNTS IN THOUSANDS) Weighted average number of common shares Outstanding-Basic................................... 66,487 67,650 68,815 Dilutive effect of outstanding stock options.......... 1,467 1,295 1,194 ------- ------- ------- Weighted average number of common shares Outstanding-Diluted................................. 67,954 68,945 70,009 ======= ======= =======
CONCENTRATION OF RISK The Company maintains cash and short-term investments with highly qualified financial institutions. At various times, such amounts are in excess of insured limits. DEFERRED RENT Certain of the Company's operating leases for its retail locations include scheduled increasing monthly payments. In accordance with generally accepted accounting principles, the Company has accounted for the leases to provide straight-line charges to operations over the lives of the leases. REVENUE RECOGNITION Revenue is recognized at the point of sale for retail sales and at the time of shipment for wholesale sales. SHIPPING AND HANDLING COSTS The Company follows the provisions of Emerging Issues Task Force Issue No. 00-10, "Accounting for Shipping and Handling Fees and Costs." Any amounts billed to third-party customers for shipping and handling are included as component of revenue. Shipping and handling costs incurred are included as a component of cost of sales. PRE-OPENING COSTS The Company expenses, as incurred, all pre-opening costs related to the opening of new retail stores. STATEMENTS OF CASH FLOWS The Company prepares its statements of cash flows using the indirect method as prescribed by the Statement of Financial Accounting Standards No. 95. The Company considers all investments with original maturities of three months or less to be cash equivalents. Cash payments for income taxes were $21,756,000, $12,474,425 and $25,260,277 in 1999, 2000 and 2001, respectively. Interest payments totaled approximately $86,000, $31,000 and $92,000 for the years December 31, 1999, 2000 and 2001, respectively. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company's financial instruments consist of cash, short-term and long-term investments, short-term trade receivables and payables. The carrying value for all such instruments, considering the terms, appropriate fair value at December 31, 2000 and 2001, respectively. Page 41 IMPAIRMENT OF LONG-LIVED ASSETS The Company reviews its long-lived assets for impairment whenever events or changes indicate that the carrying amount of an asset or group of assets may not be recoverable. No impairment losses were recorded during the years ended December 31, 1999, 2000 or 2001. NEW AUTHORITATIVE PRONOUNCEMENTS In June 2001, the FASB approve two final statements: SFAS No. 141, "Business Combinations," which provides guidance on the accounting for business combinations and SFAS 142, "Goodwill and Other Intangible Assets," which defines when and how goodwill and other intangible assets are amortized. These statements are effective as of January 1, 2002. Management does not expect that the adoption of SFAS 141 and SFAS 142 will 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 is effective for the financial statements issued for fiscal years beginning after December 15, 2001 and interim periods with those fiscal years. Management does not expect that the adoption of SFAS 144 will have an impact on the Company's financial position or results of operations. RECLASSIFICATIONS Certain amounts in the prior years have been reclassified to conform to the current year's presentation. 4. INCOME TAX PROVISION The provisions for income taxes from continuing operations for the years ended December 31, 1999, 2000 and 2001 are as follows:
YEARS ENDED DECEMBER 31, (AMOUNTS IN THOUSANDS) 1999 2000 2001 ------- -------- ------- Current: Federal..................... $20,192 $20,917 $29,340 State....................... 2,885 5,270 7,558 ------- -------- ------- 23,077 26,187 36,898 Deferred......................... (710) (1,523) (5,460) ------- -------- ------- Provisions for income taxes...... $22,367 $24,664 $31,438 ======= ======== =======
Page 42 Differences between the provisions for income taxes and income taxes at the statutory federal income tax rate for the years ended December 31, 1999, 2000 and 2001 are as follows:
YEAR ENDED DECEMBER 31, (AMOUNTS IN THOUSANDS) 1999 2000 2001 AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT --------- ------- --------- ------- -------- ------- Income tax at statutory federal rate........................ $19,777 35.0% $22,232 35.0% $27,959 35.0% State income taxes, net of federal income tax effect........... 3,012 5.3 3,386 5.3 4,258 5.3 Effect of permanent differences..... (64) (0.1) (291) (0.5) (404) (0.5) Welfare to work, LARZ and other job credits................... (380) (0.6) (663) (1.0) (375) (0.4) Other............................... 22 - - - - - --------- ------- --------- ------- -------- ------- $22,367 39.6% $24,664 38.8% $31,438 39.4% ========= ======= ========= ======= ======== =======
