Item 1. Business
The Company is an extreme value retailer of primarily consumable general merchandise with an emphasis on name-brand products. The Company’s stores offer a wide assortment of regularly available consumer goods as well as a broad variety of first-quality closeout merchandise. As of April 2, 2011, the Company operated 285 retail stores with 211 in California, 35 in Texas, 27 in Arizona, and 12 in Nevada. These stores averaged approximately 21,200 gross square feet. In fiscal 2011, on a comparable 52-week period, the Company’s stores open for the full year averaged net sales of $4.9 million per store and $291 per estimated saleable square foot, which the Company believes is the highest among all dollar store chains. In fiscal 2011, on a comparable 52-week period, 242 non-Texas stores open for the full year averaged net sales of $5.1 million per store and $307 per estimated saleable square foot and the 32 Texas stores open for the full year averaged net sales of $3.4 million per store and $181 per estimated saleable square foot.
The Company opened its first 99¢ Only Stores location in 1982 and believes that it operates the nation’s oldest existing general merchandise chain where items are primarily priced at 99.99¢ or less. The Company opened eleven new stores during fiscal 2011. Of these, six stores are located in California, two in Arizona and three in Texas. The Company closed one store in California during fiscal 2011 upon the expiration of its lease. In fiscal 2012, the Company plans to open at least 16 stores, with the majority of new stores expected to be opened in California during the second half of fiscal 2012.
The Company also sells merchandise through its Bargain Wholesale division at prices generally below normal wholesale levels to retailers, distributors and exporters. Bargain Wholesale complements the Company’s retail operations by exposing the Company to a broader selection of opportunistic buys and generating additional sales with relatively small incremental operating expenses and sometimes at prices higher than those customary at the Company’s retail stores. Bargain Wholesale represented 3.1% of the Company’s total sales in fiscal 2011.
On March 11, 2011, the Company announced that its Board of Directors had received a proposal from members of the Schiffer/Gold family, together with Leonard Green & Partners, L.P., to acquire the Company in a “going private” transaction for $19.09 per share in cash. The Company's Board of Directors formed a special committee of independent directors (the "Special Committee") to consider the proposal. The Special Committee, which has engaged independent financial and legal advisors, is also authorized to consider other proposals and strategic alternatives. There is no assurance that a definitive offer for a change of control transaction will be made or, if made, that such a transaction would be consummated. See “Risk Factors -- The going private proposal, and any related Special Committee Process, could materially and adversely affect the Company’s business and financial results; in addition, there can be no assurance that any definitive offer for a change of control transaction will be made or, if made, that such a transaction will be consummated.”
Industry
The Company participates primarily in the extreme value retail industry, with its 99¢ Only Stores. Extreme value retail is distinguished from other retail formats in that substantial portions of purchases are acquired at prices substantially below original wholesale cost through closeouts, manufacturer overruns, and other special-situation merchandise transactions. As a result, a substantial portion of the product mix is comprised of a frequently changing selection of specific brands and products. Special-situation merchandise is complemented by re-orderable merchandise which is also often purchased below normal wholesale prices. Extreme value retail is also distinguished by offering this merchandise to customers at prices significantly below typical retail prices.
The Company considers closeout merchandise as any item that is not generally re-orderable on a regular basis. Closeout or special-situation merchandise becomes available for a variety of reasons, including a manufacturer’s over-production, discontinuance due to a change in style, color, size, formulation or packaging, the inability to move merchandise effectively through regular channels, reduction of excess seasonal inventory, discontinuation of test-marketed items, products close to their “best when used by” date, and the financial needs of the supplier.
Most extreme value retailers also sell merchandise that can be purchased from a manufacturer or wholesaler on a regular basis. Although this merchandise can often be purchased at less than normal wholesale and sold below normal retail, the discount, if any, is generally less than with closeout merchandise. Extreme value retailers sell regularly available merchandise to provide a degree of consistency in their product offerings and to establish themselves as a reliable source of basic goods.
The Company also sells merchandise through its Bargain Wholesale division, which is generally obtained through the same or shared purchases of the retail operations. The Company maintains showrooms at its main distribution facility in the City of Commerce, California and at the Company’s distribution facility in the Houston, Texas area. Additionally, the Company has a showroom located in Chicago, Illinois. Advertising of wholesale merchandise is conducted primarily at trade shows and by catalog mailings to past and potential customers. Wholesale customers include a wide and varied range of major retailers, as well as smaller retailers, distributors, and wholesalers.
Business Strategy
The Company’s business strategy is to provide a primary shopping destination for price-sensitive consumers and a fun treasure-hunt shopping experience for other value conscious consumers for food and other basic household items. The Company’s core strategy is to offer good to excellent values on a wide selection of quality food and basic household items with a focus on name brands and an exciting assortment of surprises, primarily at a price point of 99.99¢ or less, in attractively merchandised, clean and convenient stores. The Company’s strategies to accomplish this include the following:
Focus on “Name-Brand” Consumables. The Company strives to exceed its customers’ expectations of the range and quality of name-brand consumable merchandise that are in most cases priced at 99.99¢ or less. During fiscal 2011, the Company purchased merchandise from more than 999 suppliers, including 3M, Colgate-Palmolive, Dole, Energizer Battery, Frito-Lay, General Mills, Georgia Pacific, Hasbro, Heinz, Hershey Foods, Johnson & Johnson, Kellogg’s, Kraft, Nestle, Procter & Gamble, Quaker, Revlon, and Unilever.
Broad Selection of Regularly Available Merchandise. The Company offers consumer items in each of the following staple product categories: food (including frozen, refrigerated, and produce items), beverages, health and beauty care, household products (including cleaning supplies, paper goods, etc.), housewares (including glassware, kitchen items, etc.), hardware, stationery, party goods, seasonal goods, baby products, toys, giftware, pet products, plants and gardening, clothing, electronics and entertainment. The Company carries name-brand merchandise, off-brands and its own private-label items. The Company believes that by consistently offering a wide selection of basic household consumable items, the Company encourages customers to shop at the stores for their everyday household needs, which the Company believes leads to an increased frequency of customer visits. The Company’s total retail sales by product category for fiscal years 2011, 2010 and 2009 are set forth below:
Fun Treasure-Hunt Shopping Experience. The Company’s practices of buying closeouts and other opportunistic purchases and pricing them primarily at 99.99¢ or less, typically dramatically below retail prices, helps to create a sense of fun and excitement. The constantly changing selection of these special extreme values, often in limited quantities, helps to create a sense of urgency when shopping and increase shopping frequency, while generating customer goodwill, loyalty and awareness via word-of-mouth.
Attractively Merchandised and Well-Maintained Stores. The Company strives to provide its customers an exciting shopping experience in customer-service-oriented and friendly stores that are attractively merchandised, brightly lit and well maintained. The Company’s stores are laid out with items in the same category grouped together. The shelves are generally restocked throughout the day. The Company believes that offering merchandise in an attractive, convenient and familiar environment creates stores that are appealing to a wide demographic of customers.
Strong Long-Term Supplier Relationships. The Company believes that it has developed a reputation as a leading purchaser of name-brand, re-orderable, and closeout merchandise at discounted prices. A number of consistent behaviors have contributed to building the Company’s reputation, including its willingness and consistent practice over many years to take on large volume purchases and take possession of merchandise immediately, its ability to pay cash or accept abbreviated credit terms, its commitment to honor all issued purchase orders, and its willingness to purchase goods close to a target season or out of season. The Company’s experienced buying staff, with the ability to make immediate buying decisions, also enhances its strong supplier relationships. The Company believes its relationships with suppliers are further enhanced by its ability to minimize channel conflict for the manufacturer. Additionally, the Company believes it has well-maintained, attractively merchandised stores that have contributed to a reputation among suppliers for protecting their brand image.
Savvy Purchasing. The Company purchases merchandise at substantially discounted prices as a result of its buyers’ knowledge and experience in their respective categories, its negotiating ability, and its established reputation among its suppliers. The Company applies its negotiating ability to its purchasing of corporate supplies, construction and services.
Store Location and Size. The Company’s 99¢ Only Stores are conveniently located in freestanding buildings, neighborhood shopping centers, regional shopping centers or downtown central business districts, all of which are locations where the Company believes consumers are likely to do their regular household shopping. As of April 2, 2011, the Company’s 285 existing 99¢ Only Stores averaged approximately 21,200 gross square feet and the Company currently targets new store locations between 15,000 and 19,000 gross square feet. The Company believes its larger store size versus that of other typical “dollar store” chains allows it to more effectively display a wider assortment of merchandise, carry deeper stock positions, and provide customers with a more inviting environment that the Company believes encourages customers to shop longer and buy more. In the past, as part of its strategy to expand retail operations, the Company has at times opened larger new stores in close proximity to existing smaller stores where the Company determined that the trade area could support a larger store. In some of these situations, the Company retained its existing store.
Complementary Bargain Wholesale Operation. Bargain Wholesale complements the Company’s retail operations by allowing the Company to be exposed to a broader selection of opportunistic buys and generate additional sales with relatively small incremental operating expense. The Bargain Wholesale division sells to local, regional, national, and international accounts. The Company maintains showrooms in the City of Commerce, California where it is based, as well as in Houston, Texas and Chicago, Illinois.
Growth Strategy
The Company’s long-term growth plan is to become a premier nationwide extreme value retailer. Management believes that short-term growth will primarily result from new store openings in its existing markets of California, Arizona, Nevada and Texas.
Growth in Existing Markets. By continuing to develop new stores in its current markets, the Company believes it can leverage its brand awareness in these regions and take advantage of its existing warehouse and distribution facilities, regional advertising and other management and operating efficiencies. This focus on growth through existing distribution facilities will help management to focus on implementing scalable systems.
Long-Term Geographic Expansion. The Company’s long-term plan is to become a nationwide retailer by opening clusters of stores in densely populated geographic regions across the country. The Company believes that its strategy of consistently offering a broad selection of name-brand consumables at value pricing in a convenient store format is portable to other densely populated areas of the United States. In 1999, the Company opened its first 99¢ Only Stores location outside the state of California in Las Vegas, Nevada; Arizona followed in 2001 and Texas in 2003.
Real Estate Acquisitions. The Company considers both real estate lease and purchase opportunities, and may consider for future expansion the acquisitions of a chain, or chains, of retail stores in existing markets or other regions, primarily for the purpose of acquiring favorable locations.
Retail Operations
The Company’s stores offer customers a wide assortment of regularly available consumer goods, as well as a broad variety of quality, closeout merchandise, generally at a significant discount from standard retail prices. Merchandise sold in the Company’s 99¢ Only Stores is priced primarily at or below 99.99¢ per item.
The following table sets forth certain relevant information with respect to the Company’s retail operations (dollar amounts in thousands, except sales per square footage):
(a) For fiscal 2011, net retail sales were $1,380.4 million and based on a 53-week period, compared to a 52-week period, for the other periods presented.
(b) One California store was closed due to the expiration of its lease.
(c) Includes 32 Texas stores open for a full year. Texas stores open for the full year on a comparable 52-week period had average sales of $3.4 million per store and average sales per estimated saleable square foot of $181. All non-Texas stores open for the full year on a comparable 52-week period had average sales of $5.1 million per store and $307 of average sales per estimated saleable square foot.
(d) 12 underperforming stores in Texas were closed in fiscal 2010 and one California store was closed due to the expiration of its lease. See Note 10 to the Consolidated Financial Statements for additional information regarding the Texas Market.
(e) Includes 31 Texas stores open for a full year. Texas stores open for the full year had average sales of $3.4 million per store and average sales per estimated saleable square foot of $180. All non-Texas stores open for the full year had average sales of $5.0 million per store and $305 of average sales per estimated saleable square foot.
(f) Four underperforming stores in Texas were closed in fiscal 2009 and one additional Texas store was closed due to a hurricane which was re-opened in May 2009. The leases had expired for two of the four stores that were closed in fiscal 2009.
(g) Includes 39 Texas stores open for a full year. Texas stores open for the full year had average sales of $2.7 million per store and average sales per estimated saleable square foot of $142. All non-Texas stores open for the full year had average sales of $5.0 million per store and $301 of average sales per estimated saleable square foot.
(h) Two underperforming stores closed in Houston, Texas.
(i) Includes 39 Texas stores open for a full year. Texas stores open for the full year had average sales of $2.6 million per store and average sales per estimated saleable square foot of $128. All non-Texas stores open for the full year had average sales of $4.9 million per store and $291 of average sales per estimated saleable square foot.
(j) Includes 36 Texas stores open for a full year. Texas stores open for the full year had average sales of $2.4 million per store and average sales per saleable square foot of $120. All non-Texas stores open for the full year had average sales of $4.8 million per store and $284 of average sales per estimated saleable square foot.
(k) For stores open for the entire fiscal year.
(l) Change in comparable store net sales compares net sales for all stores open at least 15 months. The Company normally does not relocate stores or close them if renovations are taking place. In a rare situation where a store is relocated, or closed and later re-opened at the same location, the relocated or re-opened store is considered a new store for any comparable store sales analysis, and would only be included in the comparable store sales analysis once it has been open, or re-opened, for 15 months.
Merchandising. All of the Company’s stores offer a broad variety of first-quality, name-brand and other closeout merchandise as well as a wide assortment of regularly available consumer goods. The Company also carries private-label consumer products made for the Company. The Company believes that the success of its 99¢ Only Stores concept arises in part from the value inherent in pricing consumable items primarily at 99.99¢ or less per item, many of which are name-brands, and most of which typically retail elsewhere at higher prices.
Approximately half of the merchandise purchased by the Company is available for reorder including many branded consumable items. The mix and the specific brands of merchandise frequently change, depending primarily upon the availability of closeout and other special-situation merchandise at suitable prices. Since commencing its closeout purchasing strategy for its stores, the Company has been able to obtain sufficient name-brand closeouts as well as re-orderable merchandise at attractive prices. Management believes that the frequent changes in specific name-brands and products found in its stores from one week to the next, encourage impulse and larger volume purchases, result in customers shopping more frequently, and help to create a sense of urgency, fun and excitement. Unlike many discount retailers, the Company rarely imposes limitations on the quantity of specific value-priced items that may be purchased in a single transaction.
The Company targets value-conscious consumers from a wide range of socio-economic backgrounds with diverse demographic characteristics. Purchases are by cash, credit card, debit card or EBT (electronic benefit transfers). The Company’s stores currently do not accept checks or manufacturer’s coupons. The Company’s stores are open every day except Christmas, with operating hours designed to meet the needs of families.
Store Size, Layout and Locations. The Company strives to provide stores that are attractively merchandised, brightly lit, well-maintained, “destination” locations. The layout of each of the Company’s stores is customized to the configuration of the individual location. The interior of each store is designed to reflect a generally uniform format, featuring attractively displayed products in windows, consistent merchandise display techniques, bright lighting, lower shelving height that allows visibility throughout the store, customized check-out counters and a distinctive color scheme on its interior and exterior signage, price tags, baskets and shopping bags. The Company emphasizes a strong visual presentation in all key traffic areas of each store. Merchandising displays are maintained throughout the day, changed frequently, and often incorporate seasonal themes. The Company believes that the frequently changing value priced name-brands, convenient and inviting layout, and the lower shelving height, help encourage the typical customer to shop more of the whole store.
Advertising. Advertising expenditures were $5.5 million, $4.1 million and $4.4 million or 0.4%, 0.3% and 0.4% of net retail sales for fiscal 2011, 2010 and 2009, respectively. The Company allocates the majority of its advertising budget to print advertising. The Company’s advertising strategy emphasizes the offering of nationally recognized, name-brand merchandise at significant savings. The Company manages its advertising expenditures by an efficient implementation of its advertising program combined with word-of-mouth publicity, locations with good visibility, and efficient signage. Because of the Company’s distinctive grand opening promotional campaign, which usually includes the pricing of nine iPods and other high value items at only 99.99¢ each, grand openings often attract long lines of customers and receive media coverage.
Purchasing
The Company believes a primary factor contributing to its success is its ability to identify and take advantage of opportunities to purchase merchandise with high customer appeal and interest at prices lower than regular wholesale. The Company purchases most merchandise directly from the manufacturer. Other sources of merchandise include wholesalers, manufacturers’ representatives, importers, barter companies, auctions, professional finders and other retailers. The Company develops new sources of merchandise primarily by attending industry trade shows, advertising, distributing marketing brochures, cold calling, and obtaining referrals.
The Company seldom has continuing contracts for the purchase of merchandise and must continuously seek out buying opportunities from both its existing suppliers and new sources. No single supplier accounted for more than 5% of the Company’s total purchases in fiscal 2011. During fiscal 2011, the Company purchased merchandise from more than 999 suppliers, including 3M, Colgate-Palmolive, Dole, Energizer Battery, Frito-Lay, General Mills, Georgia Pacific, Hasbro, Heinz, Hershey Foods, Johnson & Johnson, Kellogg’s, Kraft, Nestle, Procter & Gamble, Quaker, Revlon, and Unilever. Many of these companies have been supplying products to the Company for over twenty years.
A significant portion of the merchandise purchased by the Company in fiscal 2011 was closeout or special-situation merchandise. The Company has developed strong relationships with many manufacturers and distributors who recognize that their special-situation merchandise can be moved quickly through the Company’s retail and wholesale distribution channels. The Company’s buyers search continuously for closeout opportunities. The Company’s experience and expertise in buying merchandise has enabled it to develop relationships with many manufacturers that frequently offer some or all of their closeout merchandise to the Company prior to attempting to sell it through other channels. The key elements to these supplier relationships include the Company’s (i) ability to make immediate buying decisions, (ii) experienced buying staff, (iii) willingness to take on large volume purchases and take possession of merchandise immediately, (iv) ability to pay cash or accept abbreviated credit terms, (v) commitment to honor all issued purchase orders and (vi) willingness to purchase goods close to a target season or out of season. The Company believes its relationships with its suppliers are further enhanced by its ability to minimize channel conflict for a manufacturer.
The Company’s strong relationships with many manufacturers and distributors, along with its ability to purchase in large volumes, also enable the Company to purchase re-orderable name-brand goods at discounted wholesale prices. The Company focuses its purchases of re-orderable merchandise on a limited number of stock keeping units (“SKU’s”) per product category, which allows the Company to make purchases in large volumes.
The Company utilizes and develops private label consumer products to broaden the assortment of merchandise that is consistently available. The Company also imports merchandise in product categories such as kitchen items, housewares, toys, seasonal products, party, pet-care and hardware which the Company believes are not brand sensitive to consumers.
Warehousing and Distribution
An important aspect of the Company’s purchasing strategy involves its ability to warehouse and distribute merchandise quickly and with flexibility. The Company’s distribution centers are strategically located to enable quick turnaround of time-sensitive products as well as to provide long-term warehousing capabilities for one-time closeout purchases and seasonal or holiday items. A large majority of the merchandise sold by the Company is received, processed for retail sale and then distributed to the retail locations from Company-operated warehouse and distribution facilities.
The Company utilizes its internal fleet and outside carriers for both outbound shipping and a backhaul program. The Company also receives merchandise shipped by rail to its City of Commerce, California distribution center which has a railroad spur on the property. The Company has primarily used common carriers or owner-operators to deliver to stores outside of Southern California including its stores in Northern and Central California, Texas, Arizona and Nevada. The Company believes that its current California and Texas distribution centers will be able to support its anticipated growth throughout fiscal 2012, with the possible exception of its California cold storage facilities which may need to be supplemented or replaced. However, there can be no assurance that the Company’s existing warehouses will provide adequate storage space for the Company’s long-term storage needs or to support sales levels at peak seasons for perishable products, that high levels of opportunistic purchases may not temporarily pressure warehouse capacity, or that the Company will not make changes, including capital expenditures, to expand or otherwise modify its warehousing and distribution operations.
The Company arranges with vendors of certain merchandise to ship directly to its store locations. The Company's primary distribution practice, however, is to have merchandise delivered from its vendors to the Company's warehouses, where it is stored for timely shipment to its store locations.
Information pertaining to warehouse and distribution facilities is described under Item 2. Properties.