Page 43 A detail of the Company's deferred tax asset as of December 31, 2000 and 2001 is as follows:
YEAR ENDED DECEMBER 31, (AMOUNTS IN THOUSANDS) 2000 2001 AMOUNT AMOUNT -------- -------- Inventory......................... $ 516 $ 494 Uniform inventory capitalization.................... 1,026 1,771 Depreciation...................... 3,018 6,141 Liability for claims.............. 112 112 Workers' compensation............. 1,114 2,231 Deferred rent..................... 840 831 State taxes....................... 1,839 2,575 Other, net........................ 308 (2,109) Net operating loss carry-forward.. 8,608 8,182 -------- -------- $17,381 $20,228 Valuation allowance............... (4,540) (4,540) -------- -------- $12,841 $15,688 ======== ========
In connection with the acquisition and subsequent sale of Universal and Odd's-N-End's, the Company has remaining federal net operating loss carry- forwards of approximately $24.6 million which it can use to offset income. Future use of this loss carry-forwards may be limited and expire at various dates through 2013. Due to the uncertainty of the future use of such loss carry-forwards, the Company has recorded a valuation allowance equal to the tax effect of the loss carry-forward that may not be realizable. 5. 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. 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. As of December 31, 2000 and 2001, the fair value of investments approximated the carrying values and were invested as follows:
(AMOUNTS IN THOUSANDS) MATURITY 1 YEAR MATURITY 1 YEAR WITHIN 1 OR WITHIN 1 OR 2000 YEAR MORE 2001 YEAR MORE -------- -------- ------- -------- -------- ------ Municipal bonds............... $65,621 $62,754 $2,867 $113,075 $112,542 $533 Corporate Securities.......... 2,000 2,000 - 981 981 - Commercial paper.............. 44,676 44,676 - 34,043 34,043 - -------- -------- ------- -------- -------- ------ $112,297 $109,430 $2,867 $148,099 $147,566 $533 ======== ======== ======= ======== ======== ======
6. PURCHASE OF FACILITY In December 2000, the Company exercised its option to purchase its main warehouse, distribution and corporate office facility (approximately 880,000 square feet) for $10.5 million. Included in property and equipment is approximately $13.7 million of land and building, at cost, related to this property. Page 44 7. RELATED-PARTY TRANSACTIONS The Company leases certain retail facilities from its principal shareholders. Rental expense for these facilities was approximately $1.9 million, $1.9 million and $1.9 million in 1999, 2000 and 2001, respectively. Effective September 30, 2000, the Company sold its discontinued operation, Universal International, Inc. to a Company owned 100% by Dave and Sherry Gold, both significant shareholders of 99 Cents Only Stores (see note 12). Mr. Gold is also an executive officer and director. In the fourth quarter of 2000, the Company received $1.3 million in management fees under the service agreement with Universal. The Company also received $0.4 million in lease payments for rental of a distribution facility to Universal. During 2001, the Company received $3.7 million in fees under the service agreement, $1.4 million in lease payments and sold $4.7 million in merchandise at a 10% mark-up. Subsequent to December 31, 2001, Universal ceased operations and closed its business. It is expected that Universal will terminate its service agreement and lease arrangement with 99 Cents Only Stores some time during the first half of 2002. 8. COMMITMENTS AND CONTINGENCIES CREDIT FACILITY The Company does not maintain any credit facilities with any bank. LEASE COMMITMENTS The Company leases various facilities under operating lease except for two, which were classified as a capital lease and will expire at various dates through 2017. Some of the lease agreements contain renewal options and/or provide for scheduled increases or increases based on the Consumer Price Index. Total minimum lease payments under each of these lease agreements, including scheduled increases, are charged to operations on a straight-line basis over the life of each respective lease. Certain leases require the payment of property taxes, maintenance and insurance. Rental expense charged to operations in 1999, 2000 and 2001 was approximately $11.0 million, $15.6 million and $19.4 million, respectively. As of December 31, 2001, the minimum annual rentals payable under all non-cancelable operating leases were as follows: (Amounts in thousands)
YEAR ENDING DECEMBER 31: OPERATING CAPITAL LEASES LEASES --------- -------- 2002..................................... $18,284 $169 2003..................................... 18,319 169 2004..................................... 17,116 169 2005..................................... 14,517 169 2006..................................... 11,837 169 Thereafter............................... 32,434 1,568 --------- -------- Future Minimum lease payment............. $112,507 $2,413 Less amount representing interest........ (736) --------- -------- Present value of future lease payments... $1,677 ========
In addition, the Company also leases certain retail facilities on a month-to-month basis. The aggregate monthly rental payment for month-to-month leases at December 31, 2001 was approximately thirteen thousand dollars. In 2001, the Company incurred $0.2 million in interest and depreciation relating to two stores in which the properties were classified as a capital lease. Page 45 Interest paid in relation to capital leases aggregated $0.1, $0.0 and $0.1 million for fiscal years ended 1999, 2000 and 2001 respectively. In 2001, the Company incurred $0.1 million of depreciation related to two stores in which the properties were classified as capital leases. WORKER'S COMPENSATION Effective August 11, 1993, the Company became self-insured as to worker's compensation claims. The Company carries excess worker's compensation insurance, which covers any individual claim in excess of $250,000 with a $2.0 million ceiling. The Company provides for losses of estimated known and incurred but not reported insurance claims. Known claims are estimated and accrued when reported. At December 31, 2000 and 2001, the Company had accrued approximately $2.8 million and $5.5 million, respectively, for estimated worker's compensation claims. In connection with the self-insurance of worker's compensation, the Company is required, by the State of California, to maintain a $1.6 million surety bond. LEGAL MATTERS The Company is named as a defendant in various legal matters arising in the normal course of business. In management's opinion, none of these matters will have a material effect on the Company's financial position or its results of operations. ADVERTISING The Company expenses advertising costs as incurred. Advertising expenses were $2.4 million, $2.7 million and $3.4 million for 1999, 2000 and 2001, respectively. 9. STOCK-BASED COMPENSATION PLANS The Company has one stock option plan, the 1996 Stock Option Plan. Option may be granted as incentive or non-statutory stock options. The Company accounts for its stock option plan under APB Opinion No. 25, under which no compensation cost has been recognized in fiscal 1999, 2000 and fiscal 2001 respectfully. All share amounts have been restated to reflect the four-for-three stock split to be distributed on April 3, 2002 The following table summarizes stock options available for grant:
YEAR ENDED DECEMBER 1999 2000 2001 ----------- ----------- ----------- Beginning Balance................ 2,118,648 4,469,005 3,478,532 Authorized....................... 4,000,200 - - Granted.......................... (1,946,129) (1,654,804) (1,178,491) Cancelled........................ 296,286 664,331 163,020 Available for future grant....... 4,469,005 3,478,532 2,463,061
Page 46 A summary of the status of the Company's stock option plan at December 31, 1999, December 31, 2000 and December 31, 2001 and changes during the years then ended is presented in the table and narrative below:
YEAR ENDED DECEMBER 31, 1999 2000 2001 SHARES WTD AVG SHARES WTD AVG SHARES WTD AVG EX PRICE EX PRICE EX PRICE ------------------- ---------------------- ----------------------- Outstanding at the beginning of the year.................. 5,195,383 $7.68 5,970,422 $10.68 5,277,176 $13.06 Granted...................... 1,946,129 17.60 1,654,805 17.00 1,178,491 20.40 Exercised.................... (874,804) 7.59 (1,683,720) 7.94 (1,097,918) 10.89 Cancelled.................... (296,286) 12.67 (664,331) 14.49 (163,020) 18.88 Outstanding at the end of the year..................... 5,970,422 10.68 5,277,176 13.06 5,194,729 15.00 Exercisable at the end of the year..................... 2,282,854 5.92 2,319,656 8.77 2,587,947 11.36 Weighted average fair value of options granted........... $11.34 $12.09 $13.80