Information Systems
Over the last three fiscal years, the Company continued to make significant investments in a variety of infrastructure, data management, and process improvement projects. Infrastructure investments enabled the Company to achieve level one compliance with Payment Card Industry (PCI) standards, which were certified by a qualified third party IT security firm. Additionally, store network upgrades including high speed wireless data backup lines were installed to assure a high level of availability and speed for credit card processing and delivery of critical item information to the stores, and wireless network upgrades and hardware capacity improvements improved availability and reliability for warehouse operations to support a successful migration to a perpetual inventory system in fiscal 2010.
The Company currently operates financial, accounting, human resources, and payroll data processing using Lawson Software’s Financial and Human Resource Suites on an SQL database running on a Windows operating system. The Company completed a major upgrade to its Lawson financial and human resources management systems during fiscal 2009 and is now running Lawson version 9. This upgrade addressed both security and performance concerns from the prior release and converted many customized features to a standard interface approach, laying a foundation to leverage additional Lawson functionality in the coming years. In fiscal 2010, a standard sales audit package from Epicor systems was implemented with an enhancement to support short-interval intra-day polling of store systems.
The Company also implemented system improvements to support the reengineering of the processes and information flow in the main Commerce Distribution Center. Primary amongst these improvements were completion of racking systems, real time pallet movement tracking through wireless command and tracking systems, a perpetual warehouse inventory system that is now updated via periodic cycle counting, and improvements in truck utilization. In the second half of fiscal 2010, cycle counts and test counts replaced and eliminated the semi-annual physical inventory counts in the Company’s main Commerce distribution center. These changes helped to reduce transportation costs, improve DC labor productivity and throughput, and enhance DC inventory accounting and expiration date control.
The Company also operates several proprietary systems which accommodate the Company’s unique flexibility requirements in product sourcing and acquisition that are tightly coupled with HighJump warehouse solutions. These proprietary systems include an IBM UNIX-based purchase order and inventory control system, a store ordering system that utilizes radio frequency hand-held scanning devices in each store, and a back office personal computer system at each store that collects and transmits a variety of operational data to central processing systems. The Company utilizes a proprietary Point of Sale (“POS’’) barcode scanning system to record and process retail sales in each of its stores and electronic polling to collect sales data for analysis, reporting and processing.
During fiscal 2009 and fiscal 2010, the Company focused its efforts on business process improvement, enhanced data structures, and improved data integrity through modifications to its proprietary systems and upgrades of existing vendor systems. The first stage of these improvements was to centralize and normalize more of the Company’s critical data in standard, high speed database platforms. This data integrity and normalization will continue in fiscal 2012. Over the next 2-3 years, the Company intends to differentiate and isolate proprietary systems from those functions which can be more cost effectively managed on industry standard platforms. An example of a conversion from the proprietary core to an industry standard platform in fiscal 2010 was the conversion of the sales audit function to an industry leading Epicor package solution. In fiscal 2011, the Company has begun the process of converting to industry leading packages for Master Data Management and Point-of-Sale systems and enhancing its use of Data Warehouse and proprietary systems for purchasing and store merchandise ordering.
Competition
The Company faces competition in both the acquisition of inventory and the sale of merchandise from other discount stores, single-price-point merchandisers, mass merchandisers, food markets, drug chains, club stores, wholesalers, and other retailers. Industry competition for acquiring closeout merchandise also includes a large number of retail and wholesale companies and individuals. In some instances these competitors are also customers of the Company’s Bargain Wholesale division. There is increasing competition with other wholesalers and retailers, including other extreme value retailers, for the purchase of quality closeout and other special-situation merchandise. Some of these competitors have substantially greater financial resources and buying power than the Company. The Company’s ability to compete will depend on many factors, including the success of its purchase and resale of such merchandise at lower prices than its competitors. In addition, the Company may face intense competition in the future from new entrants in the extreme value retail industry that could have an adverse effect on the Company’s business and results of operations.
Employees
At April 2, 2011, the Company had approximately 12,000 employees including approximately 10,700 in its retail operations, 900 in its warehousing and distribution operations and 400 in its corporate offices. The Company considers relations with its employees to be good. The Company offers certain benefits to benefit-eligible employees, including life, health and disability insurance, paid time off (vacation, holidays, and sick leave), a 401(k) plan with a Company match and a deferred compensation plan for certain key management employees of the Company.
None of the Company’s employees are party to a collective bargaining agreement and none are represented by a labor union.
Trademarks and Service Marks
“99¢ Only Stores,” “Rinso,” and “Halsa” are among the Company’s service marks and trademarks, and are listed on the United States Patent and Trademark Office Principal Register. “Bargain Wholesale” is among the fictitious business names used by the Company. Management believes that the Company’s trademarks, service marks, and fictitious business names are an important but not critical element of the Company’s merchandising strategy. The Company routinely undertakes enforcement efforts against certain parties whom it believes are infringing upon its “99¢” family of marks and its other intellectual property rights, although the Company believes that simultaneous litigation against all persons everywhere whom the Company believes to be infringing upon these marks is not feasible.
Seasonality
For information regarding the seasonality of the Company’s business, see “Item 6. Selected Financial Data. Seasonality and Quarterly Fluctuations,” which is incorporated by reference in this Item 1.
Environmental Matters
In the ordinary course of business, the Company handles or disposes of commonplace household products that are classified as hazardous materials under various environmental laws and regulations. Under various federal, state, and local environmental laws and regulations, current or previous owners or occupants of property may face liability associated with hazardous substances. These laws and regulations often impose liability without regard to fault. In the future the Company may be required to incur substantial costs for preventive or remedial measures associated with hazardous materials. The Company has several storage tanks at its warehouse facilities, including: an aboveground and an underground diesel storage tank at the City of Commerce, California warehouse; ammonia storage at the Southern California cold storage facility and the Texas warehouse; aboveground diesel and propane storage tanks at the Texas warehouse; an aboveground propane storage tank at the main Southern California warehouse; an aboveground propane storage tank at the Company’s leased Slauson distribution center in City of Commerce, California; and an aboveground propane tank located at the warehouse the Company owns in Eagan, Minnesota, which is currently being marketed for sale. The Company has not been notified of, and is not aware of, any material current environmental liability, claim or non-compliance, concerning its owned or leased real estate.
Available Information
The Company makes available free of charge its annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K through a hyperlink from the "Investor Relations" portion of its website, www.99only.com, to the Securities and Exchange Commission's website, www.sec.gov. Such reports are available on the same day that they are electronically filed with or furnished to the Securities and Exchange Commission by the Company.
Item 1A.
Item 1A. Risk Factors
The going private proposal, and any related Special Committee process, could materially and adversely affect the Company’s business and financial results; in addition, there can be no assurance that any definitive offer for a change of control transaction will be made or, if made, that such a transaction will be consummated.
On March 11, 2011, the Company announced the receipt of a going private proposal from the Schiffer/Gold family and Leonard Green & Partners, L.P. The Company's Board of Directors formed a special committee of independent directors to consider the proposal. The Special Committee, which has engaged independent financial and legal advisors, is also authorized to consider other proposals and strategic alternatives. The proposal and any related process undertaken by the Special Committee could cause distractions and disruptions in our business. We may also encounter difficulty in retaining officers and other key employees who may be concerned about their future roles with the Company if such a transaction were completed. Further, the costs associated with the evaluation of the proposal and any related processes are expected to be considerable, regardless of whether any transaction is consummated. All of the foregoing could materially and adversely affect our business and financial results. In addition, there is no assurance that a definitive offer for a change of control transaction will be made, or, if made, that such a transaction will be consummated. If a change of control transaction does not occur, the share price of our common stock may decline significantly to the extent that the current market price of our common stock reflects an expectation that a transaction will be completed.
Inflation may affect the Company’s ability to keep pricing almost all of its merchandise at 99.99¢ or less
The Company’s ability to provide quality merchandise for profitable resale primarily at a price point of 99.99¢ or less is subject to certain economic factors, which are beyond the Company’s control. Inflation could have a material adverse effect on the Company’s business and results of operations, especially given the constraints on the Company’s ability to pass on incremental costs due to price increases or other factors. A sustained trend of significantly increased inflationary pressure could require the Company to abandon its customary practice of not pricing its merchandise at more than a dollar, which could have a material adverse effect on its business and results of operations. The Company can pass price increases on to customers to a certain extent, such as by selling smaller units for the same price and increasing the price of merchandise presently sold at less than 99.99¢ (e.g., the Company currently prices some items at 29.99¢, 59.99¢, and the like, and also sells other items at two at 99.99¢, three at 99.99¢, and so forth, but there are limits to the ability to effectively increase prices on a sufficiently wide range of merchandise in this manner while rarely exceeding a dollar). In certain circumstances, the Company has dropped and may continue to drop some items from its offerings due to vendor wholesale price increases or availability, which may adversely affect sales. In September 2008, the Company increased its primary price point to 99.99¢ from 99¢, and also added 99/100¢ to its price points on almost all items. See also “The Company is vulnerable to uncertain economic factors, changes in the minimum wage, and increased workers’ compensation and healthcare costs” for a discussion of additional risks attendant to inflationary conditions.
The Company is dependent primarily on new store openings for future growth
The Company’s ability to generate growth in sales and operating income depends in part on its ability to successfully open and operate new stores outside of its core market of Southern California and to manage future growth profitably. The Company’s strategy depends on many factors, including its ability to identify suitable markets and sites for new stores, negotiate leases or purchases with acceptable terms, refurbish stores, successfully compete against local competition and the increasing presence of large and successful companies entering or expanding into the markets in which the Company operates, upgrade its financial and management information systems and controls, gain brand recognition and acceptance in new markets, and manage operating expenses and product costs. In addition, the Company must be able to hire, train, motivate, and retain competent managers and store personnel at increasing distances from the Company’s headquarters. Many of these factors are beyond the Company’s control or are difficult to manage. As a result, the Company cannot assure that it will be able to achieve its goals with respect to growth. Any failure by the Company to achieve these goals on a timely basis, differentiate itself and obtain acceptance in markets in which it currently has limited or no presence, attract and retain management and other qualified personnel, appropriately upgrade its financial and management information systems and controls, and manage operating expenses could adversely affect its future operating results and its ability to execute the Company’s business strategy.
A variety of factors, including store location, store size, local demographics, rental terms, competition, the level of store sales, availability of locally sourced as well as intra-Company distribution of merchandise, locally prevailing wages and labor pools, distance and time from existing distribution centers, local regulations, and the level of initial advertising, influence if and when a store becomes profitable. Assuming that planned expansion occurs as anticipated, the store base will include a portion of stores with relatively short operating histories. New stores may not achieve the sales per estimated saleable square foot and store-level operating margins historically achieved at existing stores. If new stores on average fail to achieve these results, planned expansion could produce a further decrease in overall sales per estimated saleable square foot and store-level operating margins. Increases in the level of advertising and pre-opening expenses associated with the opening of new stores could also contribute to a decrease in operating margins. New stores opened in existing and in new markets have in the past and may in the future be less profitable than existing stores in the Company’s core Southern California market and/or may reduce retail sales of existing stores, negatively affecting comparable store sales. As the Company expands beyond its base in the Southwestern United States, differences in the available labor pool and potential customers could adversely impact the Company.
The Company’s operations are concentrated in California
As of April 2, 2011, 211 of the Company’s 285 stores were located in California (with 35 stores in Texas, 27 stores in Arizona and 12 stores in Nevada). The Company expects that it will continue to open additional stores in as well as outside of California. For the foreseeable future, the Company’s results of operations will depend significantly on trends in the California economy. Further declines in retail spending on higher margin discretionary items and continuing trends of increasing demand for lower margin food products due to continuing poor economic conditions in California may negatively impact our operations and profitability. California has also historically enacted minimum wages that exceed federal standards (and certain of its cities have enacted “living wage” laws that exceed State minimum wage laws) and California typically has other factors making compliance, litigation and workers’ compensation claims more prevalent and costly. Additional local regulation in certain California cities may further pressure margins.
The impact of the Company’s Texas stores on the Company’s profitability is uncertain
The Company has historically experienced, and currently continues to experience, lower sales per store and sales per estimated saleable square foot in its Texas stores compared to its non-Texas stores. There can be no assurance that the Company’s Texas operations can have any sustained positive contribution to the Company’s profitability.
Material damage to, or interruptions to, the Company’s information systems as a result of external factors, staffing shortages and difficulties in updating its existing software or developing or implementing new software could have a material adverse effect on its business or results of operations
The Company depends on information technology systems for the efficient functioning of its business. Such systems are subject to damage or interruption from power outages, computer and telecommunications failures, computer viruses, security breaches and natural disasters. Any material interruptions or the cost of replacements may have a material adverse effect on its business or results of operations.
The Company also relies heavily on its information technology staff. If the Company cannot meet its staffing needs in this area, the Company may not be able to maintain or improve its systems in the future. Further, the Company still has certain legacy systems that are not generally supportable by outside vendors, and should those of its information technology team who are conversant with such systems leave, these legacy systems could be without effective support.
The Company relies on certain software vendors to maintain and periodically upgrade many of these systems. The software programs supporting many of the Company’s systems are maintained and supported by independent software companies. The inability of these companies to continue to maintain and upgrade these information systems and software programs might disrupt or reduce the efficiency of its operations if the Company were unable to convert to alternate systems in an efficient and timely manner. In addition, costs and potential interruptions associated with the implementation of new or upgraded systems and technology could also disrupt or reduce the efficiency of the Company’s operations.
Natural disasters, unusually adverse weather conditions, pandemic outbreaks, terrorist acts, and global political events could cause temporary or permanent distribution center or store closures, impair the Company’s ability to purchase, receive or replenish inventory, or decrease customer traffic, all of which could result in lost sales and otherwise adversely affect the Company’s financial performance
The occurrence of natural disasters, such as hurricanes, fires, floods, earthquakes and tsunamis, unusually adverse weather conditions, pandemic outbreaks, terrorist acts or disruptive global political events, such as civil unrest in countries in which the Company’s suppliers are located, or similar disruptions could adversely affect the Company’s operations and financial performance. These events could result in the closure of one or more of the Company’s distribution centers or a significant number of stores, the temporary or long-term disruption in the supply of products from some local and overseas suppliers, the temporary disruption in the transport of goods from overseas, delay in the delivery of goods to the Company’s distribution centers or stores, the temporary reduction in the availability of products in its stores, and disruption to its information systems.
The Company’s current insurance program may expose the Company to unexpected costs and negatively affect its financial performance
The Company’s insurance coverage reflects deductibles, self-insured retentions, limits of liability and similar provisions that the Company believes are prudent. However, there are types of losses the Company may incur but against which it cannot be insured or which the Company believes are not economically reasonable to insure, such as losses due to employment practices, acts of war, employee and certain other crime and some natural disasters, including earthquakes and tsunamis. If the Company incurs these losses and they are material, the Company’s business could suffer. In addition, the Company self-insures a significant portion of expected losses under our workers' compensation and general liability programs. Unanticipated changes in any applicable actuarial assumptions and management estimates underlying the Company’s recorded liabilities for these losses could result in materially different amounts of expense than expected under these programs, which could have a material adverse effect on the Company’s financial condition and results of operations. Although the Company continues to maintain property insurance for catastrophic events, the Company is effectively self-insured for property losses up to the amount of its deductibles. If the Company experiences a greater number of these losses than it anticipates, the Company’s financial performance could be adversely affected.
The Company could experience disruptions in receiving and distribution
The Company’s success depends upon whether receiving and shipments are processed timely, accurately and efficiently. As the Company continues to grow, it may face increased or unexpected demands on warehouse operations, as well as unexpected demands on its transportation network. In addition, new store locations receiving shipments from distribution centers that are increasingly further away will increase transportation costs and may create transportation scheduling strains. The very nature of the Company’s closeout business makes it uniquely susceptible to periodic and difficult to foresee warehouse/distribution center overcrowding caused by spikes in inventory resulting from opportunistic closeout purchases. Such demands could cause delays in delivery of merchandise to and from warehouses and/or to stores. The Company periodically evaluates new warehouse distribution and merchandising systems and could experience interruptions during implementations of new facilities and systems. A fire, earthquake, or other disaster at the Company’s warehouses could also hurt the Company’s business, financial condition and results of operations, particularly because much of the Company’s merchandise consists of closeouts and other irreplaceable products. The Company also faces the possibility of future labor unrest that could disrupt the Company’s receiving, processing, and shipment of merchandise.
The Company depends upon its relationships with suppliers and the availability of closeout and other special-situation merchandise
The Company’s success depends in large part on its ability to locate and purchase quality closeout and other special-situation merchandise at attractive prices. This supports a changing mix of name-brand and other merchandise primarily within the 99.99¢ price point. The Company cannot be certain that such merchandise will continue to be available in the future at prices consistent with the Company business plan and/or historical costs. Further, the Company may not be able to find and purchase merchandise in necessary quantities, particularly as it grows and therefore requires a greater availability of such merchandise at competitive prices. Additionally, suppliers sometimes restrict the advertising, promotion and method of distribution of their merchandise. These restrictions in turn may make it more difficult for the Company to quickly sell these items from inventory. Although the Company believes its relationships with suppliers are good, the Company typically does not have long-term agreements or pricing commitments with any suppliers. As a result, the Company must continuously seek out buying opportunities from existing suppliers and from new sources. There is increasing competition for these opportunities with other wholesalers and retailers, discount and deep-discount stores, mass merchandisers, food markets, drug chains, club stores, and various other companies and individuals as the extreme value retail segment continues to expand outside and within existing retail channels. There is also a growth in consolidation among vendors and suppliers of merchandise targeted by the Company. A disruption in the availability of merchandise at attractive prices could impair the Company’s business.
The Company purchases in large volumes and its inventory is highly concentrated
To obtain inventory at attractive prices, the Company takes advantage of large volume purchases, closeouts and other special situations. As a result, inventory levels are generally higher than other discount retailers and from time to time this can result in an over-capacity situation in the warehouses and place stress on the Company’s warehouse and distribution operations as well as the back rooms of its retail stores. This can also result in shrink due to spoilage if merchandise cannot be sold in anticipated timeframes. The Company’s short-term and long-term store and warehouse inventory, net of allowance, approximated $196.1 million and $176.0 million at April 2, 2011 and March 27, 2010, respectively. The Company periodically reviews the net realizable value of its inventory and makes adjustments to its carrying value when appropriate. The current carrying value of inventory reflects the Company’s belief that it will realize the net values recorded on the balance sheet. However, the Company may not do so, and if it does not, this may result in overcrowding and supply chain difficulties. If the Company sells large portions of inventory at amounts less than their carrying value or if it writes down or otherwise disposes of a significant part of inventory, cost of sales, gross profit, operating income, and net income could decline significantly during the period in which such event or events occur. Margins could also be negatively affected should the grocery category sales become a larger percentage of total sales in the future, and by increases in shrinkage and spoilage from perishable products.
If the Company fails to protect its brand name, competitors may adopt trade names that dilute the value of the Company’s brand name
The Company may be unable or unwilling to strictly enforce its trademark in each jurisdiction in which it does business. Also, the Company may not always be able to successfully enforce its trademarks against competitors or against challenges by others. The Company’s failure to successfully protect its trademarks could diminish the value and efficacy of its brand recognition, and could cause customer confusion, which could, in turn, adversely affect the Company’s sales and profitability.
The Company faces strong competition
The Company competes in both the acquisition of inventory and sale of merchandise with other wholesalers and retailers, discount and deep-discount stores, single price point merchandisers, mass merchandisers, food markets, drug chains, club stores and other retailers. It also competes for retail real estate sites. In the future, new companies may also enter the extreme value retail industry. It is also becoming more common for superstores to sell products competitive with the Company’s product offerings. Additionally, the Company currently faces increasing competition for the purchase of quality closeout and other special-situation merchandise, and some of these competitors are entering or may enter the Company’s traditional markets. Also, as it expands, the Company will enter new markets where its own brand is weaker and established brands are stronger, and where its own brand value may have been diluted by other retailers with similar names appearances and/or business models. Some of the Company’s competitors have substantially greater financial resources and buying power than the Company does, as well as nationwide name-recognition and organization. The Company’s ability to compete will depend on many factors including the ability to successfully purchase and resell merchandise at lower prices than competitors and the ability to differentiate itself from competitors that do not share the Company’s price and merchandise attributes, yet may appear similar to prospective customers. The Company also faces competition from other retailers with similar names and/or appearances. The Company cannot assure that it will be able to compete successfully against current and future competitors in both the acquisition of inventory and the sale of merchandise.
The Company is vulnerable to uncertain economic factors, changes in the minimum wage, and increased workers’ compensation and healthcare costs
The Company’s future results of operations and ability to provide quality merchandise constrained by our price points that are primarily 99.99¢ or less could be hindered by certain economic factors beyond its control, including but not limited to:
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future inflation both in the United States as well as in other countries in which the products it sells are manufactured or from which parts and materials are sourced;
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increases in prices from our merchandise, supply and service vendors;
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increases in employee health and other benefit costs and the impact of new federal health care laws and regulations;
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increases in minimum and prevailing wage levels, as well as “living wage” pressures;
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increases in government regulatory compliance costs;
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decreases in consumer confidence levels;
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increases in transportation and fuel costs, which affect both the Company, as it ships over longer distances, and its customers and suppliers;
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increases in unionization efforts, including campaigns at the store and warehouse levels;
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increases in workers’ compensation costs and self-insured workers’ compensation liabilities due to increased claims costs, as well as political and legislative pressure or judicial rulings.
The Company faces risks associated with international sales and purchases
International sales historically have not been important to the Company’s overall net sales. However, some of the Company’s inventory is manufactured outside the United States and there are many risks associated with doing business internationally. International transactions may be subject to risks such as:
- political instability;
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lack of knowledge by foreign manufacturers of or compliance with applicable federal and state product, content, packaging and other laws, rules and regulations;
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foreign currency exchange rate fluctuations;
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uncertainty in dealing with foreign vendors and countries where the rule of law is less established;
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risk of loss due to overseas transportation;
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import and customs review can delay delivery of products as could labor disruptions at ports;
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changes in import and export regulations, including “trade wars” and retaliatory responses;
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changes in tariff, import duties and freight rates;
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testing and compliance.
The United States and other countries have at times proposed various forms of protectionist trade legislation. Any resulting changes in current tariff structures or other trade policies could result in increases in the cost of and/or reduction in the availability of certain merchandise and could adversely affect the Company’s ability to purchase such merchandise.
The Company has potential risks regarding its store physical inventories
Currently, the Company does not have a perpetual inventory system in place and believes that such process will not be feasible in the near future. Furthermore, physical inventories in all existing stores are not performed at the end of each fiscal period, and there are additional processes and procedures surrounding store physical inventories that the Company believes need to be improved. In particular, the Company has identified that certain personnel managing or performing physical inventories need additional training in order to consistently follow the Company’s physical inventory processes and procedures, and properly document the physical inventory results.
If these physical inventory processes and procedures are not improved, this could have an adverse affect on the Company’s physical inventory results, shrinkage and margins.
The Company could encounter risks related to transactions with affiliates
The Company leases 13 of its stores and a parking lot for one of those stores from the Gold family and their affiliates, of which 12 stores are leased on a month to month basis. Under current policy, the Company only enters into real estate transactions with affiliates for the renewal or modification of existing leases and on occasions where it determines that such transactions are in the Company’s best interests. Moreover, the independent members of the Board of Directors must unanimously approve all real estate transactions between the Company and its affiliates. They must also determine that such transactions are no less favorable than a negotiated arm’s-length transaction with a third party. The Company cannot guarantee that it will reach agreements with the Gold family on renewal terms for the properties it currently leases from them. Also, even if terms were negotiated that were acceptable to the Company, it cannot be certain that such terms would meet the standard required for approval by the independent directors. If the Company fails to renew one or more of these leases, it would be forced to relocate or close the leased stores. Any relocations or closures could potentially result in significant closure expense and could adversely affect the Company’s net sales and operating results.
The Company relies heavily on its executive management team
The Company relies heavily on the continued service of its executive management team. The Company does not have employment agreements with any of its officers. Also, the Company does not maintain key person life insurance on any of its officers. The Company’s future success will depend on its ability to identify, attract, hire, train, retain and motivate other highly skilled management personnel. Competition for such personnel is intense, and the Company may not successfully attract, assimilate or sufficiently retain the necessary number of qualified candidates.
The Company’s operating results may fluctuate and may be affected by seasonal buying patterns
Historically, the Company’s highest net sales and highest operating income have occurred during the quarter ended on or near December 31, which includes the Christmas and Halloween selling seasons. During fiscal 2011 and 2010, the Company generated approximately 25.7% and 26.5%, respectively, of its net sales during this quarter. If for any reason the Company’s net sales were to fall below norms during this quarter, it could have an adverse impact on profitability and impair the results of operations for the entire fiscal year. Transportation scheduling, warehouse capacity constraints, supply chain disruptions, adverse weather conditions, labor disruptions or other disruptions during the peak holiday season could also affect net sales and profitability for the fiscal year.
In addition to seasonality, many other factors may cause the results of operations to vary significantly from quarter to quarter. These factors, some beyond the Company’s control, include the following:
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the number, size and location of new stores and timing of new store openings;
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the distance of new stores from existing stores and distribution sources;
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the level of advertising and pre-opening expenses associated with new stores;
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the integration of new stores into operations;
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the general economic health of the extreme value retail industry;
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changes in the mix of products sold;
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increases in fuel, shipping merchandise and energy costs;
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the ability to successfully manage inventory levels and product mix across its multiple distribution centers and its stores;
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changes in personnel;
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the expansion by competitors into geographic markets in which they have not historically had a strong presence;
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fluctuations in the amount of consumer spending; and
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the amount and timing of operating costs and capital expenditures relating to the growth of the business and the Company’s ability to uniformly capture such costs.
The Company could be exposed to product liability or packaging violation claims
The Company purchases many products on a closeout basis, some of which are manufactured or distributed by overseas entities, and some of which are purchased by the Company through brokers or other intermediaries as opposed to directly from their manufacturing or distribution sources. Many products are also sourced directly from manufacturers. The closeout nature of certain of these products and transactions may impact the Company’s opportunity to investigate all aspects of these products. The Company attempts to ensure compliance, and to test products when appropriate, as well as to procure product insurance from its vendors and to be listed as an additional insured for certain products and/or by certain product vendors, and it does not purchase merchandise when it is cognizant of or foresees a problem, but there can be no assurance that the Company will consistently succeed in these efforts. The Company has or has had, and in the future could face, labeling, environmental, or other claims, from private litigants as well as from governmental agencies.
The Company faces risks related to protection of customers’ banking and merchant card data, as well as other data related to the Company’s employees, customers, vendors and other parties
In connection with merchant card sales and other transactions, including bank cards, debit cards, credit cards and other merchant cards, the Company transmits confidential banking and merchant card information. Additionally, as part of the Company’s normal business activities, the Company collects and stores certain information, related to its employees, customers, vendors and other parties. The Company has certain procedures and technology in place to protect such data, but third parties may have the technology or know-how to breach the security of this information, and the Company’s security measures and those of our banks, merchant card processing and other technology vendors may not effectively prohibit others from obtaining improper access to this information. Any security breach could expose the Company to risks of data loss, litigation and liability and could seriously disrupt our operations and any resulting negative publicity could significantly harm our reputation.
The Company is subject to environmental regulations
Under various federal, state and local environmental laws and regulations, current or previous owners or occupants of property may face liability associated with hazardous substances. These laws and regulations often impose liability without regard to fault. In the future, the Company may be required to incur substantial costs for preventive or remedial measures associated with hazardous materials. The Company has several storage tanks at its warehouse facilities, including: an aboveground and an underground diesel storage tank at the City of Commerce, California warehouse; ammonia storage tanks at the Southern California cold storage facility and the Texas warehouse; aboveground diesel and propane storage tanks at the Texas warehouse; an aboveground propane storage tank at the main Southern California warehouse; an aboveground propane storage tank at the Company’s leased Slauson distribution center in City of Commerce, California; and an aboveground propane tank located at the warehouse the Company owns in Eagan, Minnesota, which is currently being marketed for sale. Although the Company has not been notified of, and is not aware of, any material current environmental liability, claim or non-compliance, it could incur costs in the future related to owned properties, leased properties, storage tanks, or other business properties and/or activities. In the ordinary course of business, the Company handles or disposes of commonplace household products that are classified as hazardous materials under various environmental laws and regulations. The Company has adopted policies regarding the handling and disposal of these products, but the Company cannot be assured that its policies and training are comprehensive and/or are consistently followed, and the Company is still potentially subject to liability under, or violations of, these environmental laws and regulations in the future even if its policies are consistently followed.
Anti-takeover effect; concentration of ownership by existing officers and principal stockholders
In addition to some governing provisions in the Company’s Articles of Incorporation and Bylaws, the Company is also subject to certain California laws and regulations which could delay, discourage or prevent others from initiating a potential merger, takeover or other change in control transaction, even if such actions would benefit both the Company and its shareholders. Moreover, David Gold, the Chairman of the Board of Directors and members of his family (including Eric Schiffer, Chief Executive Officer, Jeff Gold, President and Chief Operating Officer and Howard Gold, Executive Vice President of Special Projects) and certain of their affiliates and the Company’s other directors and executive officers beneficially own as of April 2, 2011, an aggregate of 23,741,645, or 33.7%, of the Company’s outstanding common shares. As a result, they have the ability to influence the Company’s policies and matters requiring a shareholder vote, including the election of directors and other corporate action, and potentially to prevent a change in control. This could adversely affect the voting and other rights of other shareholders and could depress the market price of the Company’s common stock.
The Company’s common stock price could decrease and fluctuate significantly
Trading prices for the Company’s common stock could decrease and fluctuate significantly due to many factors, including:
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the reasons set forth above under “The consideration of the going private proposal and any related process could adversely affect the Company’s business and financial results; in addition, there can be no assurance that any definitive offer for a change of control transaction will be made, or, if made, that such a transaction will be consummated”;
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the depth of the market for the Company’s common stock;
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changes in expectations of future financial performance, including financial estimates by securities analysts;
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variations in operating results;
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conditions or trends in the industry or industries of any significant vendors or other stakeholders;
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the conditions of the market generally or the extreme value or retail industries;
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additions or departures of key personnel;
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future sales of common stock by the Company, its officers and the principal shareholders;
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government regulation affecting the business;
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increased competition;
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increases in minimum wages;
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workers’ compensation costs and new laws and regulations;
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the Company’s ability to control shrink;
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consolidation of consumer product companies;
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municipal regulation of “dollar” stores; and
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other risk factors as disclosed herein.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
As of April 2, 2011, the Company owned 66 stores and leased 219 of its 285 store locations. Additionally, as of April 2, 2011, the Company owned four parcels of land and three buildings for potential store sites.
The Company’s leases generally provide for a fixed minimum rental, and some leases require additional rental based on a percentage of sales once a minimum sales level has been reached. Management believes that the Company’s stable operating history, excellent credit record, and ability to generate substantial customer traffic give the Company leverage when negotiating lease terms. Certain leases include cash reimbursements from landlords for leasehold improvements and other cash payments received from landlords as lease incentives. The Company currently leases 13 store locations and a parking lot associated with one of these stores from the Gold family and their affiliates, of which 12 stores are leased on a month to month basis. The Company enters into real estate transactions with affiliates only for the renewal or modification of existing leases, and on occasions where it determines that such transactions are in the Company’s best interests. Moreover, the independent members of the Board of Directors must unanimously approve all real estate transactions between the Company and its affiliates. They must also determine that such transactions are not less favorable to the Company than a negotiated arm’s-length transaction with a third party. The Company cannot guarantee that it will reach agreements with the Gold family on renewal terms for the properties the Company currently leases from them. In addition, even if the Company reaches agreement on such terms, it cannot be certain that the independent directors will approve them. If the Company fails to renew one of these leases, it would be forced to relocate or close the leased store.
The large majority of the Company’s store leases were entered into with multiple renewal options of typically five years per option. Historically, the Company has exercised the large majority of the lease renewal options as they arise, and anticipates continuing to do so for the majority of leases for the foreseeable future.
The following table sets forth, as of April 2, 2011, information relating to the calendar year expiration dates of the Company’s current stores leases:
(a)
Includes 13 stores leased on a month-to-month basis. This includes 12 stores that are leased from Gold family and their affiliates.
The Company owns its main distribution center and executive office facility, located in the City of Commerce, California. The Company also owns an additional warehouse storage space nearly adjacent to its main distribution facility.
The Company owns a distribution center in the Houston area to service its Texas operations.
The Company also owns a cold storage distribution center and leases additional warehouse facilities located near the City of Commerce, California. As the Company’s needs change, it may relocate, expand, and/or otherwise increase/decrease the size and/or costs of its distribution/warehouse facilities.
The Company also owns a warehouse in Eagan, Minnesota. The Company commenced marketing this warehouse for sale during the fourth quarter of fiscal 2008, and it is reflected in assets held for sale in the Company’s consolidated balance sheets. Although the Company anticipates a sale of this warehouse in excess of its book value, no assurance can be given as to how much the warehouse will be sold for.
Item 3.
Item 3. Legal Proceedings
The Company is subject to private lawsuits, administrative proceedings and claims that arise in our ordinary course of business. A number of these lawsuits, proceedings and claims may exist at any given time. While the resolution of a lawsuit, proceeding or claim may have an impact on our financial results for the period in which it is resolved, and litigation is inherently unpredictable, in management’s opinion, none of these matters arising in the ordinary course of business is expected to have a material adverse effect on the Company’s financial position, results of operations, or overall liquidity. Material pending legal proceedings (other than ordinary routine litigation incidental to our business) and material proceedings known to be contemplated by governmental authorities are reported in our Securities Exchange Act of 1934 (“Securities Exchange Act”) reports.
Going Private Proposal
Following the recent announcement by the Company of the receipt of a going private proposal, eight complaints have been filed related to such proposal, all in the Los Angeles County Superior Court (the "Actions"). The plaintiffs in the Actions claim to be shareholders of the Company and propose to represent a class of all of the Company's public shareholders. The Actions name the Company, various of its officers and directors, and Leonard Green & Partners L.P. (and in one instance certain entities affiliated with Leonard Green & Partners) as defendants. The Actions assert claims for breach of fiduciary duty and aiding and abetting breach of fiduciary duty. Plaintiffs seek to enjoin a going private transaction and, in the alternative, seek unspecified damages in the event such a transaction is consummated. The Actions have been ordered stayed pending an initial status conference. The Actions are: Southeastern Pennsylvania Transportation Authority v. David Gold, et al. (filed March 14, 2011, amended March 23, 2011); John Chevedden v. 99¢ Only Stores, et al. (filed March 16, 2011); Rana Fong v. 99¢ Only Stores, et al. (filed March 17, 2011); Norfolk County Retirement Board v. Jeff Gold, et al. (filed March 22, 2011); Tammy Newman v. 99¢ Only Stores, et al. (filed March 25, 2011); Key West Police and Fire Pension Fund v. Eric G. Flamholtz, et al. (filed April 5, 2011); and Allen Mitchell v. 99¢ Only Stores, et al. (filed April 11, 2011).
Pricing Policy Matters
The district attorneys of two California counties and one city attorney have notified the Company that they are planning a possible civil action against the Company alleging that its .99 cent pricing policy, adopted in September 2008, constitutes false advertising and/or otherwise violates California's pricing laws. In response to this notification and an associated invitation from these governmental entities, the Company provided a detailed position statement with respect to its pricing structure.
Leonard Morales and Steven Calabro vs. 99¢ Only Stores, Superior Court of the State of California, County of Los Angeles. Plaintiffs filed a putative class action complaint against the Company in July 2010, claiming violations of California’s Unfair Competition Law (California Business & Professions Code Section 17200) and Consumer Legal Remedies Act (California Civil Code Section 1750, et seq.), as well as unjust enrichment, arising out of the Company’s September 2008 change in its pricing policy. Plaintiffs seek restitution of all amounts allegedly “wrongfully obtained” by the Company, injunctive and declaratory relief, prejudgment and post-judgment interest, and their attorney’s fees and costs. The Company filed a demurrer to all of the causes of action in this complaint as well as a motion to strike certain portions of it. In response to these motions, the plaintiffs requested that their case be consolidated with the Kavis lawsuit described below, and the two sets of plaintiffs filed a consolidated amended complaint. The Company has filed a demurrer and motion to strike directed towards portions of the amended complaint, and these motions were heard on April 27, 2011. These motions have been fully briefed and argued and the parties are awaiting a ruling from the Court. Discovery has begun in this case and is ongoing.
Phillip Kavis, Debra Major, Barbara Maines, and Susan Jonas v. 99¢ Only Stores, David Gold, Jeff Gold, Howard Gold, and Eric Schiffer, Superior Court of the State of California, County of Los Angeles. Plaintiffs filed a putative class action complaint against the Company in July 2010, claiming violations of California’s Unfair Competition Law (California Business & Professions Code Section 17200), False Advertising Law (California Business & Professions Code Section 17500), and Consumer Legal Remedies Act (California Civil Code Section 1770), as well as intentional misrepresentation, negligent misrepresentation, breach of the implied covenant of good faith and fair dealing, and unjust enrichment, arising out of the Company’s September 2008 change in its pricing policy. Plaintiffs seek actual damages, restitution, including disgorgement of all profits and unjust enrichment allegedly obtained by the Company, statutory damages and civil penalties, equitable and injunctive relief, exemplary damages, prejudgment and post-judgment interest, and their attorney’s fees and costs. The Company filed a demurrer to all of the causes of action in this complaint as well as a motion to strike certain portions of it. In response to these motions, the plaintiffs requested that their case be consolidated with the Morales lawsuit described above and filed a consolidated amended complaint. The Company has filed a demurrer and motion to strike directed towards portions of the amended complaint, and these motions were heard on April 27, 2011. These motions have been fully briefed and argued and the parties are awaiting a ruling from the Court. Discovery has begun in this case and is ongoing.
We cannot predict the outcome of these lawsuits or of any action or lawsuit that may be brought against the Company by the above-referenced governmental entities, or the amount of potential loss, if any, the Company could face as a result of such lawsuits or actions. We believe our pricing structure is lawful, and that our .99 cent pricing policy has an established precedent similar to the .9 cent pricing policy used for decades by gas stations across the country. We believe our .99 cent pricing policy has been well publicized with items properly price-signed in the stores such that it would not cause a reasonable consumer to be deceived, and we intend to vigorously defend these lawsuits as well as any such other lawsuit or action that may arise.
Wage and Hour Matters
Luis Palencia v. 99¢ Only Stores, Superior Court of the State of California, County of Sacramento. Plaintiff, a former assistant manager for the Company, who was employed with the Company from June 12, 2009 through September 9, 2009, filed this action in June 2010, asserting claims on behalf of himself and all others allegedly similarly situated under the California Labor Code for alleged unpaid overtime due to “off the clock” work, failure to pay minimum wage, failure to provide meal and rest periods, failure to provide proper wage statements, failure to pay wages timely during employment and upon termination and failure to reimburse business expenses. Mr. Palencia also asserts a derivative claim for unfair competition under the California Business and Professions Code. Mr. Palencia seeks to represent three sub-classes: (i) an “unpaid wages subclass” of all non-exempt or hourly paid employees who worked for the Company in California within four years prior to the filing of the complaint until the date of certification, (ii) a “non-compliant wage statement subclass” of all non-exempt or hourly paid employees of the Company who worked in California and received a wage statement within one year prior to the filing of the complaint until the date of certification, and (iii) an “unreimbursed business expenses subclass” of all employees of the Company who paid for business-related expenses, including expenses for travel, mileage expenses, or cell phones in California within four years prior to the filing of the complaint until the date of certification. Plaintiff seeks to recover alleged unpaid wages, interest, attorney’s fees and costs, declaratory relief, restitution, statutory penalties and liquidated damages. He also seeks to recover civil penalties as an “aggrieved employee” under the Private Attorneys General Act of 2004. Discovery has commenced but no class certification or trial date has been set. We cannot predict the outcome of this lawsuit or the amount of potential loss, if any, the Company could face as a result of such lawsuit.