The weighted average fair value at the date of grant for options granted during fiscal 2001, 2000 and 1999 were estimated using black-scholes pricing model with the following assumptions: weighted average risk-free interest rate of 5.44%, 5.70% and 5.50%; weighted average volatility of 49.09%, 54.00% and 67.00%; expected life of 10 years; and weighted average dividend yield of 0.0%. The following table summarized information about stock options outstanding at December 31, 2001:
WEIGHTED AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE RANGE OF EXERCISE OPTIONS CONTRACTUAL EXERCISE OPTIONS EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE - -------------------- ----------- ----------- -------- ----------- --------- $3.51-$4.46 326,296 4.4 $2.69 326,296 $2.69 $5.82-$8.70 521,457 5.3 5.28 521,457 5.28 $10.60-$15.69 707,773 6.4 11.28 703,773 11.28 $16.00-$23.50 2,496,710 7.8 17.17 1,036,421 17.19 $24.12-$31.86 1,142,493 9.3 20.52 - - ----------- ----------- -------- ----------- --------- 5,194,729 7.5 $15.00 2,587,947 $11.36 =========== =========== ======== =========== =========
The Company has elected to continue to measure compensation costs associated with its stock option plan under APB 25, "Accounting for Stock Issued to Employees" and accordingly, under SFAS No. 123, the expected impact on the Company's financial statements is included in this expanded footnote disclosure. Had the Company applied the fair value based method of accounting, which is not required, to all grants of stock options, under SFAS 123, the Company would have recorded additional compensation expense and computed pro forma net income and earnings per share amounts as follows for the years ended December 31, 1999, 2000 and 2001 (amounts in thousands, except for per share data): Page 47
DECEMBER 31, 1999 2000 2001 ------- ------- ------ Additional compensation expense....... $16,071 $11,888 $9,818 Pro forma net income.................. 5,900 25,920 38,625 Pro forma earnings per share: Basic................................. $0.09 $0.38 $0.56 Diluted............................... $0.09 $0.38 $0.55
These pro forma amounts were determined by estimating the fair value of each option on its grant date using the Black-Scholes option-pricing model with the following assumptions:
DECEMBER 31, 1999 2000 2001 -------- -------- -------- Risk free interest rate............ 5.50% 5.70% 5.44% Expected life...................... 10 years 10 years 10 Years Expected stock price volatility.... 67% 54% 49% Expected dividend yield............ None None None
10. OPERATING SEGMENTS The Company has two business segments, retail operations and wholesale distribution. 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 the same as those described above in the summary of significant accounting policies. 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 or 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. The Company had no customers representing more than 10 percent of net sales. Substantially all of the Company's net sales were to customers located in the United States. Reportable segment information for the years ended December 31, 1999, 2000 and 2001 follows (in 000's):
RETAIL WHOLESALE TOTAL 1999 Net sales............ $312,306 $47,652 $359,958 Gross Margin......... 130,317 11,145 141,462 2000 Net sales............ $402,071 $49,876 $451,947 Gross Margin......... 166,054 10,498 176,552 2001 Net sales............ $522,019 $56,250 $578,269 Gross Margin......... 217,015 10,833 227,848
Page 48 11. 401(K) PLAN In 1998 the Company adopted a 401(k) Plan (the Plan). All full-time employees are eligible to participate in the plan after 3 months of service. The Company does not match employee contributions. The Company may elect to make a discretionary contribution to the Plan. For the years ended December 31, 1999, 2000 and 2001, no discretionary contributions were made. 12. DISCONTINUED OPERATIONS On March 4, 2000, the Board of Directors approved the disposition of Universal International, Inc. and Odd's-n-End's, Inc., which comprises the retail operations of Odds-n-Ends, Inc. and Only Deals, Inc. The Company engaged an investment-banking firm in May 2000 to evaluate and identify potential buyers for the Universal business and expected to sell Universal within the one-year time frame. The investment banking firm's marketing process focused upon selling the business as a going concern. From June 2000 through August 2000, sales presentations were delivered to both strategic buyers and financial buyers. This process did not generate the expected interest level from potential buyers that had been anticipated. The highest offer for the Universal business was significantly less than the Company's