Sheridan Reed v. 99¢ Only Stores, Superior Court of the State of California, County of Los Angeles. Plaintiff, a former store manager for the Company, filed this action in April 2010. He originally asserted claims on behalf of himself and all others allegedly similarly situated under the California Labor Code for alleged failure to pay overtime at the proper rate, failure to pay vested vacation wages, failure to pay wages timely upon termination of employment and failure to provide accurate wage statements. Mr. Reed also asserted a derivative claim for unfair competition under the California Business and Professions Code. In September 2010, Mr. Reed amended his complaint to seek civil penalties under the Private Attorneys General Act of 2004. Mr. Reed seeks to represent four sub-classes: (i) all non-exempt or hourly current or former employees who worked for the Company in California within four years prior to the filing of the complaint until the date of certification who were paid bonuses, commissions or incentive wages, who worked overtime, and for whom the bonuses, commissions or incentive wages were not included as part of the regular rate of pay for overtime purposes, (ii) all non-exempt or hourly current or former employees who worked for the Company in California within four years prior to the filing of the complaint until the date of certification who earned vacation wages and were not paid their vested vacation wages at the time of termination; (iii) all non-exempt or hourly current or former employees who worked for the Company in California within four years prior to the filing of the complaint until the date of certification who were not furnished a proper itemized wage statement; and (iv) all non-exempt or hourly current or former employees who worked for the Company in California within four years prior to the filing of the complaint until the date of certification who were not paid all wages due upon termination. Plaintiff seeks to recover alleged unpaid wages, statutory penalties, interest, attorney’s fees and costs, declaratory relief, injunctive relief and restitution. He also seeks to recover civil penalties as an “aggrieved employee” under the Private Attorneys General Act of 2004. Discovery has commenced but no class certification or trial date has been set. We cannot predict the outcome of this lawsuit or the amount of potential loss, if any, the Company could face as a result of such lawsuit.
Employment Discrimination Matter
Linda Niemiller v. 99¢ Only Stores, Superior Court of the State of California, County of Los Angeles. Plaintiff, a former assistant manager for the Company, filed this action in March 2011. She asserts claims on behalf of herself, and all others allegedly similarly situated, under the California Fair Employment and Housing Act and the California Business and Professions Code based on allegations that the Company has a pattern or practice of denying and/or failing to promote women to the position of Store Manager and to provide them with compensation equal to that of men doing equal work. She also asserts an individual claim for retaliation based on the allegation that the Company failed to promote her in retaliation for her having opposed and objected to discrimination based on gender. Plaintiff seeks to represent a class of all allegedly similarly situated current, past and future women as to whom the Company has denied hiring and promotion to the position of Store Manager and equal compensation in the State of California on the basis of gender. She seeks to recover back pay, front pay, general and special damages, punitive damages, injunctive and declaratory relief, an order assigning herself and members of the putative class to those jobs they purportedly would have held but for Defendant’s allegedly discriminatory practices, an adjustment of the wage rates, benefits, and seniority rights for herself and members of the putative class to that level which they purportedly would be enjoying but for the Company’s alleged discriminatory practices, pre-judgment interest and attorney’s fees and costs. We cannot predict the outcome of this lawsuit or the amount of potential loss, if any, the Company could face as a result of such lawsuit.
Item 4.
Item 4. (Removed and Reserved)
PART II
Item 5.
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Company’s common stock is traded on the New York Stock Exchange under the symbol “NDN.” The following table sets forth, for the fiscal periods indicated, the high and low closing prices per share of the common stock as reported by the New York Stock Exchange.
As of April 2, 2011, the Company had 376 shareholders of record and approximately 12,525 beneficial holders of its common stock.
The Company has not paid cash dividends with respect to its common stock since it became a public company in 1996. The Company presently intends to retain future earnings to finance continued system improvements, store development, and other expansion and therefore does not anticipate the payment of any cash dividends for the foreseeable future. Payment of future dividends, if any, will depend upon future earnings and capital requirements of the Company and other factors, which the Board of Directors considers appropriate.
On September 14, 2010, at the Company’s 2010 Annual Meeting of Shareholders, the shareholders of the Company approved the 99¢ Only Stores 2010 Equity Incentive Plan (the “2010 Plan”). There will be no further grants under the Company’s prior equity compensation plan, the 1996 Stock Option Plan, as amended (the “1996 Plan”). The 2010 Plan authorizes the issuance of 4,999,999 shares of the Company’s common stock, of which 4,964,000 were available as of April 2, 2011 for future awards. This includes the unused capacity that will be rolled over from the 1996 Plan and that will become subject to the terms of the 2010 Plan, whereas any awards under the 1996 Plan that are outstanding as of the effective date shall continue to be subject to the terms and conditions of the 1996 Plan. Employees, non-employee directors and consultants of the Company and its affiliates are eligible to receive awards under the 2010 Plan, as determined by the Compensation Committee of the Company’s Board of Directors. All stock options grants are made at fair market value at the date of grant or at a price determined by the Compensation Committee of the Company’s Board of Directors, which consists exclusively of independent members of the Board of Directors. Stock options typically vest over a three-year period, one-third one year from the date of grant and one-third per year on the anniversary of the date of the grant thereafter. Stock options typically expire ten years from the date of grant.
The Company accounts for stock- based compensation expenses in accordance with ASC 718, “Compensation-Stock Compensation”. In fiscal 2011 and 2010, the Company recognized $2.9 million and $7.7 million, respectively, in shared-based compensation expense (see Note 8 to Consolidated Financial Statements for detailed discussion). The Company’s 2010 Equity Incentive Plan will expire in 2020. For further information regarding the 2010 Plan, see the Company’s Current Report on Form 8-K filed on September 17, 2010.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides information as of April 2, 2011 about the Company’s common stock that may be issued upon the exercise of options granted to employees or members of the Company’s Board of Directors under the Company’s existing 2010 Equity Incentive Plan.
(1)
This amount includes 500,000 shares potentially issuable pursuant to outstanding performance stock units granted under the Company’s 1996 Stock Option Plan. This amount also includes 18,000 shares potentially issuable pursuant to outstanding restricted stock units granted to certain employees under the Company’s 2010 Equity Incentive Plan. The actual number of shares of Company common stock to be issued depends on the reaching of the vesting requirements as specified by the performance stock units and the restricted stock unit awards.
(2)
Performance stock units and restricted stock units do not have an exercise price and thus they have been excluded from the weighted average exercise price calculation in column (b).
Stock Repurchase Program
For information on common stock repurchases, see Note 9 to Consolidated Financial Statements, which is incorporated by reference in this Item 2.
Performance Graph
The following graph sets forth the percentage change in cumulative total shareholder return of the Company’s common stock during the period from March 31, 2006 to April 2, 2011, compared with the cumulative returns of the S&P Mid Cap 400 Index and the Russell 2000 Index. The comparison assumes $100 was invested on March 31, 2006 in the common stock and in each of the foregoing indices shown. The stock price performance on the following graph is not necessarily indicative of future stock price performance.
Item 6.
Item 6. Selected Financial Data
The following table sets forth selected financial and operating data of the Company for the periods indicated. The data set forth below should be read in conjunction with the consolidated financial statements and notes thereto. The period ended on April 2, 2011 is comprised of 53 weeks while the other periods presented are comprised of 52 weeks.
(a)
Includes retail operating data solely for the Company’s 99¢ Only Stores. For comparability purposes, comparable stores net sales, average net sales per store and average net sales per estimated saleable square foot are based on comparable 52 weeks, for all periods presented.
(b)
Change in comparable stores net sales compares net sales for all stores open at least 15 months. The Company normally does not relocate stores or close them if renovations are taking place. In a rare situation where a store is relocated, or closed and later re-opened at the same location, the relocated or re-opened store is considered a new store for any comparable store sales analysis, and would only be included in the comparable store sales analysis once it has been open, or re-opened, for 15 months.
(c)
Computed based upon estimated total saleable square footage of stores open for the full year.
(d)
Includes 32 Texas stores open for a full year. Texas stores open for the full year had average sales of $3.4 million per store and average sales per estimated saleable square foot of $181. All non-Texas stores open for the full year had average sales of $5.1 million per store and $307 of average sales per estimated saleable square foot.
(e)
Includes 31 Texas stores open for a full year. Texas stores open for the full year had average sales of $3.4 million per store and average sales per estimated saleable square foot of $180. All non-Texas stores open for the full year had average sales of $5.0 million per store and $305 of average sales per estimated saleable square foot.
(f)
Includes 39 Texas stores open for a full year. Texas stores open for the full year had average sales of $2.7 million per store and average sales per estimated saleable square foot of $142. All non-Texas stores open for the full year had average sales of $5.0 million per store and $301 of average sales per estimated saleable square foot.
(g)
Includes 39 Texas stores open for a full year. Texas stores open for the full year had average sales of $2.6 million per store and average sales per estimated saleable square foot of $128. All non-Texas stores open for the full year had average sales of $4.9 million per store and $291 of average sales per estimated saleable square foot.
(h)
Includes 36 Texas stores open for a full year. Texas stores open for the full year had average sales of $2.4 million per store and average sales per estimated saleable square foot of $120. All non-Texas stores open for the full year had average sales of $4.8 million per store and $284 of average sales per estimated saleable square foot.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in connection with “Item 6. Selected Financial Data” and “Item 8. Financial Statements and Supplementary Data” of this Form 10-K.
General
The Company follows a fiscal calendar consisting of four quarters with 91 days, each ending on the Saturday closest to the calendar quarter-end, and a 52-week fiscal year with 364 days, with a 53-week year every five to six years. Unless otherwise stated, references to years in this report relate to fiscal years rather than calendar years. The Company’s fiscal year 2011 (“fiscal 2011”) which began on March 28, 2010 and ended on April 2, 2011, consisted of 53 weeks with one additional week included in the fourth quarter. The Company’s fiscal year 2010 (“fiscal 2010”) began on March 29, 2009 and ended March 27, 2010, consisted of 52 weeks and its fiscal year 2009 (“fiscal 2009”) began on March 30, 2008 and ended March 28, 2009, also consisted of 52 weeks. For comparability purposes, annual same-store sales, average annual sales per store and annual sales per estimated saleable square foot calculations included in this Form 10-K are based on comparable 52 weeks, ended on March 26, 2011 for fiscal 2011 and ended on March 27, 2010 for fiscal 2010.
In fiscal 2011, a 53-week period, 99¢ Only Stores had net sales of $1,423.9 million, operating income of $117.5 million and net income of $74.3 million. Net sales increased 5.1% over fiscal 2010 primarily due to the benefit of an additional extra week as noted above, eleven new store openings since the end of fiscal 2010 and a 0.7% increase in same-store sales. Average sales per store open the full year, on a comparable 52-week period, increased to $4.9 million in fiscal 2011 from $4.8 million, in fiscal 2010. Average net sales per estimated saleable square foot (computed for stores open for the full year), on a comparable 52-week period increased to $291 per square foot for fiscal 2011 from $289 per square foot for fiscal 2010. This increase reflects the Company’s opening of smaller locations for new store development and increases in same-store sales. Existing stores at April 2, 2011 average approximately 21,200 gross square feet. The Company currently is targeting locations between 15,000 and 19,000 gross square feet.
In fiscal 2011, the Company continued to expand its store base, opening eleven new stores. Of these newly opened stores, six stores are located in California, two in Arizona and three in Texas. The Company closed one store in California upon expiration of its lease during fiscal 2011. In fiscal 2012, the Company plans to increase its store count by approximately 6%, with the majority of new stores expected to be opened in California during the second half of fiscal 2012. The Company believes that near term growth in fiscal 2012 will primarily result from new store openings in its existing territories and increases in same-store sales.
On March 11, 2011, the Company announced that its Board of Directors had received a proposal from members of the Schiffer/Gold family, together with Leonard Green & Partners, L.P., to acquire the Company in a “going private” transaction for $19.09 per share in cash. The Special Committee composed of independent directors and assisted by independent financial and legal advisors was formed to evaluate the proposal and authorized to consider other proposals and strategic alternatives. There is no assurance that a definitive offer for a change of control transaction will be made or, if made, that such a transaction would be consummated. See “Risk Factors -- The going private proposal, and any related Special Committee Process, could materially and adversely affect the Company’s business and financial results; in addition, there can be no assurance that any definitive offer for a change of control transaction will be made or, if made, that such a transaction will be consummated.”
Critical Accounting Policies and Estimates
The preparation of financial statements requires management to make estimates and assumptions that affect reported earnings. These estimates and assumptions are evaluated on an on-going basis and are based on historical experience and other factors that management believes are reasonable. Estimates and assumptions include, but are not limited to, the areas of inventories, long-lived asset impairment, legal reserves, self-insurance reserves, leases, taxes and share-based compensation.
The Company believes that the following represent the areas where more critical estimates and assumptions are used in the preparation of our financial statements:
Inventory valuation: Inventories are valued at the lower of cost (first in, first out) or market. Valuation allowances for shrinkage and obsolete and excess inventory are also recorded. Shrinkage is estimated as a percentage of sales for the period from the last physical inventory date to the end of the applicable period. Such estimates are based on experience and the most recent physical inventory results. Physical inventories are taken at each of the Company’s retail stores at least once a year by an independent inventory service company. Additional store level physical inventories are taken by the service company from time to time based on a particular store’s performance and/or book inventory balance. The Company also performs inventory reviews and analysis on a quarterly basis for both warehouse and store inventory to determine inventory valuation allowances for excess and obsolete inventory. The Company’s policy is to analyze all items held in inventory that would not be sold through at current sales rates over a twenty-four month period to determine what merchandise should be reserved for as excess and obsolete. The valuation allowances for obsolete and excess inventory in many locations (including various warehouses, store backrooms, and sales floors of all its stores) require management judgment and estimates that may impact the ending inventory valuation as well as gross margins. The Company does not believe that there is a reasonable likelihood that there will be a material change in the future estimates or assumptions that the Company uses to calculate these inventory valuation reserves. As an indicator of the sensitivity of this estimate, a 10% increase in our estimates of expected losses from shrinkage and the excess and obsolete inventory provision at April 2, 2011, would have increased these reserves by approximately $1.5 million and $0.4 million, respectively and reduced fiscal 2011 pre-tax earnings by the same amounts.
In order to obtain inventory at attractive prices, the Company takes advantage of large volume purchases, closeouts and other similar purchase opportunities. As such, the Company’s inventory fluctuates from period to period and the inventory balances vary based on the timing and availability of such opportunities. The Company’s inventory was $191.5 million for the fiscal year ended April 2, 2011 and $171.2 million for the fiscal year ended March 27, 2010.
Long-lived asset impairment: In accordance with ASC 360 “Accounting for the Impairment or Disposal of Long-lived Assets” (“ASC360”), the Company assesses the impairment of long-lived assets annually or when events or changes in circumstances indicate that the carrying value may not be recoverable. Recoverability is measured by comparing the carrying amount of an asset to expected future net cash flows generated by the asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, the carrying amount is compared to its fair value and an impairment charge is recognized to the extent of the difference. Factors that the Company considers important which could individually or in combination trigger an impairment review include the following: (1) significant underperformance relative to expected historical or projected future operating results; (2) significant changes in the manner of the Company’s use of the acquired assets or the strategy for the Company’s overall business; and (3) significant changes in the Company’s business strategies and/or negative industry or economic trends. On a quarterly basis, the Company assesses whether events or changes in circumstances occur that potentially indicate that the carrying value of long-lived assets may not be recoverable. The primary factor that could impact the outcome of an impairment evaluation is the estimate of future cash flows expected to be generated by the asset being evaluated. Considerable management judgment is necessary to estimate the cash flows. Accordingly, if actual results fall short of such estimates, significant future impairments could result. In fiscal 2011, the Company did not record any long-lived asset impairment charges. In fiscal 2010, due to the underperformance of one California store, the Company concluded that the carrying value of its long-lived asset was not recoverable and accordingly recorded an asset impairment charge of $0.4 million. In fiscal 2009, the Company recorded impairment charges of $10.4 million because it concluded that the carrying value of certain long-lived assets was not recoverable. These charges primarily consisted of a leasehold improvement impairment charge of approximately $10.1 million related to the Company’s Texas market plan and an impairment charge of approximately $0.3 million related to the underperformance of a store in California. See Note 10 to Consolidated Financial Statements for further information regarding the charges related to the Company’s Texas operations. The Company has not made any material changes to its long-lived asset impairment methodology during fiscal 2011.
Legal reserves: The Company is subject to private lawsuits, administrative proceedings and claims that arise in the ordinary course of business. A number of these lawsuits, proceedings and claims may exist at any given time. While the resolution of a lawsuit, proceeding or claim may have an impact on our financial results for the period in which it is resolved, and litigation is inherently unpredictable, in management’s opinion, none of these matters arising in the ordinary course of business are expected to have a material adverse effect on the Company’s financial position, results of operations, or overall liquidity. Material pending legal proceedings (other than ordinary routine litigation incidental to our business) and material proceedings known to be contemplated by governmental authorities are reported in our Securities Exchange Act reports. In accordance with ASC 450 “Accounting for Contingencies” (“ASC 450”), the Company records a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated.
There were no material changes in the estimates or assumptions used to determine legal reserves during fiscal 2011 and a 10% change in legal reserves will not be material to the Company’s consolidated financial position or results of operations.
Self-insured workers’ compensation liability: The Company self-insures for workers’ compensation claims in California and Texas. The Company establishes a reserve for losses of both estimated known claims and incurred but not reported insurance claims. The estimates are based on reported claims and actuarial valuations of estimated future costs of reported and incurred but not yet reported claims. Should the estimates fall short of the actual claims paid, the liability recorded would not be sufficient and additional workers’ compensation costs, which may be significant, would be incurred. The Company does not discount the projected future cash outlays for the time value of money for claims and claim related costs when establishing its workers’ compensation liability. As an indicator of the sensitivity of this estimate, at April 2, 2011, a 10% increase in our estimate of expected losses from workers compensation claims would have increased this reserve by approximately $4.2 million and reduced fiscal 2011 pre-tax earnings by the same amount.
Operating leases: The Company recognizes rent expense for operating leases on a straight-line basis (including the effect of reduced or free rent and rent escalations) over the applicable lease term. The difference between the cash paid to the landlord and the amount recognized as rent expense on a straight-line basis is included in deferred rent. Cash reimbursements received from landlords for leasehold improvements and other cash payments received from landlords as lease incentives are recorded as deferred tenant improvements. Deferred rent related to landlord incentives is amortized as an offset to rent expense using the straight-line method over the applicable lease term.
For store closures where a lease obligation still exists, the Company records the estimated future liability associated with the rental obligation on the cease use date (when the store is closed) in accordance with ASC 420 “Exit or Disposal Cost Obligations” (“ASC420”). Liabilities are established at the cease use date for the present value of any remaining operating lease obligations, net of estimated sublease income, and at the communication date for severance and other exit costs, as prescribed by ASC 420. Key assumptions in calculating the liability include the timeframe expected to terminate lease agreements, estimates related to the sublease potential of closed locations, and estimation of other related exit costs. If actual timing and potential termination costs or realization of sublease income differ from our estimates, the resulting liabilities could vary from recorded amounts. These liabilities are reviewed periodically and adjusted when necessary.
During fiscal 2011, the Company accrued an additional $0.4 million in lease termination costs associated with the closing of Texas stores in prior periods. During fiscal 2010, the Company closed 12 of its Texas stores and accrued approximately $3.0 million in lease termination costs associated with the closing of seven out of the 12 Texas stores. Of the $3.0 million lease termination costs accrual, the Company recognized a net expense of $2.5 million as these costs were partially offset by a reduction in expenses of $0.5 million due to the reversal of deferred rent and tenant improvements related to these stores during fiscal 2010. See Note 10 to Consolidated Financial Statements for further information regarding the lease termination charges related to Company’s Texas operations.