expectations. As a result of the difficulties encountered in trying to sell Universal and the necessity to complete the process by December 31, 2000 it was decided by the Board of Directors to be in the Company's and the shareholders' best interest to sell Universal for the Company's carrying value as of the close of business on September 30, 2000 to, Universal Deals, Inc., a limited liability company owned 100% by David and Sherry Gold, both significant shareholders of 99 Cents Only Stores. Mr. Gold is also Chairman and CEO of 99 Cents Only Stores. The sales price for Universal was the Company's carrying value as of the close of business on September 30, 2000, which was $33.9 million. The net assets at September 30, 2000 included $29.2 million in inventory, net fixed assets of $7.6 million and $0.6 million of other assets. These assets were offset by $3.5 million of accounts payable, accrued and other liabilities. In connection with this transaction 99 Cents Only Stores is providing certain ongoing administrative and other services to Universal pursuant to a Services Agreement. The management fee is based on 6% of Universal's sales volume. The net losses of these operations for all periods are included in the consolidated statements of income under "discontinued operations." Revenues from such operations were $83,264 in 1999. The provisions for loss on discontinued operations reflected in the statement of income, includes the write-down of the assets of Universal operations to estimate net realizable values and the estimated cost of disposing these operations along with the estimated loss of $1.2 million through the estimated date of disposal, less the expected tax benefits of approximately $2,613 applicable thereto. In the fourth quarter of 2000, the Company received $1.3 million in management fees under the service agreement with Universal. The Company also received $0.4 million in lease payments for rental of a distribution facility to Universal. During 2001, the Company received $3.7 million in fees under the service agreement, $1.4 million in lease payments and sold $4.7 million in merchandise at a 10% mark-up. Subsequent to December 31, 2001, Universal ceased operations and closed its business. It is expected that Universal will terminate its service agreement and lease arrangement with 99 Cents Only Stores some time during the first half of 2002. 13. STOCK SPLIT On March 9, 2002, the Company's Board of Directors approved a four-for-three stock split to be distributed on April 3, 2002 to shareholders of record on March 25, 2002. The accompanying financial statements have been adjusted to give retroactive effect to this stock split as if it had occurred at the beginning of all periods presented. Page 49 On February 17, 2001, the Company's Board of Directors approved a three-for-two stock split to be distributed on March 20, 2001 to shareholders of record on May 14, 2001. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information regarding Directors and Executive Officers of the registrant required by Item 401 of Regulation S-K and information regarding Directors and Executive Officers of the registrant required by Item 405 of Regulation S-K is presented under the captions "Election of Directors," "Management" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the definitive Proxy Statement for the Company's 2002 Annual Meeting of Shareholders, and is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information required by Item 402 of Regulation S-K is presented under the caption "Executive Compensation" in the definitive Proxy Statement for the Company's 2002 Annual Meeting of Shareholders, and is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by Item 403 of Regulation S-K is presented under the caption "Principal Shareholders" in the definitive Proxy Statement for the Company's 2002 Annual Meeting of Shareholders, and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Item 404 of Regulation S-K is presented under the caption "Certain Relationships" in the definitive Proxy Statement for the Company's 2002 Annual Meeting of Shareholders, and is incorporated herein by reference. Page 50 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K 1. Financial Statements. Reference is made to the Index to the Financial Statements set forth in item 8 on page 34 of this Form 10-K. 2. Financial Statement Schedules. All Schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are included herein. 3. Exhibits. The Exhibits listed on the accompanying Index to Exhibits are filed as part of, or incorporated by reference into, this report. 4. Reports on Form 8-K. Page 51 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this annual report Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. 99 CENTS ONLY STORES By : /s/ Eric Schiffer -------------------- President Pursuant to the requirements of the Securities Exchange Act of 1934 this Annual Report on Form 10K has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE /s/ David Gold Chairman of the Board and March 28, 2002 - ---------------------- Chief Executive Officer /s/ Howard Gold Senior Vice President of March 28, 2002 - ---------------------- Distribution and Director /s/ Jeff Gold Senior Vice President of Real March 28, 2002 - ---------------------- Estate and Information Systems and Director /s/ Eric Schiffer President and Director March 28, 2002 - ---------------------- /s/ Andy Farina Chief Financial Officer March 28, 2002 - ---------------------- /s/ William Christy Director March 28, 2002 - ---------------------- /s/ Lawrence Glascott Director March 28, 2002 - ---------------------- /s/ Marvin L. Holen Director March 28, 2002 - ---------------------- /s/ Ben Schwartz Director March 28, 2002 - ---------------------- /s/ John Shields Director March 28, 2002 - ----------------------
Page 52 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders and Board of Directors of 99 Cents Only Stores: We have audited in accordance with auditing standards generally accepted in the United States, the financial statements of 99 Cents Only Stores in this Form 10-K and have issued our report thereon dated February 20, 2002 (except for the matters discussed in Note 13, as to which date is March 9, 2002). Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the accompanying index is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP Los Angeles, California February 20, 2002 (Except for the matters discussed in Note 13, as to which the date is March 9, 2002) Page 53
99 CENTS ONLY STORES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 2001 (AMOUNTS IN THOUSANDS) BEGINNING END OF OF YEAR ADDITION REDUCTION OTHER YEAR --------- -------- --------- ----- ------ For the year ended December 31, 2001: Allowance for doubtful accounts $113 177 125 - $165 Inventory reserve $1,279 179 234 $1,224 For the year ended December 31, 2000: Allowance for doubtful accounts $140 - $27 - $113 Inventory reserve 1,503 - 224 - 1,279 For the year ended December 31, 1999: Allowance for doubtful accounts 169 - 29 - 140 Inventory reserve 2,589 - 1,086 - 1,503
Page 54 Exhibit Index Exhibit Description 3.1 Amended and Restated Articles of Incorporation of the Registrant.(1) 3.2 Amended and Restated Bylaws of the Registrant.(1) 4.1 Specimen certificate evidencing Common Stock of the Registrant.(1) 10.1 Form of Indemnification Agreement and Schedule of Indemnified Parties.(1) 10.2 [Reserved] 10.3 Form of Tax Indemnification Agreement, between and among the Registrant and the Existing Shareholders.(1) 10.4 1996 Stock Option Plan.(1) 10.5 Lease for 730 West Foothill Boulevard, Azusa, California, dated as of December 1, 1995, by and between the Registrant as Tenant and HKJ Gold, Inc. as Landlord, as amended(1). 10.6 Lease for 13023 Hawthorne Boulevard, Hawthorne, California, dated April 1 1994, by and between the Registrant as Tenant and HKJ Gold, Inc. as Landlord, as amended.(1) 10.7 Lease for 6161 Atlantic Boulevard, Maywood, California, dated November 11, 1985, by and between the Registrant as Lessee and David and Sherry Gold, among others, as Lessors.(1) 10.8 Lease for 14139 Paramount Boulevard, Paramount, California, dated as of March 1 1996, by and between the Registrant as Tenant and 14139 Paramount Properties as Landlord, as amended.(1) 10.9 Release Agreement, dated March 25, 1996, regarding 11382 Beach Boulevard, Stanton, California, by and between the Registrant and 11382 Beach Partnership.(1) 10.10 Lease for 6124 Pacific Boulevard, Huntington Park, California, dated January 31, 1991, by and between the Registrant as Tenant and David and Sherry Gold as the Landlord, as amended.(1) 10.11 Lease for 14901 Hawthorne Boulevard, Lawndale, California, dated November 1, 1991, by and between Howard Gold, Karen Schiffer and Jeff Gold, dba 14901 Hawthorne Boulevard Partnership as Landlord and the Registrant as Tenant, as amended.(1) 10.12 Lease for 5599 Atlantic Avenue, North Long Beach, California, dated August 13, 1992, by and between the Registrant as Tenant and HKJ Gold, Inc. as Landlord, as amended.(1) 10.13 Lease for 1514 North Main Street, Santa Ana, California, dated as of November 12, 1993, by and between the Registrant as Tenant and Howard Gold, Jeff Gold, Eric J. Schiffer and Karen R. Schiffer as Landlord, as amended.