Tax Valuation Allowances and Contingencies: The Company accounts for income taxes in accordance with ASC 740 “Income Taxes” (“ASC 740”), which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. ASC 740-10-55 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the net deferred tax assets will not be realized. The Company had approximately $54.7 million and $70.9 million in net deferred tax assets that are net of tax valuation allowances of $5.8 million as of April 2, 2011 and March 27, 2010. Management evaluated the available evidence in assessing the Company’s ability to realize the benefits of the net deferred tax assets at April 2, 2011 and concluded it is more likely than not that the Company will not realize a portion of its net deferred tax assets. The remaining balance of the net deferred tax assets should be realized through future operating results and the reversal of taxable temporary differences. Income tax contingencies are accounted for in accordance with ASC 740-10-50 and may require significant management judgment in estimating final outcomes. The Company had approximately $1.4 million at March 28, 2009 of unrecognized tax benefits related to uncertain tax positions. The statute of limitations have expired for the periods related to these uncertain tax positions at the end of fiscal 2010. There are no new uncertain tax positions at the end of fiscal 2011.
Share-Based Compensation: The Company has a stock incentive plan in effect under which the Company grants stock options, performance stock units (“PSUs”) and restricted stock units (“RSUs”). The Company accounts for stock-based compensation expense under the fair value recognition provisions of ASC 718, “Compensation-Stock Compensation” (“ASC 718”). ASC 718 requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as an expense ratably over the requisite service periods. The Company estimates the fair value for each option award as of the date of grant using the Black-Scholes option pricing model. The Black-Scholes model considers, among other factors, the expected life of the award and the expected volatility of the Company’s stock price. Stock options are granted to employees at exercise prices equal to the fair market value of the Company’s stock at the dates of grant. The Company recognizes the stock-based compensation expense ratably over the requisite service periods, which is generally a vesting term of three years. Stock options typically have a term of 10 years. The fair value of the PSUs and RSUs is based on the stock price on the grant date. The compensation expense related to PSUs is recognized only when it is probable that the performance criteria will be met. The compensation expense related to RSUs is recognized based on the number of shares expected to vest. During fiscal 2011, expected stock price volatility and the assumed risk free rate decreased slightly based upon recent historical trends. These changes are not material to the Company’s consolidated financial position or results of operations. There were no other material changes in the estimates or assumptions used to determine stock-based compensation during fiscal 2011.
Results of Operations
The following discussion defines the components of the statement of income and should be read in conjunction with “Item 6. Selected Financial Data.”
Net Sales: Revenue is recognized at the point of sale for retail sales. Bargain Wholesale sales revenue is recognized on the date merchandise is shipped. Bargain Wholesale sales are primarily shipped free on board shipping point.
Cost of Sales: Cost of sales includes the cost of inventory, freight in, inter-state warehouse transportation costs, inventory shrinkage (obsolescence, spoilage and shrink), and is net of discounts and allowances. Cash discounts for satisfying early payment terms are recognized when payment is made, and allowances and rebates based upon milestone achievements such as reaching a certain volume of purchases of a vendor’s products are included as a reduction of cost of sales when such contractual milestones are reached in accordance with ASC 605-50-25 “Revenue Recognition-Customer Payments and Incentives-Recognition”. In addition, the Company analyzes its inventory levels and related cash discounts received to arrive at a value for cash discounts to be included in the inventory balance. The Company does not include purchasing, receiving, distribution, warehouse costs and transportation to and from stores in its cost of sales, which totaled $67.5 million, $66.3 million and $74.1 million as of fiscal 2011, 2010 and 2009, respectively. Due to this classification, the Company's gross profit rates may not be comparable to those of other retailers that include costs related to their distribution network in cost of sales.
Selling, General, and Administrative Expenses: Selling, general, and administrative expenses include purchasing, receiving, inspection and warehouse costs, the costs of selling merchandise in stores (payroll and associated costs, occupancy and other store-level costs), distribution costs (payroll and associated costs, occupancy, transportation to and from stores, and other distribution-related costs), and corporate costs (payroll and associated costs, occupancy, advertising, professional fees, stock-based compensation expense and other corporate administrative costs). Selling, general, and administrative expenses also include depreciation and amortization expense.
Other (Income) Expense: Other (income) expense relates primarily to the interest income on the Company’s marketable securities, net of interest expense on the Company’s capitalized leases and the impairment charge related to the Company’s marketable securities.
The following table sets forth for the periods indicated, certain selected income statement data, including such data as a percentage of net sales. The period ended on April 2, 2011 is comprised of 53 weeks while the other periods presented are comprised of 52 weeks (percentages may not add up due to rounding):
Fiscal Year Ended April 2, 2011 Compared to Fiscal Year Ended March 27, 2010
Net sales. Total net sales increased $68.7 million, or 5.1%, to $1,423.9 million in fiscal 2011, a 53-week period, from $1,355.2 million in fiscal 2010, a 52-week period. Net retail sales increased $66.1 million, or 5.0%, to $1,380.4 million in fiscal 2011 from $1,314.2 million in fiscal 2010, and include the benefit of an additional extra week included in the fourth quarter of fiscal 2011, which contributed an additional $26.9 million of retail sales. Of the remaining $39.2 million increase in net retail sales, $9.5 million was due to a 0.7% increase in comparable stores net sales for all stores open at least 15 months in fiscal 2011 and 2010, calculated on a comparable 52-week period. The comparable stores net sales increase was attributable to a 1.0% increase in transaction counts and decrease in average ticket size by 0.3% to $9.58 from $9.61. The full year fiscal 2011 effect of stores opened in fiscal 2010 increased sales by $20.9 million and the effect of 11 new stores opened during fiscal 2011 increased net retail sales by $16.0 million, based on a 52 week period. The increase in sales was partially offset by a decrease in sales of approximately $7.2 million due to the effect of the closing of one store in California upon expiration of its lease during fiscal 2011 and closing of 12 stores in Texas and one store in California during fiscal 2010. Bargain Wholesale net sales increased approximately by $2.6 million, or 6.3%, to $43.5 million in fiscal 2011 from $41.0 million in fiscal 2010. Of the $2.6 million increase in Bargain Wholesale net sales, $1.0 million was due to the effect of the additional week included in the fourth quarter of fiscal 2011.
During fiscal 2011, the Company added eleven new stores: six in California, two in Arizona and three in Texas. The Company closed one store in California during fiscal 2011. At the end of fiscal 2011, the Company had 285 stores compared to 275 as of the end of fiscal 2010. Gross retail square footage at the end of fiscal 2011 and fiscal 2010 was 6.05 million and 5.86 million, respectively. For 99¢ Only Stores open all of fiscal 2011, the average net sales per estimated saleable square foot, on a comparable 52-week period, was $291 and the average annual net sales per store were $4.9 million, including the Texas stores open for the full year. Non-Texas stores net sales averaged $5.1 million per store and $307 per square foot. Texas stores open for a full year averaged net sales of $3.4 million per store and $181 per square foot.
Gross profit. Gross profit increased $23.7 million, or 4.3%, to $581.1 million in fiscal 2011 from $557.4 million in fiscal 2010. As a percentage of net sales, overall gross margin decreased to 40.8% in fiscal 2011 from 41.1% in fiscal 2010. Among gross profit components, cost of products sold increased to 56.4% of net sales for fiscal 2011compared to 56.1% of net sales for fiscal 2010 due to merchandise price increases and a shift in product mix. The freight costs for fiscal 2011 increased by 30 basis points compared to fiscal 2010. For fiscal 2011, shrinkage decreased to 2.5% of net sales compared to 2.6% of net sales for fiscal 2010. The remaining change was made up of decreases in other less significant items included in cost of sales.
Operating expenses. Operating expenses decreased by $0.6 million, or 0.1%, to $436.0 million in fiscal 2011 from $436.6 million in fiscal 2010. As a percentage of net sales, operating expenses decreased to 30.6% for fiscal 2011 from 32.2% for fiscal 2010. Of the 160 basis point decrease in operating expenses as a percentage of net sales, retail operating expenses decreased by 40 basis points, distribution and transportation costs decreased by 20 basis points, corporate expenses decreased by 30 basis points, and other items decreased by 70 basis points as described below.
Retail operating expenses for fiscal 2011 decreased as a percentage of net sales by 40 basis points to 22.5% of net sales, compared to 22.9% of net sales for fiscal 2010. The majority of the decrease as a percentage of net sales was due to lower rent expenses and lower payroll-related expenses as a result of improvement in labor productivity. These decreases were partially offset by a slight increase in outside service fees, advertising and various other expenses as a percentage of net sales.
Distribution and transportation expenses for fiscal 2011 decreased as a percentage of net sales by 20 basis points to 4.7% of net sales, compared to 4.9% of net sales for fiscal 2010. The decrease as a percentage of net sales was primarily due to overall improvements in efficiencies.
Corporate operating expenses for fiscal 2011 decreased as a percentage of net sales by 30 basis points to 3.2% of net sales, compared to 3.5% of net sales for fiscal 2010. The decrease as a percentage of net sales was primarily due to lower payroll and payroll related expenses and various other expenses which were partially offset by a slight increase in repair and maintenance costs.
The remaining operating expenses for fiscal 2011 decreased as a percentage of net sales by 70 basis points to 0.3% of net sales, compared to 1.0% for fiscal 2010. The decrease in other operating expenses was primarily due to the reduction of stock-based compensation by approximately $4.8 million, compared to fiscal 2010, related to a decrease in performance stock unit expense. The performance stock unit expense was higher in fiscal 2010 because the majority of the performance criteria were met in fiscal 2010. In addition, the decrease in other operating expenses in fiscal 2011, compared to fiscal 2010, was due to the proceeds from a legal settlement from a third party administrator related to workers’ compensation of approximately $2.2 million which was received in fiscal 2011 and net lease termination and closing costs of approximately $2.5 million which were included in fiscal 2010.
Depreciation and amortization. Depreciation and amortization increased $0.2 million, or 0.8%, to $27.6 million in fiscal 2011 from $27.4 million in fiscal 2010. The increase was primarily a result of new depreciable assets added as a result of new store openings. Depreciation as a percentage of net sales decreased to 1.9% from 2.0% of net sales due to the increase in sales.
Operating income. Operating income was $117.5 million for fiscal 2011 compared to operating income of $93.4 million for fiscal 2010. Operating income as a percentage of net sales was 8.3% in fiscal 2011 compared to operating income as a percentage of net sales of 6.9% in fiscal 2010. This was primarily due to the changes in gross margin and operating expenses discussed above.
Other income, net. Other income increased to $0.7 million in fiscal 2011 compared to $0.1 million in fiscal 2010. The increase in other income of $0.6 million was primarily due to a lower investment impairment charge of $0.1 million for fiscal 2011 compared to an investment impairment charge of $0.8 million for fiscal 2010 related to credit losses on the Company’s available for sale securities. This change was offset by lower interest income which decreased to $0.9 million for fiscal 2011 from $1.1 million for fiscal 2010, primarily due to lower interest rates. Interest expense decreased to $0.1 million for fiscal 2011 compared to interest expense of $0.2 million for fiscal 2010.
Provision for income taxes. The income tax provision in fiscal 2011 was $43.9 million compared to $33.1 million in fiscal 2010, due to the increase in pre-tax income. The effective tax rate for fiscal 2011 was 37.1% compared to an effective tax rate of 35.4% for fiscal 2010. The effective tax rate for fiscal 2011 was higher than fiscal 2010, primarily due to a one-time benefit of approximately $1.4 million in fiscal 2010 related to the expiration of the statutes of limitations related to uncertain tax positions, which equates to an approximately 1% reduction in effective tax rate for fiscal 2010. The effective combined federal and state income tax rates are less than the statutory rates in each period due to tax credits and the effect of certain revenues and/or expenses that are not subject to taxation.
Net income. As a result of the items discussed above, net income increased $13.9 million, or 22.9%, to $74.3 million in fiscal 2010 from $60.4 million in fiscal 2010. Net income as a percentage of net sales increased to 5.2% in fiscal 2011 from 4.5% in fiscal 2010.
Fiscal Year Ended March 27, 2010 Compared to Fiscal Year Ended March 28, 2009
Net sales. Total net sales increased $52.2 million, or 4.0%, to $1,355.2 million in fiscal 2010 from $1,302.9 million in fiscal 2009. Net retail sales increased $52.1 million, or 4.1%, to $1,314.2 million in fiscal 2010 from $1,262.1 million in fiscal 2009. Of the $52.1 million increase in net retail sales, $47.6 million was due to a 3.9% increase in comparable stores net sales for all stores open at least 15 months in fiscal 2010 and 2009. The comparable stores net sales increase was attributable to a 4.0% increase in transaction counts and decrease in average ticket size by 0.1% to $9.59 from $9.60. The full year fiscal 2010 effect of stores opened in fiscal 2009 increased sales by $19.5 million and the effect of nine new stores opened during fiscal 2010 increased net retail sales by $19.7 million. The increase in sales was partially offset by a decrease in sales of approximately $34.7 million due to the effect of the closing of 17 stores in Texas and one in California during fiscal 2010 and fiscal 2009. Bargain Wholesale net sales increased $0.1 million, or 0.3%, to $41.0 million in fiscal 2010 from $40.8 million in fiscal 2009.
During fiscal 2010, the Company added nine stores: eight in California and re-opened one store in Texas, which was closed due to a hurricane. The Company closed 12 stores in Texas and one in California during fiscal 2010. At the end of fiscal 2010, the Company had 275 stores compared to 279 as of the end of fiscal 2009. Gross retail square footage at the end of fiscal 2010 and fiscal 2009 was 5.86 million and 5.99 million, respectively. For 99¢ Only Stores open all of fiscal 2010, the average net sales per estimated saleable square foot was $289 and the average annual net sales per store were $4.8 million, including the Texas stores open for the full year. Non-Texas stores net sales averaged $5.0 million per store and $305 per square foot. Texas stores open for a full year averaged net sales of $3.4 million per store and $180 per square foot.
Gross profit. Gross profit increased $45.6 million, or 8.9%, to $557.4 million in fiscal 2010 from $511.8 million in fiscal 2009. As a percentage of net sales, overall gross margin increased to 41.1% in fiscal 2010 from 39.3% in fiscal 2009. The increase in gross profit margin was primarily due to a decrease in cost of products sold to 56.1% of net sales for fiscal 2010 compared to 57.1% of net sales for fiscal 2009 due to a favorable shift in product mix and new buying and merchandising initiatives to drive sales of higher margin items. In addition, an increase in gross profit margin was also due to a decrease in spoilage/shrinkage to 2.6% of net sales in fiscal 2010 compared to 3.2% in fiscal 2009. This reduction in shrinkage is primarily due to a one time reduction in shrink reserves of approximately $1.8 million for Texas based on the shrink analysis performed at the end of fiscal 2010 and lower overall shrink as a result of the trend of physical inventories taken during fiscal 2010 as well as a decrease in recorded scrap from perishables. The remaining change was made up of increases and decreases in other less significant items included in cost of sales.
Operating expenses. Operating expenses decreased by $28.0 million, or 6.0%, to $436.6 million in fiscal 2010 from $464.6 million in fiscal 2009. As a percentage of net sales, operating expenses decreased to 32.2% for fiscal 2010 from 35.7% for fiscal 2009. Of the 340 basis points decrease in operating expenses as a percentage of net sales, retail operating expenses decreased by 150 basis points, distribution and transportation costs decreased by 80 basis points, corporate expenses decreased by 70 basis points, and other items decreased by 40 basis points as described below.
Retail operating expenses for fiscal 2010 decreased as a percentage of net sales by 150 basis points to 22.9% of net sales, compared to 24.4% of net sales for fiscal 2009. The majority of the decrease as a percentage of net sales was due to lower payroll-related expenses as a result of improvement in labor productivity, lower rent expenses and the implementation of new cost control methods resulting in lower utilities and supplies costs.
Distribution and transportation expenses for fiscal 2010 decreased as a percentage of net sales by 80 basis points to 4.9% of net sales, compared to 5.7% of net sales for fiscal 2009. The decrease as a percentage of net sales was primarily due to improvements in labor efficiencies, improved processing methods, lower fuel costs and improved trailer utilization.
Corporate operating expenses for fiscal 2010 decreased as a percentage of net sales by 70 basis points to 3.5% of net sales, compared to 4.2% of net sales for fiscal 2009. The decrease as a percentage of net sales was primarily due to lower payroll and payroll related expenses, consulting and professional fees, and legal costs.
The remaining operating expenses for fiscal 2010 decreased as a percentage of net sales by 40 basis points to 1.0% of net sales, compared to 1.4% for fiscal 2009. The decrease in other operating expenses compared to the fiscal 2009 was primarily due to a reduction in an asset impairment charge of $9.9 million, and a severance charge of approximately $1.4 million related to the Company’s Texas operations, as well as the recording of a $0.8 million loss on a foreclosure sale of a shopping center owned by the La Quinta Partnership, partially offset by the recording of the Company’s share of a gain on a sale of the primary asset of the Reseda Partnership of approximately $0.2 million and consolidation of the partner’s gain of the Reseda Partnership of approximately $1.4 million during fiscal 2009.
The decreases in fiscal 2010 operating expenses compared to fiscal 2009 were partially offset by an increase of $4.6 million in stock-based compensation expense primarily related to performance stock unit expense, and lease termination and closing costs of approximately $1.2 million related to the closure of some Texas stores in fiscal 2010. The remaining change of $0.3 million was made up of increases and decreases in other less significant items included in other operating expenses.
Depreciation and amortization. Depreciation and amortization decreased $6.9 million, or 20.0%, to $27.4 million in fiscal 2010 from $34.3 million in fiscal 2009. The decrease was primarily a result of closing 17 stores in Texas and one store in California and also due to the assets that became fully depreciated in existing stores compared to the amount of new depreciable assets added as a result of new store openings. Depreciation as a percentage of net sales decreased to 2.0% from 2.6% of net sales for the reasons discussed above as well as due to sales improvements.
Operating income. Operating income was $93.4 million for fiscal 2010 compared to operating income of $12.9 million for fiscal 2009. Operating income as a percentage of net sales was 6.9% in fiscal 2010 compared to operating income as a percentage of net sales of 1.0% in fiscal 2009. This was primarily due to the changes in gross margin and operating expenses discussed above.
Other income, net. Other income decreased $0.9 million to $0.1 million in fiscal 2010 compared to $1.0 million in fiscal 2009. The decrease in other income was primarily due to lower interest income which decreased to $1.1 million for fiscal 2010 from $3.5 million for fiscal 2009, primarily due to lower interest rates. The decrease in other income for fiscal 2010 was partially offset by a decrease of $0.9 million for an investment impairment charge related to the Company’s available for sale securities. The Company recorded an investment impairment charge related to credit losses of approximately $0.8 million for fiscal 2010 compared to an investment impairment charge of $1.7 million for fiscal 2009 related to the Company’s available for sale securities. The decrease was also offset by lower interest expense which was $0.2 million for fiscal 2010 compared to interest expense of $0.9 million for fiscal 2009.
Provision for income taxes. The income tax provision in fiscal 2010 was $33.1 million compared to $4.1 million in fiscal 2009, due to the increase in pre-tax income. The effective tax rate for fiscal 2010 was 35.4% compared to an effective tax rate of 29.3% for fiscal 2009. In fiscal 2009, the Company wrote off approximately $1.4 million of Texas net operating loss credits due to the Company’s decision to exit the Texas market. The effective combined federal and state income tax rates are less than the statutory rates in each period due to tax credits and the effect of certain revenues and/or expenses that are not subject to taxation.
Net income. As a result of the items discussed above, net income increased $52.0 million, or 612.7%, to $60.4 million in fiscal 2010 from $8.5 million in fiscal 2009. Net income as a percentage of net sales increased to 4.5% in fiscal 2010 from 0.7% in fiscal 2009.
Effects of Inflation
The Company experienced increases in health care costs, fuel costs and some vendor prices during fiscal 2011. During fiscal 2010, inflation had a minimal impact on the Company’s overall operations. Increases in various costs due to future inflation may impact the Company’s operating results to the extent that such increases cannot be passed along to its customers. See Item 1A, “Risk Factor - Inflation may affect the Company’s ability to keep pricing almost all of its merchandise at 99.99¢ or less.”
Liquidity and Capital Resources
The Company funds its operations principally from cash provided by operations, short-term investments and cash on hand, and has generally not relied upon external sources of financing. The Company’s capital requirements result primarily from purchases of inventory, expenditures related to new store openings, including purchases of land, and working capital requirements for new and existing stores. The Company takes advantage of closeout and other special-situation opportunities, which frequently result in large volume purchases, and as a consequence its cash requirements are not constant or predictable during the year and can be affected by the timing and size of its purchases.
Net cash provided by operating activities in fiscal 2011, 2010, and 2009 was $79.8 million, $74.9 million, and $62.9 million, respectively, consisting primarily of $117.3 million, $89.9 million, and $47.9 million, respectively, of net income adjusted for depreciation and other non-cash items. Net cash used in working capital activities was $37.2 million and $12.6 million in fiscal 2011 and 2010, respectively. Net cash provided by working capital activities was $23.2 million in fiscal 2009. Net cash used by working capital activities in fiscal 2011 primarily reflects the increases in inventories, deposits and other assets, income taxes receivable and a decrease in workers’ compensation liability, which were partially offset by the increase in accounts payable and a decrease in accounts receivable. Net cash used by working capital activities in fiscal 2010 primarily reflects the increases in inventories and income taxes receivable, which were partially offset by the increases in accounts payable, accrued expenses and workers’ compensation liability. Net cash provided by working capital activities in fiscal 2009 primarily reflects increases in accounts payable and other accrued expenses, partially offset by an increase in inventories. In fiscal 2011, the Company’s inventories increased by approximately $20.0 million compared to fiscal 2010, primarily due to growth in the number of stores and increased in-stock levels at the stores. In fiscal 2010, the Company’s inventories increased by $19.3 million compared to fiscal 2009, primarily due to the increase in sales and the Easter selling season.
Net cash used in investing activities during fiscal 2011, 2010, and 2009 was $86.7 million, $83.6 million, and $37.6 million, respectively. In fiscal 2011, 2010, and 2009 the Company used $61.1 million, $34.8 million, and $34.2 million, respectively, for property acquisition, leasehold improvements, fixtures and equipment for new store openings, information technology projects and other capital projects. In addition, during fiscal 2009, the Company paid $4.6 million for the purchase of assets related to its partnerships. In fiscal 2011, 2010, and 2009, the Company received cash inflows of $43.6 million, $31.5 million, and $59.2 million, respectively, from the sale and maturity of available for sale securities, and paid $69.3 million, $81.1 million, and $60.7 million, respectively, for the purchases of investments. The investing activities in fiscal 2011 and fiscal 2010 also reflect the proceeds of $0.2 million and $0.8 million, respectively, from the disposal and sale of fixed assets during fiscal 2011. The investing activities in fiscal 2009 also reflect the proceeds of $2.2 million from the sale of the assets of the Company’s partnerships as well as $0.5 million from the disposal of fixed assets.
Net cash provided by financing activities during fiscal 2011 was $3.7 million, which is composed primarily of proceeds of $5.0 million from the exercise of stock options partially offset by payments of $2.3 million to satisfy employee tax obligations related to the issuance of performance stock units as part of the Company’s equity incentive plan. Net cash provided by financing activities during fiscal 2010 was $6.7 million, which is composed primarily of proceeds of $7.8 million from the exercise of stock options partially offset by payments of $2.7 million to satisfy employee tax obligations related to the issuance of performance stock units as part of the Company’s equity incentive plan. The Company also paid approximately $0.3 million to acquire the remaining noncontrolling interest in a partnership during fiscal 2010. Net cash used in financing activities during fiscal 2009 was $12.9 million, which consisted primarily of repurchases of the Company’s common stock.
The Company estimates that total capital expenditures in fiscal year 2012 will be approximately $64.8 million and relate principally to property acquisitions of approximately $29.1 million, $17.8 million for leasehold and fixtures and equipment for new store openings, $14.9 million for information technology projects and $3.0 million for other capital projects. The Company may also consider additional opportunistic real estate purchases primarily to reduce its rental expense. The Company intends to fund its liquidity requirements in fiscal 2012 from net cash provided by operations, short-term investments, and cash on hand.
In June 2008, based on the Company’s outlook, cash position, and stock price relative to potential value, the Company's Board of Directors authorized a share repurchase program for the purchase of up to $30 million of the Company's common stock. Under the authorization, the Company may purchase shares from time to time in the open market or in privately negotiated transactions in compliance with the applicable rules and regulations of the Securities and Exchange Commission. However, the timing and amount of such purchases will be at the discretion of management, and will depend on market conditions and other considerations which may change. As of March 28, 2009, the Company had repurchased a total of 1,660,296 shares of common stock at an average price of $7.76 per share, for a total of $12.9 million. The Company has approximately $17.1 million that remains authorized and available to repurchase shares of Company’s common stock under this program. The Company had no share purchases during fiscal 2011.
The Company issues performance stock units as part of our equity incentive plan. The number of shares issued on the date the performance stock units vest is net of the statutory withholding requirements that the Company pays in cash to the appropriate taxing authorities on behalf of the employees. During fiscal 2011, the Company withheld approximately 146,000 shares to satisfy $2.3 million of employee tax obligations. Although shares withheld are not issued, they are treated as common stock repurchases in the Company’s Consolidated Financial Statements, as they reduce the number of shares that would have been issued upon vesting.
Off-Balance Sheet Arrangements
As of April 2, 2011, the Company had no off-balance sheet arrangements.
Contractual Obligations
The following table summarizes the Company’s consolidated contractual obligations (in thousands) as of April 2, 2011.
The Company does not have any liabilities related to uncertain tax positions as of April 2, 2011. See Note 5, “Income Tax Provision” to Consolidated Financial Statements.
Lease Commitments
The Company leases various facilities under operating leases (except for one location that is classified as a capital lease), which will expire at various dates through fiscal year 2031. Most of the lease agreements contain renewal options and/or provide for fixed rent escalations or increases based on the Consumer Price Index. Total minimum lease payments under each of these lease agreements, including scheduled increases, are charged to operations on a straight-line basis over the term of each respective lease. Most leases require the Company to pay property taxes, maintenance and insurance. Rental expense charged to operations in fiscal 2011, 2010, and 2009 were approximately $56.7 million, $60.7 million and $60.6 million, respectively. The Company typically seeks leases with a five-year to ten-year term and with multiple five-year renewal options. See “Item 2. Properties”. The large majority of the Company’s store leases were entered into with multiple renewal periods, which are typically five years and occasionally longer.
Variable Interest Entities
At April 2, 2011 and March 27, 2010, the Company no longer has any variable interest entities.
Seasonality and Quarterly Fluctuations
The Company has historically experienced and expects to continue to experience some seasonal fluctuations in its net sales, operating income, and net income. The highest sales periods for the Company are the Christmas, Halloween and Easter seasons. A proportionately greater amount of the Company’s net sales and operating and net income is generally realized during the quarter ended on or near December 31. The Company’s quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including the timing of certain holidays such as Easter, the timing of new store openings and the merchandise mix.
New Authoritative Pronouncements
Information regarding new authoritative pronouncements is contained in Note 1 to the Consolidated Financial Statements for the year ended April 2, 2011, which is incorporated herein by this reference.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to interest rate risk for its investments in marketable securities but management believes the risk is not material. At April 2, 2011, the Company had $196.2 million in securities maturing at various dates through May 2046, with approximately 94.3% maturing within one year. At March 27, 2010, the Company had $170.4 million in securities maturing at various dates through May 2046, with approximately 91.3% maturing within one year. The Company’s investments are comprised primarily of marketable investment grade government and municipal bonds, corporate bonds, auction rate securities, asset-backed securities, commercial paper, and money market funds. Because the Company generally invests in securities with terms of one year or less, the Company generally holds investments until maturity, and therefore should not bear any interest risk due to early disposition. The Company does not enter into any derivative or interest rate hedging transactions. The Company’s investment portfolio has certain perpetual preferred stocks with periodic recurring dividend payments that were less than 1.0% of the Company’s investment portfolio in fiscal 2011. At April 2, 2011, the fair value of investments approximated the carrying value. Based on the investments outstanding at April 2, 2011, a 1% increase in interest rates would reduce the fair value of the Company’s total investment portfolio by approximately $0.2 million or 0.1%. The Company has no outstanding debt as of April 2, 2011.
Item 8.
Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
99¢ Only Stores
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
99¢ Only Stores
City of Commerce, California
We have audited the accompanying consolidated balance sheets of the 99¢ Only Stores and consolidated entities (the “Company”) as of April 2, 2011 and March 27, 2010 and the related consolidated statements of income, shareholders’ equity, and cash flows for the years ended April 2, 2011, March 27, 2010 and March 28, 2009. In connection with our audits of the financial statements, we have also audited the financial statement schedule listed in the accompanying index under Item 15(b). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedule. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company at April 2, 2011 and March 27, 2010, and the results of its operations and its cash flows for the years ended April 2, 2011, March 27, 2010 and March 28, 2009 in conformity with accounting principles generally accepted in the United States of America.
Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein for the years ended April 2, 2011, March 27, 2010 and March 28, 2009.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of April 2, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated May 26, 2011 expressed an unqualified opinion thereon.
/s/ BDO USA, LLP
Los Angeles, California
May 26, 2011
99¢ Only Stores
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)
The accompanying notes are an integral part of these financial statements.
99¢ Only Stores
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share data)
The accompanying notes are an integral part of these financial statements.
99¢ Only Stores
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
YEARS ENDED APRIL 2, 2011, MARCH 27, 2010 and MARCH 28, 2009
(Amounts in thousands)
The accompanying notes are an integral part of these financial statements.
99¢ Only Stores
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
The accompanying notes are an integral part of these financial statements.
99¢ Only Stores
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fiscal Years Ended April 2, 2011, March 27, 2010 and March 28, 2009
1.
Basis of Presentation and Summary of Significant Accounting Policies
Nature of Business
The Company is incorporated in the State of California. The Company is an extreme value retailer of primarily consumable and general merchandise with an emphasis on name-brand products. As of April 2, 2011, the Company operated 285 retail stores with 211 in California, 35 in Texas, 27 in Arizona, and 12 in Nevada. The Company is also a wholesale distributor of various consumer products.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its subsidiaries and variable interest entities required to be consolidated in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Intercompany accounts and transactions between the consolidated companies have been eliminated in consolidation.
Fiscal Periods
The Company follows a fiscal calendar consisting of four quarters with 91 days, each ending on the Saturday closest to the calendar quarter-end, and a 52-week fiscal year with 364 days, with a 53-week year every five to six years. Unless otherwise stated, references to years in this report relate to fiscal years rather than calendar years. The Company’s fiscal year 2011 (“fiscal 2011”) which began on March 28, 2010 and ended on April 2, 2011, consisted of 53 weeks with one additional week included in the fourth quarter. The Company’s fiscal year 2010 (“fiscal 2010”) began on March 29, 2009 and ended March 27, 2010, consisted of 52 weeks and its fiscal year 2009 (“fiscal 2009”) began on March 30, 2008 and ended March 28, 2009, also consisted of 52 weeks. For comparability purposes, annual same-store sales, average annual sales per store and annual sales per estimated saleable square foot calculations included in this Form 10-K are based on comparable 52 weeks, ended on March 26, 2011 for fiscal 2011 and ended on March 27, 2010 for fiscal 2010.
Use of Estimates
The preparation of the financial statements in conformity with GAAP 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.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year presentation.
Cash
For purposes of reporting cash flows, cash includes cash on hand and at the stores and cash in financial institutions. Cash balances held at financial institutions are generally in excess of federally insured limits. The Company has not experienced any losses in such accounts. These accounts are only insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000. The Company’s cash balances held at financial institutions and exceeding FDIC insurance totaled $32.4 million and $29.3 million, respectively as of April 2, 2011 and March 27, 2010. The Company places its temporary cash investments with what it believes to be high credit, quality financial institutions and limits the amount of credit exposure to any one financial institution.
Allowance for Doubtful Accounts
In connection with its wholesale business, the Company evaluates the collectability of accounts receivable based on a combination of factors. In cases where the Company is aware of circumstances that may impair a specific customer’s ability to meet its financial obligations subsequent to the original sale, the Company will record an allowance against amounts due and thereby reduce the net recognized receivable to the amount the Company reasonably believes will be collected. For all other customers and tenants, the Company recognizes allowances for doubtful accounts based on the length of time the receivables are past due, industry and geographic concentrations, the current business environment and the Company’s historical experiences.
Investments
The Company’s investments in debt and equity securities are classified as available for sale and are comprised primarily of marketable investment grade government and municipal bonds, corporate bonds and equity securities, auction rate securities, asset-backed securities, commercial paper and money market funds. The Company has included its auction rate securities in non-current assets on the Company’s consolidated balance sheets as of April 2, 2011 and March 27, 2010. See Note 3, “Investments.”
Investment securities are recorded as required by Accounting Standard Codification (“ASC”) 320, “Investments-Debt and Equity Securities” (“ASC 320”). These investments are carried at fair value, based on quoted market prices or other readily available market information. Investments are adjusted for the amortization of premiums or discounts to maturity and such amortization is included in interest income. Unrealized gains and losses, net of taxes, are included in accumulated other comprehensive income, which is reflected as a separate component of shareholders’ equity in the Company’s Consolidated Balance Sheets. Gains and losses are recognized when realized in the Company’s Consolidated Statements of Income. When it is determined that an other-than-temporary decline in fair value has occurred, the amount of the decline that is related to a credit loss is recognized in earnings.
Inventories
Inventories are valued at the lower of cost (first in, first out) or market. Valuation allowances for shrinkage and obsolete and excess inventory are also recorded. Shrinkage is estimated as a percentage of sales for the period from the last physical inventory date to the end of the applicable period. Such estimates are based on experience and the most recent physical inventory results. Physical inventories are taken at each of the Company’s retail stores at least once a year by an independent inventory service company. Additional store level physical inventories are taken by the service company from time to time based on a particular store’s performance and/or book inventory balance. The Company also performs inventory reviews and analysis on a quarterly basis for both warehouse and store inventory to determine inventory valuation allowances for excess and obsolete inventory. The Company’s policy is to analyze all items held in inventory that would not be sold through at current sales rates over a twenty-four month period to determine what merchandise should be reserved for as excess and obsolete. The valuation allowances for obsolete and excess inventory in many locations (including various warehouses, store backrooms, and sales floors of all its stores), require management judgment and estimates that may impact the ending inventory valuation and valuation allowances that may affect the reported gross margin for the period.
In order to obtain inventory at attractive prices, the Company takes advantage of large volume purchases, closeouts and other similar purchase opportunities. As such, the Company’s inventory fluctuates from period to period and the inventory balances vary based on the timing and availability of such opportunities. The Company’s inventory was $191.5 million for the fiscal year ended April 2, 2011, $171.2 million for the fiscal year ended March 27, 2010.
At times, the Company also makes large block purchases of inventory that it plans to sell over a period of longer than twelve months. As of April 2, 2011 and March 27, 2010, the Company held inventory of specific products identified that it expected to sell over a period that exceeds twelve months of approximately $4.5 million and $4.8 million, respectively, which is included in deposits and other assets in the consolidated financial statements.
Property and Equipment
Property and equipment are carried at cost and are depreciated or amortized on a straight-line basis over the following useful lives:
Owned buildings and improvements
Lesser of 30 years or the estimated useful life of the improvement
Leasehold improvements
Lesser of the estimated useful life of the improvement or remaining lease term
Fixtures and equipment
5 years
Transportation equipment
3-5 years
Information technology systems
For major corporate systems, estimated useful life up to 7 years; for functional stand alone systems, estimated useful life up to 5 years
The Company’s policy is to capitalize expenditures that materially increase asset lives and expense ordinary repairs and maintenance as incurred.
Long-Lived Assets
In accordance with ASC 360 “Property, Plant and Equipment” (“ASC360”), the Company assesses the impairment of long-lived assets quarterly or when events or changes in circumstances indicate that the carrying value may not be recoverable. Recoverability is measured by comparing the carrying amount of an asset to expected future net cash flows generated by the asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, the carrying amount is compared to its fair value and an impairment charge is recognized to the extent of the difference. Factors that the Company considers important which could individually or in combination trigger an impairment review include the following: (1) significant underperformance relative to expected historical or projected future operating results; (2) significant changes in the manner of the Company’s use of the acquired assets or the strategy for the Company’s overall business; and (3) significant changes in the Company’s business strategies and/or negative industry or economic trends. On a quarterly basis, the Company assesses whether events or changes in circumstances occur that potentially indicate that the carrying value of long-lived assets may not be recoverable. Considerable management judgment is necessary to estimate projected future operating cash flows. Accordingly, if actual results fall short of such estimates, significant future impairments could result. During fiscal 2011, the Company did not record any long-lived asset impairment charges. During fiscal 2010, due to the underperformance of one store in California, the Company concluded that the carrying value of its long-lived assets was not recoverable and accordingly recorded an asset impairment charge of $0.4 million. During fiscal 2009, the Company recorded impairment charges of $10.4 million because it concluded that the carrying value of certain long-lived assets was not recoverable. These charges primarily consisted of a leasehold improvement impairment charge of approximately $10.1 million related to the Company’s Texas market plan and an impairment charge of approximately $0.2 million related to the underperformance of a store in California. See Note 10 to Consolidated Financial Statements for further information regarding the charges related to Company’s Texas operations. The Company has not made any material changes to its long-lived asset impairment methodology during fiscal 2011.
Lease Acquisition Costs
The Company follows the policy of capitalizing allowable expenditures that relate to the acquisition and signing of its retail store leases. These costs are amortized on a straight-line basis over the applicable lease term.
Income Taxes
The Company utilizes the liability method of accounting for income taxes as set forth in ASC 740 “ Income Taxes” (“ASC 740”). Under the liability method, deferred tax assets and liabilities are recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. ASC 740 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the net deferred tax assets will not be realized. The Company’s ability to realize deferred tax assets is assessed throughout the year and a valuation allowance is established accordingly. On April 1, 2007, the Company adopted ASC 740-10, “Income Taxes - Overall” (“ASC740-10”) which requires the Company to recognize in the consolidated financial statements the impact of a tax position only if it is more likely than not to be sustained upon examination based on the technical merits of the position. The Company recognizes potential interest and penalties related to uncertain tax positions in income tax expense. Refer to Note 5 “Income Tax Provision” for further discussion of income taxes and the impact of adopting ASC 740-10.
Earnings Per Share Attributed to 99¢ Only Stores
“Basic” earnings per share are computed by dividing net income by the weighted average number of shares outstanding for the year. “Diluted” earnings per share are computed by dividing net income by the total of the weighted average number of shares outstanding plus the dilutive effect of outstanding equity awards (applying the treasury stock method).
A reconciliation of the basic and diluted weighted average number of shares outstanding for the years ended April 2, 2011, March 27, 2010 and March 28, 2009 is as follows:
Potentially dilutive stock options of 1.9 million, 2.4 million and 4.9 million shares for the years ended April 2, 2011, March 27, 2010 and March 28, 2009, respectively, were excluded from the calculation of the weighted average number of common shares outstanding because they were anti-dilutive.
Stock-Based Compensation
The Company has a stock incentive plan in effect under which the Company grants stock options, performance stock units (“PSUs”) and restricted stock units (“RSUs”). The Company accounts for stock-based compensation expense under the fair value recognition provisions of ASC 718, “Compensation-Stock Compensation” (“ASC 718”). ASC 718 requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as an expense ratably over the requisite service periods. The Company estimates the fair value for each option award as of the date of grant using the Black-Scholes option pricing model. The Black-Scholes model considers, among other factors, the expected life of the award and the expected volatility of the Company’s stock price. Stock options are granted to employees at exercise prices equal to the fair market value of the Company’s stock at the dates of grant. The Company recognizes the stock-based compensation expense ratably over the requisite service periods, which is generally a vesting term of three years. Stock options typically have a term of 10 years. The fair value of the PSUs and RSUs is based on the stock price on the grant date. The compensation expense related to PSUs is recognized only when it is probable that the performance criteria will be met. The compensation expense related to RSUs is recognized based on the number of shares expected to vest.