(1) 10.14 Lease for 6121 Wilshire Boulevard, Los Angeles, California, dated as of July 1, 1993, by and between the Registrant as Tenant and HKJ Gold, Inc. as Landlord, as amended; and lease for 6101 Wilshire Boulevard, Los Angeles, California, dated as of December 1, 1995, by and between the Registrant as Tenant and David and Sherry Gold as Landlord, as amended.(1) 10.15 Lease for 8625 Woodman Avenue, Arleta, California, dated as of July 8, 1993, by and between the Registrant as Tenant and David and Sherry Gold as Landlord, as amended.(1) 10.16 Lease for 2566 East Florence Avenue, Walnut Park, California, dated as of April 18, 1994, by and between HKJ Gold, Inc. as Landlord and the Registrant as Tenant, as amended.(1) 10.17 Lease for 3420 West Lincoln Avenue, Anaheim, California, dated as of March 1, 1996, by and between the Registrant as Tenant and HKJ Gold, Inc. as Landlord, as amended.(1) 10.18 Master Lease for 4000 East Union Pacific Avenue, City of Commerce, California ("Warehouse and Distribution Facility Lease"), dated as of December 20, 1993, by and between the Registrant as Lessee and TBC Realty II Corporation ("TBC") as Lessor, together with Lease Guaranty ("Lease Guaranty"), dated December 20, 1993, by and between Sherry and David Gold and TBC with respect thereto and Letter Agreement, dated December 15, 1993, among Registrant, The Mead Corporation, TBC and Citicorp Leasing, Inc. with respect to the Lease Guaranty.(1) Page 55 10.10 Hawaiian Gardens Indemnity Agreement, dated as of March 25, 1996, by and between the Registrant and HKJ Gold, Inc.(1) 10.20 North Broadway Indemnity Agreement, dated as of May 1, 1996, by and between HKJ Gold, Inc. and the Registrant.(1) 10.21 Lease for 2606 North Broadway, Los Angeles, California, dated as of May 1, 1996, by and between HKJ Gold, Inc. as Landlord and the Registrant as Tenant.(1) 10.22 Grant Deed concerning 8625 Woodman Avenue, Arleta, California, dated May 2, 1996, made by David Gold and Sherry Gold in favor of Au Zone Investments #2, L.P., a California limited partnership.(1) 10.23 Grant Deed concerning 6101 Wilshire Boulevard, Los Angeles, California, dated May 2, 1996, made by David Gold and Sherry Gold in favor of Au Zone Investments #2, L.P., a California limited partnership.(1) 10.24 Grant Deed concerning 6124 Pacific Boulevard, Huntington Park, California, dated May 2, 1996, made by David Gold and Sherry Gold in favor of Au Zone Investments #2, L.P., a California limited partnership.(1) 10.25 Grant Deed concerning 14901 Hawthorne Boulevard, Lawndale, California, dated May 2, 1996, made by Howard Gold, Karen Schiffer and Jeff Gold in favor of Au Zone Investments #2, L.P., a California limited partnership.(1) 10.26 Services Agreement, dated as of December 28, 2000, by and between Universal International, Inc. and the registrant. 23.1 Consent of Arthur Andersen LLP.* 99.1 Registrant Letter to Securities and Exchange Commission.* * Filed herewith (1) Incorporated by reference from the Company's Registration Statement on Form S-1 as filed with the Securities and Exchange Commission on May 21, 1996. Page 56 EX-23 3 exhibit_23-1.txt EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports dated February 20, 2002 (except for the matters discussed in Note 13, as which the date is March 9, 2002) included in 99 Cents Only Store's annual report on Form 10-K for the year ended December 31, 2001, into the Company's previously filed Registration Statement File Nos. 333-26575, 333-80185 and 333-66729. ARTHUR ANDERSEN LLP Los Angeles, California March 26, 2002 EX-99 4 exhibit_99-1.txt EXHIBIT 99.1 99 Cents Only Stores 4000 Union Pacific Avenue City of Commerce, CA. 90023 Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549 March 28, 2002 Ladies and Gentlemen: This will confirm that 99 Cents Only Stores (the "Company") has received a letter from Arthur Andersen LLP ("Arthur Andersen") with respect to Arthur Andersen's audit of the Company's consolidated financial statements for the year ended December 31, 2001. Arthur Andersen's letter certifies that the audit was subject to Arthur Andersen's quality control system for the U.S. accounting and auditing practice to provide reasonable assurance that the engagement was conducted in compliance with professional standards, that there was appropriate continuity of Arthur Andersen personnel working on the audit, availability of national office consultation, and availability of personnel at foreign affiliates of Arthur Andersen to conduct the relevant portions of the audit. Very truly yours, /s/ Andrew Farina Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----