Cost of Sales
Cost of sales includes the cost of inventory, freight in, inter-state warehouse transportation costs, obsolescence, spoilage, scrap and inventory shrinkage, and is net of discounts and allowances. Cash discounts for satisfying early payment terms are recognized when payment is made, and allowances and rebates based upon milestone achievements such as reaching a certain volume of purchases of a vendor’s products are included as a reduction of cost of sales when such contractual milestones are reached in accordance with ASC 605-50-25, “Revenue Recognition-Customer Payments and Incentives-Recognition”. In addition, the Company analyses its inventory levels and related cash discounts received to arrive at a value for cash discounts to be included in the inventory balance. The Company does not include purchasing, receiving, and distribution warehouse costs in its cost of sales. Due to this classification, the Company's gross profit rates may not be comparable to those of other retailers that include costs related to their distribution network in cost of sales.
Operating Expenses
Selling, general and administrative expenses include purchasing, receiving, inspection and warehouse costs, the costs of selling merchandise in stores (payroll and associated costs, occupancy and other store-level costs), distribution costs (payroll and associated costs, occupancy, transportation to and from stores and other distribution-related costs) and corporate costs (payroll and associated costs, occupancy, advertising, professional fees, and other corporate administrative costs).
Leases
The Company recognizes rent expense for operating leases on a straight-line basis (including the effect of reduced or free rent and rent escalations) over the applicable lease term. The difference between the cash paid to the landlord and the amount recognized as rent expense on a straight-line basis is included in deferred rent. Cash reimbursements received from landlords for leasehold improvements and other cash payments received from landlords as lease incentives are recorded as deferred rent. Deferred rent related to landlord incentives is amortized as an offset to rent expense using the straight-line method over the applicable lease term.
For store closures where a lease obligation still exists, the Company records the estimated future liability associated with the rental obligation on the cease use date (when the store is closed) in accordance with ASC 420, “Exit or Disposal Cost Obligations” (“ASC 420”). Liabilities are established at the cease use date for the present value of any remaining operating lease obligations, net of estimated sublease income, and at the communication date for severance and other exit costs, as prescribed by ASC 420. Key assumptions in calculating the liability include the timeframe expected to terminate lease agreements, estimates related to the sublease potential of closed locations, and estimation of other related exit costs. If actual timing and potential termination costs or realization of sublease income differ from the Company’s estimates, the resulting liabilities could vary from recorded amounts. These liabilities are reviewed periodically and adjusted when necessary.
During fiscal 2011, the Company increased its estimated lease termination costs accrual by $0.4 million for Texas stores closed in previous periods. During fiscal 2010, the Company closed 12 of its Texas stores and accrued approximately $3.0 million in lease termination costs associated with the closing of seven out of the 12 Texas stores. Of the $3.0 million lease termination costs accrual, the Company recognized a net expense of $2.5 million as these costs were partially offset by a reduction in expenses of $0.5 million due to the reversal of deferred rent and tenant improvements related to these stores during fiscal 2010. The Company also accrued approximately $1.3 million in lease termination costs associated with the closing of four of its Texas stores and lease termination costs for one contracted store during fiscal 2009. See Note 10 to Consolidated Financial Statements for further information regarding the lease termination charges related to Company’s Texas operations.
Revenue Recognition
The Company recognizes retail sales in its retail stores at the time the customer takes possession of merchandise. All sales are net of discounts and returns and exclude sales tax. Wholesale sales are recognized in accordance with the shipping terms agreed upon on the purchase order. Wholesale sales are typically recognized free on board ("FOB") origin where title and risk of loss pass to the buyer when the merchandise leaves the Company's distribution facility.
The Company has a gift card program. The Company records the sale of gift cards as a current liability and recognizes a sale when a customer redeems a gift card. The liability for outstanding gift cards is recorded in accrued expenses. The Company has not recorded any breakage income related to its gift card program.
Self-insured Workers’ Compensation
The Company self-insures for workers’ compensation claims in California and Texas. The Company establishes a liability for losses of both estimated known and incurred but not reported insurance claims based on reported claims and actuarial valuations of estimated future costs of reported and incurred but not yet reported claims. Should an amount of claims greater than anticipated occur, the liability recorded may not be sufficient and additional workers’ compensation costs, which may be significant, could be incurred. The Company has not discounted the projected future cash outlays for the time value of money for claims and claim-related costs when establishing its workers’ compensation liability in its financial reports for April 2, 2011 and March 27, 2010.
Pre-Opening Costs
The Company expenses, as incurred, all pre-opening costs related to the opening of new retail stores.
Advertising
The Company expenses advertising costs as incurred, except the costs associated with television advertising, which are expensed the first time the advertising takes place. Advertising expenses were $5.5 million, $4.1 million and $4.4 million for the fiscal years ended April 2, 2011, March 27, 2010 and March 28, 2009, respectively.
Statements of Cash Flows
Cash payments for income taxes were $37.7 million, $40.8 million and $10.7 million in fiscal 2011, 2010, and 2009, respectively. Interest payments totaled less than $0.1 million in fiscal 2011. There were no interest payments in fiscal 2010. Interest payments totaled approximately $0.2 in fiscal 2009. Non-cash investing activities included $1.7 million, $1.1 million and $0.3 million in fixed assets purchase accruals for fiscal 2011, 2010 and 2009, respectively. In fiscal 2009, non-cash investing activities also include $9.3 million of the La Quinta Partnership foreclosure trustee sale proceeds. Additionally, in fiscal 2009, non-cash financing activities included a $7.3 million loan payment to pay off the outstanding loan of the foreclosed assets of the La Quinta Partnership.
Fair Value of Financial Instruments
The Company’s financial instruments consist principally of cash and cash equivalents, short-term and long-term marketable securities, accounts receivable, accounts payable, accruals and other liabilities. Cash and cash equivalents, short-term and long-term marketable securities are measured and recorded at fair value. Accounts receivable and other receivables are financial assets with carrying values that approximate fair value. Accounts payable and other accrued expenses are financial liabilities with carrying values that approximate fair value. The Company believes all of the financial instruments’ recorded values approximate fair market value because of their nature and respective durations.
The Company complies with the provisions of ASC 820, “Fair Value Measurements and Disclosures” (“ASC 820”). ASC 820 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements required under other accounting pronouncements. ASC 820-10-35, “Subsequent Measurement” (“ASC 820-10-35”), clarifies that fair value is an exit price, representing the amount that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. ASC 820-10-35 also requires that a fair value measurement reflect the assumptions market participants would use in pricing an asset or liability based on the best information available. Assumptions include the risks inherent in a particular valuation technique (such as a pricing model) and/or the risks inherent in the inputs to the model. The Company also follows ASC 825, “Financial Instruments”, to expand required disclosures.
ASC 820-10-35 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy under ASC 820-10-35 are described below:
Level 1: Defined as observable inputs such as quoted prices in active markets for identical assets or liabilities.
Level 2: Defined as observable inputs other than Level 1 prices. These include quoted prices for similar assets or liabilities in an active market, quoted prices for identical assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3: Defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.
The Company utilizes the best available information in measuring fair value. The following table summarizes, by level within the fair value hierarchy, the financial assets and liabilities recorded at fair value on a recurring basis as of April 2, 2011 (in thousands):
Level 1 investments include money market funds and perpetual preferred stocks of $153.0 million and $0.7 million, respectively. The fair value of money market funds and perpetual preferred stocks are based on quoted market prices in an active market and there are no restrictions on the redemption of money market funds or perpetual preferred stocks. Level 1 also includes $4.9 million of deferred compensation assets that fund the liabilities related to the Company’s deferred compensation, including investments in trust funds. These investments were classified as Level 1. The fair values of these funds are based on quoted market prices in an active market.
Level 2 investments include municipal bonds, asset-backed securities and corporate bonds of $31.2 million, $1.7 million and $1.2 million, respectively. The fair value of municipal bonds, asset-backed securities and corporate bonds are based on quoted prices for similar assets or liabilities in an active market.
Level 3 investments include auction rate securities of $8.4 million. The fair value of auction rate securities is based on the valuation from an independent securities valuation firm by using applicable methods and techniques for this class of security.
The Company did not have any transfers of investments in and out of Levels 1 and 2 during fiscal 2011.
The valuation of the auction rate securities is based on Level 3 unobservable inputs which consist of recommended fair values provided by Houlihan Capital Advisors, LLC, an independent securities valuation firm. These securities are held as “available-for-sale” in the Company’s consolidated balance sheet. Based on their estimated fair value, the Company recorded an unrealized gain in the valuation of these securities of less than $0.1 million in fiscal 2011 and an unrealized gain of less than $0.1 million, net of tax, related to these securities is included in other comprehensive income in fiscal 2011. Also, based on the estimated fair value, an other-than-temporary impairment related to credit losses of $0.1 million was recognized in earnings for fiscal 2011 for the Company’s auction rate securities. Due to the uncertainty surrounding liquidity in the auction rate securities market, the Company has classified these auction rate securities as long-term assets on its consolidated balance sheets as of April 2, 2011. The auction rate securities represent about 1% of the Company’s total assets.
The Company utilizes the best available information in measuring fair value. The following table summarizes, by level within the fair value hierarchy, the financial assets and liabilities recorded at fair value on a recurring basis as of March 27, 2010 (in thousands):
Level 1 investments include money market funds and perpetual preferred stocks of $118.8 million and $1.7 million, respectively. The fair value of money market funds and perpetual preferred stocks are based on quoted market prices in an active market and there are no restrictions on the redemption of money market funds or perpetual preferred stocks. Level 1 also includes deferred compensation liabilities and the assets that fund the Company’s deferred compensation, including investments in trust funds. These investments were classified as Level 1. The fair values of these funds are based on quoted market prices in an active market.
Level 2 investments include municipal bonds, asset-backed securities and corporate bonds of $35.2 million, $3.1 million and $1.7 million, respectively. The fair value of municipal bonds, asset-backed securities and corporate bonds are based on quoted prices for similar assets or liabilities in an active market.
Level 3 investments include auction rate securities of $10.0 million. The fair value of auction rate securities is based on the valuation from an independent securities valuation firm by using applicable methods and techniques for this class of security.
The Company did not have any transfers of investments in and out of Levels 1 and 2 during fiscal 2010.
The valuation of the auction rate securities is based on Level 3 unobservable inputs which consist of recommended fair values provided by Houlihan Capital Advisors, LLC, an independent securities valuation firm. These securities are held as “available-for-sale” in the Company’s consolidated balance sheet. Based on their estimated fair value, the Company recorded an unrealized gain in the valuation of these securities of $1.0 million in fiscal 2010 and an unrealized gain of $0.6 million, net of tax, related to these securities is included in other comprehensive income in fiscal 2010. Also, based on the estimated fair value, an other-than-temporary impairment related to credit losses of $0.6 million was recognized in earnings for fiscal 2010 for the Company’s auction rate securities. Due to the uncertainty surrounding liquidity in the auction rate securities market, the Company has classified these auction rate securities as long-term assets on its consolidated balance sheets as of March 27, 2010. The auction rate securities represent less than 2% of the Company’s total assets.
The following table summarizes the activity for the period of changes in fair value of the Company’s Level 3 investments (in thousands):
Comprehensive Income
ASC 220, “Reporting Comprehensive Income”, establishes standards for reporting and displaying comprehensive income and its components in the consolidated financial statements. The following table sets forth the calculation of comprehensive income, net of tax effects for the years indicated (in thousands):
New Authoritative Pronouncements
In June 2009, the FASB issued ASC 810 “Consolidation of Variable Interest Entities” (“VIE”) (“ASC 810”). This statement amends current U.S. GAAP by: requiring ongoing reassessments of whether an enterprise is the primary beneficiary of a VIE; amending the quantitative approach previously required for determining the primary beneficiary of the VIE; modifying the guidance used to determine whether an entity is a VIE; adding an additional reconsideration event (e.g. troubled debt restructurings) for determining whether an entity is a VIE; and requiring enhanced disclosures regarding an entity’s involvement with a VIE. The Company adopted this statement in the first quarter of fiscal 2011. The adoption of this statement did not have any impact on the Company’s consolidated financial position or results of operations.
In June 2009, the FASB issued ASC 860 “Accounting for Transfers of Financial Assets” (“ASC 860”). The statement eliminates the concept of a “qualifying special-purpose entity” and changes the requirements for derecognizing financial assets. The Company adopted this guidance in the first quarter of fiscal 2011. The adoption of this statement did not have any impact on the Company’s consolidated financial position or results of operations.
In December 2009, the FASB released ASU 2009-17 under ASC 810 “Consolidation of Variable Interest Entities”. This update consists of amendments to the FASB Statement No. 167, which was issued by the Board in June 2009. The amendments are intended to improve financial reporting by enterprises involved with variable interest entities. This update is effective for fiscal years, and interim periods within those fiscal years, beginning on or after November 15, 2009. The Company adopted this statement in the first quarter of fiscal 2011. The adoption of this statement did not have any impact on the Company’s consolidated financial position or results of operations.
2.
Property and Equipment, net
The following table provides details of property and equipment (in thousands):
3.
Investments
The following tables summarize the investments in marketable securities (in thousands):
The auction rate securities the Company holds generally are short-term debt instruments that provide liquidity through a Dutch auction process in which interest rates reset every 7 to 35 days. Beginning in February 2008, auctions of the Company’s auction rate securities failed to sell all securities offered for sale. Consequently, the principal associated with these failed auctions will not be accessible until a successful auction occurs, a buyer is found outside of the auction process, the issuers redeem the securities, the issuers establish a different form of financing to replace these securities or final payments come due to long-term contractual maturities. For each unsuccessful auction, the interest rate moves to a rate defined for each security. Currently, the Company is uncertain when the liquidity issues related to its remaining auction rate securities will improve. Accordingly, the Company has included $8.4 million and $10.0 million of its auction rate securities in non-current assets on the Company’s balance sheet as of April 2, 2011 and March 27, 2010 respectively.
The following table summarizes maturities of marketable fixed-income securities classified as available for sale as of April 2, 2011 (in thousands):
Realized gains from the sale of marketable securities were less than $0.1 million, less than $0.1 million and $0.3 million for the fiscal years ended April 2, 2011, March 27, 2010 and March 28, 2009, respectively. The Company recorded an investment impairment charge related to credit losses of approximately $0.1 million on its auction rate securities for fiscal 2011. In fiscal 2010, the Company recognized an impairment charge related to credit losses of approximately $0.6 million on its auction rate securities and approximately $0.3 million on a Bank of America perpetual preferred stock. The Company recognized approximately $1.7 million in impairment charges primarily related to a Lehman Brothers corporate bond of $0.6 million and a Lehman Brothers perpetual preferred stock of $1.0 million in fiscal 2009.
Non-tax effected net unrealized losses relating to securities that were recorded as available for sale securities were $0.5 million as of April 2, 2011. Non-tax effected net unrealized losses relating to securities that were recorded as available for sale securities were $0.8 million as of March 27, 2010. The tax effected unrealized gains and losses are included in other comprehensive income or loss in the Consolidated Statements of Shareholders’ Equity.
The following table presents the length of time securities were in continuous unrealized loss positions, but were not deemed to be other-than-temporarily impaired (in thousands):
As of April 2, 2011, there were less than $0.1 million of unrealized losses for less than twelve months, and $0.6 million of losses for twelve months or greater for 20 securities that primarily were caused by interest rate fluctuations and changes in current market conditions.
During fiscal 2011, the Company recorded approximately $0.1 million other-than-temporary impairment charges related to credit losses on its auction rate securities. During this period, the Company did not have any non-credit related other-than-temporary losses on any of its securities. Accordingly, the Company’s other comprehensive income does not include any charges related to the other-than-temporary non-credit portion of its securities.
The following table presents the length of time securities were in continuous unrealized loss positions, but were not deemed to be other-than-temporarily impaired (in thousands):
As of March 27, 2010, there were less than $0.1 million of unrealized losses for less than twelve months, and $0.9 million of losses for twelve months or greater for 26 securities that primarily were caused by interest rate fluctuations and changes in current market conditions.
During fiscal 2010, the Company recorded approximately $0.6 million and $0.3 million of other-than-temporary impairment charges related to credit losses on its auction rate securities and a Bank of America perpetual preferred stock, respectively. During this period, the Company did not have any non-credit related other-than-temporary losses on any of its securities. Accordingly, the Company’s other comprehensive income does not include any charges related to the other-than-temporary non-credit portion of its securities.
The following table sets forth a reconciliation of the changes in credit losses recognized in earnings during fiscal 2011 and fiscal 2010 (in thousands):
4.
Variable Interest Entities
At April 2, 2011 and March 27, 2010, the Company no longer has any variable interest entities.
5.
Income Tax Provision
The provision for income taxes consists of the following:
Differences between the provision for income taxes and income taxes at the statutory federal income tax rate are as follows:
In fiscal 2009, the Texas NOL tax credit was adjusted to reflect anticipated store closures. The fiscal 2010 tax provision reflects a small benefit related to the Texas NOL tax credits due to the Company’s decision to continue operations in Texas.
The Company’s net deferred tax assets are as follows:
As of April 2, 2011, the Company had federal net operating loss carryforwards of approximately $11.7 million which can be used to offset future taxable income. The utilization of these net operating loss carryforwards is limited and the carryforwards expire at various dates through 2018. The Company also has approximately $7.7 million of California Enterprise Zone credits that can be carried forward indefinitely. In addition, pursuant to the Company’s decision in August 2009 to continue operations in Texas, the Company has recorded a deferred tax asset of approximately $2.2 million related to Texas NOL credits in fiscal 2010. Based on the current estimate of future benefit utilization of these credits, the Company has also recorded a related valuation allowance of $1.9 million. The Company maintains a valuation allowance to reduce certain deferred tax assets to amounts that are, in management’s estimation, more likely than not to be realized. The valuation allowance as of April 2, 2011, relates to the deferred tax assets acquired in the acquisition of Universal International, Inc. and Texas NOL credits.
The Company had approximately $1.4 million at March 28, 2009 of unrecognized tax benefits related to uncertain tax positions. The statutes of limitations have expired for the periods related to these uncertain tax positions at the end of fiscal 2010, and accordingly, at March 27, 2010, the Company has derecognized these liabilities.
The following table provides a reconciliation of the beginning and ending amount of unrecognized tax benefit (in thousands):
The Company files income tax returns in the U.S. federal jurisdiction and in various states. The Company is subject to examinations by the major tax jurisdictions in which it files for the tax years 2005 through 2010.
6.
Related-Party Transactions
The Company leases certain retail facilities from its significant shareholders and their affiliates. Rental expense for these facilities was approximately $2.1 million in each of fiscal years 2011, 2010 and 2009.
7.
Commitments and Contingencies
Credit Facilities
The Company had no debt outstanding as of April 2, 2011 and March 27, 2010 and does not maintain any credit facilities with any financial institutions except for a small standby letter of credit as described below.
As of April 2, 2011, the Company had a standby letter of credit for approximately $0.4 million, related to one of its leased properties, where the lessor is a named beneficiary in the event of a default by the Company, and potentially is entitled to draw on the letter of credit in the event of a specified default. The letter of credit will expire in October 2011, but shall be automatically extended, without written amendment, to October 2012, unless written notice of termination is sent to the issuer. As of the date of filing this Form 10-K, the Company is in compliance with its lease terms and scheduled payments.
Lease Commitments
The Company leases various facilities under operating leases (except for one location which is classified as a capital lease) expiring at various dates through fiscal year 2031. Most of the lease agreements contain renewal options and/or provide for fixed rent escalations or increases based on the Consumer Price Index. Total minimum lease payments under each of these lease agreements, including scheduled increases, are charged to operating expenses on a straight-line basis over the term of each respective lease. Certain leases require the payment of property taxes, maintenance and insurance. Rental expense charged to operating expenses in fiscal 2011, 2010 and 2009 was approximately $56.7 million, $60.7 million and $60.6 million, respectively, of which $0.3 million, $0.3 million and $0.2 million was paid as percentage rent based on sales volume for each of the years then ended, respectively. Sub-lease income earned in fiscal 2011, 2010 and 2009 was approximately $0.9 million, $0.7 million and $1.0 million, respectively.
As of April 2, 2011, the minimum annual rentals payable and future minimum sub-lease income under all non-cancelable operating leases were as follows: (amounts in thousands):
The capital lease relates to a building for one of the Company’s stores. The gross asset amount recorded under the capital lease was $1.0 million each as of April 2, 2011 and March 27, 2010. Accumulated depreciation was $0.7 million and $0.6 million as of April 2, 2011 and March 27, 2010.
Workers’ Compensation
The Company self-insures its workers' compensation claims in California and Texas and provides for losses of estimated known and incurred but not reported insurance claims. The Company does not discount the projected future cash outlays for the time value of money for claims and claim related costs when establishing its workers’ compensation liability.
At April 2, 2011 and March 27, 2010, the Company had recorded a liability $42.4 million and $46.9 million respectively, for estimated workers’ compensation claims in California. The Company has limited self-insurance exposure in Texas and had recorded a liability of less than $0.1 million as of April 2, 2011 and approximately $0.1 million as of March 27, 2010 for workers’ compensation claims in Texas. The Company purchases workers’ compensation insurance coverage in Arizona and Nevada.
Legal Matters
The Company is subject to private lawsuits, administrative proceedings and claims that arise in our ordinary course of business. A number of these lawsuits, proceedings and claims may exist at any given time. While the resolution of a lawsuit, proceeding or claim may have an impact on our financial results for the period in which it is resolved, and litigation is inherently unpredictable, in management’s opinion, none of these matters arising in the ordinary course of business is expected to have a material adverse effect on the Company’s financial position, results of operations, or overall liquidity. Material pending legal proceedings (other than ordinary routine litigation incidental to our business) and material proceedings known to be contemplated by governmental authorities are reported in our Securities Exchange Act reports.
Going Private Proposal
Following the recent announcement by the Company of the receipt of a going private proposal, eight complaints have been filed related to such proposal, all in the Los Angeles County Superior Court (the "Actions"). The plaintiffs in the Actions claim to be shareholders of the Company and propose to represent a class of all of the Company's public shareholders. The Actions name the Company, various of its officers and directors, and Leonard Green & Partners L.P. (and in one instance certain entities affiliated with Leonard Green & Partners) as defendants. The Actions assert claims for breach of fiduciary duty and aiding and abetting breach of fiduciary duty. Plaintiffs seek to enjoin a going private transaction and, in the alternative, seek unspecified damages in the event such a transaction is consummated. The Actions have been ordered stayed pending an initial status conference. The Actions are: Southeastern Pennsylvania Transportation Authority v. David Gold, et al. (filed March 14, 2011, amended March 23, 2011); John Chevedden v. 99¢ Only Stores, et al. (filed March 16, 2011); Rana Fong v. 99¢ Only Stores, et al. (filed March 17, 2011); Norfolk County Retirement Board v. Jeff Gold, et al. (filed March 22, 2011); Tammy Newman v. 99¢ Only Stores, et al. (filed March 25, 2011); Key West Police and Fire Pension Fund v. Eric G. Flamholtz, et al. (filed April 5, 2011); and Allen Mitchell v. 99¢ Only Stores, et al. (filed April 11, 2011).
Pricing Policy Matters
The district attorneys of two California counties and one city attorney have notified the Company that they are planning a possible civil action against the Company alleging that its .99 cent pricing policy, adopted in September 2008, constitutes false advertising and/or otherwise violates California's pricing laws. In response to this notification and an associated invitation from these governmental entities, the Company provided a detailed position statement with respect to its pricing structure.
Leonard Morales and Steven Calabro vs. 99¢ Only Stores, Superior Court of the State of California, County of Los Angeles. Plaintiffs filed a putative class action complaint against the Company in July 2010, claiming violations of California’s Unfair Competition Law (California Business & Professions Code Section 17200) and Consumer Legal Remedies Act (California Civil Code Section 1750, et seq.), as well as unjust enrichment, arising out of the Company’s September 2008 change in its pricing policy. Plaintiffs seek restitution of all amounts allegedly “wrongfully obtained” by the Company, injunctive and declaratory relief, prejudgment and post-judgment interest, and their attorney’s fees and costs. The Company filed a demurrer to all of the causes of action in this complaint as well as a motion to strike certain portions of it. In response to these motions, the plaintiffs requested that their case be consolidated with the Kavis lawsuit described below, and the two sets of plaintiffs filed a consolidated amended complaint. The Company has filed a demurrer and motion to strike directed towards portions of the amended complaint, and these motions were heard on April 27, 2011. These motions have been fully briefed and argued and the parties are awaiting a ruling from the Court. Discovery has begun in this case and is ongoing.
Phillip Kavis, Debra Major, Barbara Maines, and Susan Jonas v. 99¢ Only Stores, David Gold, Jeff Gold, Howard Gold, and Eric Schiffer, Superior Court of the State of California, County of Los Angeles. Plaintiffs filed a putative class action complaint against the Company in July 2010, claiming violations of California’s Unfair Competition Law (California Business & Professions Code Section 17200), False Advertising Law (California Business & Professions Code Section 17500), and Consumer Legal Remedies Act (California Civil Code Section 1770), as well as intentional misrepresentation, negligent misrepresentation, breach of the implied covenant of good faith and fair dealing, and unjust enrichment, arising out of the Company’s September 2008 change in its pricing policy. Plaintiffs seek actual damages, restitution, including disgorgement of all profits and unjust enrichment allegedly obtained by the Company, statutory damages and civil penalties, equitable and injunctive relief, exemplary damages, prejudgment and post-judgment interest, and their attorney’s fees and costs. The Company filed a demurrer to all of the causes of action in this complaint as well as a motion to strike certain portions of it. In response to these motions, the plaintiffs requested that their case be consolidated with the Morales lawsuit described above and filed a consolidated amended complaint. The Company has filed a demurrer and motion to strike directed towards portions of the amended complaint, and these motions were heard on April 27, 2011. These motions have been fully briefed and argued and the parties are awaiting a ruling from the Court. Discovery has begun in this case and is ongoing.
We cannot predict the outcome of these lawsuits or of any action or lawsuit that may be brought against the Company by the above-referenced governmental entities, or the amount of potential loss, if any, the Company could face as a result of such lawsuits or actions. We believe our pricing structure is lawful, and that our .99 cent pricing policy has an established precedent similar to the .9 cent pricing policy used for decades by gas stations across the country. We believe our .99 cent pricing policy has been well publicized with items properly price-signed in the stores such that it would not cause a reasonable consumer to be deceived, and we intend to vigorously defend these lawsuits as well as any such other lawsuit or action that may arise.
Wage and Hour Matters
Luis Palencia v. 99¢ Only Stores, Superior Court of the State of California, County of Sacramento. Plaintiff, a former assistant manager for the Company, who was employed with the Company from June 12, 2009 through September 9, 2009, filed this action in June 2010, asserting claims on behalf of himself and all others allegedly similarly situated under the California Labor Code for alleged unpaid overtime due to “off the clock” work, failure to pay minimum wage, failure to provide meal and rest periods, failure to provide proper wage statements, failure to pay wages timely during employment and upon termination and failure to reimburse business expenses. Mr. Palencia also asserts a derivative claim for unfair competition under the California Business and Professions Code. Mr. Palencia seeks to represent three sub-classes: (i) an “unpaid wages subclass” of all non-exempt or hourly paid employees who worked for the Company in California within four years prior to the filing of the complaint until the date of certification, (ii) a “non-compliant wage statement subclass” of all non-exempt or hourly paid employees of the Company who worked in California and received a wage statement within one year prior to the filing of the complaint until the date of certification, and (iii) an “unreimbursed business expenses subclass” of all employees of the Company who paid for business-related expenses, including expenses for travel, mileage expenses, or cell phones in California within four years prior to the filing of the complaint until the date of certification. Plaintiff seeks to recover alleged unpaid wages, interest, attorney’s fees and costs, declaratory relief, restitution, statutory penalties and liquidated damages. He also seeks to recover civil penalties as an “aggrieved employee” under the Private Attorneys General Act of 2004. Discovery has commenced but no class certification or trial date has been set. We cannot predict the outcome of this lawsuit or the amount of potential loss, if any, the Company could face as a result of such lawsuit.
Sheridan Reed v. 99¢ Only Stores, Superior Court of the State of California, County of Los Angeles. Plaintiff, a former store manager for the Company, filed this action in April 2010. He originally asserted claims on behalf of himself and all others allegedly similarly situated under the California Labor Code for alleged failure to pay overtime at the proper rate, failure to pay vested vacation wages, failure to pay wages timely upon termination of employment and failure to provide accurate wage statements. Mr. Reed also asserted a derivative claim for unfair competition under the California Business and Professions Code. In September 2010, Mr. Reed amended his complaint to seek civil penalties under the Private Attorneys General Act of 2004. Mr. Reed seeks to represent four sub-classes: (i) all non-exempt or hourly current or former employees who worked for the Company in California within four years prior to the filing of the complaint until the date of certification who were paid bonuses, commissions or incentive wages, who worked overtime, and for whom the bonuses, commissions or incentive wages were not included as part of the regular rate of pay for overtime purposes, (ii) all non-exempt or hourly current or former employees who worked for the Company in California within four years prior to the filing of the complaint until the date of certification who earned vacation wages and were not paid their vested vacation wages at the time of termination; (iii) all non-exempt or hourly current or former employees who worked for the Company in California within four years prior to the filing of the complaint until the date of certification who were not furnished a proper itemized wage statement; and (iv) all non-exempt or hourly current or former employees who worked for the Company in California within four years prior to the filing of the complaint until the date of certification who were not paid all wages due upon termination. Plaintiff seeks to recover alleged unpaid wages, statutory penalties, interest, attorney’s fees and costs, declaratory relief, injunctive relief and restitution. He also seeks to recover civil penalties as an “aggrieved employee” under the Private Attorneys General Act of 2004. Discovery has commenced but no class certification or trial date has been set. We cannot predict the outcome of this lawsuit or the amount of potential loss, if any, the Company could face as a result of such lawsuit.
Employment Discrimination Matter
Linda Niemiller v. 99¢ Only Stores, Superior Court of the State of California, County of Los Angeles. Plaintiff, a former assistant manager for the Company, filed this action in March 2011. She asserts claims on behalf of herself, and all others allegedly similarly situated, under the California Fair Employment and Housing Act and the California Business and Professions Code based on allegations that the Company has a pattern or practice of denying and/or failing to promote women to the position of Store Manager and to provide them with compensation equal to that of men doing equal work. She also asserts an individual claim for retaliation based on the allegation that the Company failed to promote her in retaliation for her having opposed and objected to discrimination based on gender. Plaintiff seeks to represent a class of all allegedly similarly situated current, past and future women as to whom the Company has denied hiring and promotion to the position of Store Manager and equal compensation in the State of California on the basis of gender. She seeks to recover back pay, front pay, general and special damages, punitive damages, injunctive and declaratory relief, an order assigning herself and members of the putative class to those jobs they purportedly would have held but for the Company’s allegedly discriminatory practices, an adjustment of the wage rates, benefits, and seniority rights for herself and members of the putative class to that level which they purportedly would be enjoying but for the Company’s alleged discriminatory practices, pre-judgment interest and attorney’s fees and costs. We cannot predict the outcome of this lawsuit or the amount of potential loss, if any, the Company could face as a result of such lawsuit.
8.
Stock-Based Compensation Plans
On September 14, 2010, at the Company’s 2010 Annual Meeting of Shareholders, the shareholders of the Company approved the 99¢ Only Stores 2010 Equity Incentive Plan (the “2010 Plan”). There will be no further grants under the Company’s prior equity compensation plan, the 1996 Stock Option Plan, as amended (the “1996 Plan”). The 2010 Plan authorizes the issuance of 4,999,999 shares of the Company’s common stock, of which 4,964,000 were available as of April 2, 2011 for future awards. This includes the unused capacity that will be rolled over from the 1996 Plan and that will become subject to the terms of the 2010 Plan, whereas any awards under the 1996 Plan that are outstanding as of the effective date shall continue to be subject to the terms and conditions of the 1996 Plan. Employees, non-employee directors and consultants of the Company and its affiliates are eligible to receive awards under the 2010 Plan, as determined by the Compensation Committee of the Company’s Board of Directors. All stock options grants are made at fair market value at the date of grant or at a price determined by the Compensation Committee of the Company’s Board of Directors, which consists exclusively of independent members of the Board of Directors. Stock options typically vest over a three-year period, one-third one year from the date of grant and one-third per year on the anniversary of the date of the grant thereafter. Stock options typically expire ten years from the date of grant. The plan will expire in 2020. For further information regarding the 2010 Plan, see the Company’s Current Report on Form 8-K filed on September 17, 2010.
The following table summarizes stock awards available for grant:
(a) This amount includes 23,000 restricted stock units granted to certain employees under the Company’s 1996 Stock Option Plan, as amended (the “1996 Plan”) which was replaced by 2010 Equity Incentive Plan (the “2010 Plan”) approved at the Company’s 2010 Annual Meeting of Shareholders. The actual number of restricted stock units (and ultimately shares of Company common stock) to be issued depends on the reaching of the vesting requirements as specified by the restricted stock unit awards.
(b) This amount includes 68,000 PSUs. For stock options, this includes options cancelled before September 14, 2010 under the 1996 Plan and thereafter the options cancelled under the 2010 Plan.
(c) This amount includes 65,000 PSUs granted under the Company’s 2008 PSU Plan. The actual number of performance stock units (and ultimately shares of Company common stock) to be issued depends on the Company’s financial performance over a period of time.
(d) This amount includes 99,000 PSUs.
(e) This amount includes 127,000 PSUs potentially issuable under the Company’s 1996 Stock Option Plan. The actual number of performance stock units (and ultimately shares of Company common stock) to be issued depends on the Company’s financial performance over a period of time.
(f) This amount includes 191,000 PSUs.
In fiscal 2011, fiscal 2010 and fiscal 2009, the Company incurred total non-cash stock-based compensation expense of $2.9 million, $7.7 million and $3.1 million recorded as operating expense, before the income tax benefit of $1.2 million, $3.1 million and $1.3 million, respectively.
Stock Options
Stock options typically vest over a three-year period, one-third one year from the date of grant and one-third per year thereafter. Stock options typically expire ten years from the date of grant.
The weighted average fair values per share of stock options granted have been estimated using the Black-Scholes pricing model with the following assumptions:
The risk-free interest rate is based on the U.S. treasury yield curve in effect at the time of grant with an equivalent remaining term. Expected life represents the estimated period of time until exercise and is based on historical experience of similar options, giving consideration to the contractual terms and expectations of future employee behavior. Expected stock price volatility is based on a combination of the historical volatility of the Company’s stock and the implied volatility of actively traded options of the Company’s stock. The Company has not paid dividends in the past and does not anticipate the payment of any cash dividends for the foreseeable future. Compensation expense is recognized only for those options expected to vest, with forfeitures estimated based on the Company’s historical experience and future expectations.
Option activity under the Company’s stock option plan during the year ended April 2, 2011 is set forth below:
The aggregate pre-tax intrinsic values of options outstanding, exercisable, and exercisable and expected to vest were calculated based on the Company’s closing stock price on the last trading day of fiscal 2011. These amounts change based upon changes in the fair market value of the Company’s common stock. The aggregate pre-tax intrinsic value of options exercised in fiscal 2011 and 2010 was $3.5 million and $4.2 million, respectively. The aggregate pre-tax intrinsic value of options exercised represents the difference between the fair market value of the Company’s common stock on the date of exercise and the exercise price of each option. The total fair value of shares vested during fiscal 2011, 2010 and 2009 was $1.0 million, $2.4 million and $4.9 million, respectively.
The weighted average remaining contractual life and the weighted average per share exercise price of options outstanding and of options exercisable as of April 2, 2011 were as follows:
As of April 2, 2011, there was $0.3 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Company’s stock option plan. That cost is expected to be recognized over a weighted-average period of 1.1 years.
Performance Stock Units
During the fourth quarter of fiscal 2008, the Compensation Committee of the Company's Board of Directors granted performance stock units (“PSUs”) to certain officers and other key personnel of the Company as a long-term, stock-based performance incentive award. Pursuant to the term of the PSUs, they are eligible for conversion, on a one-for-one basis, to shares of the Company’s common stock based on (1) attainment of one or more of eight specific performance goals during the performance period (consisting of fiscal 2008 through 2012), (2) continuous employment with the Company, and (3) certain vesting requirements. As of April 2, 2011, the Company had 0.5 million PSUs issued and outstanding. The following table summarizes the PSU activity in fiscal 2011:
The fair value of the PSUs is based on the stock price on the grant date. The compensation expense related to PSUs is recognized only when it is probable that the performance criteria will be met. Based on the Company’s financial results, the Company started to recognize compensation expense related to PSUs during the first quarter of fiscal 2010, as this was the first quarter that it appeared probable that certain performance conditions would be met. The Company incurred non-cash stock-based compensation expense related to PSUs of $2.1 million and $6.5 million for fiscal 2011 and fiscal 2010, respectively, which was recorded as operating expenses. The Company did not incur non-cash stock-based compensation expense related to PSUs during fiscal 2009. There were 0.4 million PSUs vested and issued during fiscal 2011. There were 0.6 million PSUs vested during fiscal 2010 of which 0.5 million PSUs were issued during fiscal 2010. As of April 2, 2011, the unvested future compensation expense through fiscal 2013 was $1.8 million assuming all vesting criteria will be met.
Restricted Stock Units
According to the Company’s equity incentive plan, the Compensation Committee of the Company's Board of Directors granted time-based restricted stock units (“RSUs”) to certain non-officer employees of the Company as a long-term, incentive award. RSUs will cliff vest three years after being granted if the employees are still employed by the Company at such time.
The following table summarizes the RSUs activity of fiscal 2011:
The stock based compensation expense for RSUs is measured at fair value on the date of grant based on the number of shares expected to vest and the quoted market price of the Company’s common stock. The Company started to recognize compensation expense related to RSUs during the third quarter of fiscal 2011. For fiscal 2011, the Company incurred non-cash stock-based compensation expense related to RSUs of less than $0.1 million, which was recorded as operating expense. As of April 2, 2011, the Company had less than 0.1 million RSUs outstanding and compensation costs related to unvested share-based awards not yet recognized amounted to $0.2 million.
9.
Stock Repurchase Program
On June 11, 2008, the Company announced that its Board of Directors had approved a share repurchase program for the purchase of up to $30 million of shares of its common stock. Under the authorization, the Company may purchase shares from time to time in the open market or in privately negotiated transactions in compliance with the applicable rules and regulations of the SEC. However, the timing and amount of such purchases will be at the discretion of management, and will depend on market conditions and other considerations which may change. The Company has used and plans to continue to use existing cash to fund any repurchases under this program. As of April 2, 2011, the Company had approximately $17.1 million that remained authorized and available to repurchase shares of Company’s common stock under this program. The Company did not make any common stock repurchases for fiscal 2011.
The Company issues performance stock units as part of its equity incentive plans. The number of shares issued on the date the performance stock units vest is net of the statutory withholding requirements that the Company pays in cash to the appropriate taxing authorities on behalf of its employees. During fiscal 2011, the Company withheld approximately 146,000 shares to satisfy $2.3 million of employee tax obligations. Although shares withheld are not issued, they are treated as common stock repurchases in the Company’s Consolidated Financial Statements, as they reduce the number of shares that would have been issued upon vesting.
10.
Texas Market
As a result of the Company's decision in September 2008 to close its Texas operations, which was later suspended and, in August 2009, reversed, the Company closed 16 of its Texas stores starting from the fourth quarter of fiscal 2009 through the second quarter of fiscal 2010. As described in prior Company filings, the Company had recorded impairment charges as well as lease terminations costs related to closing some of these stores. As of March 28, 2009, and March 27, 2010, the Company had an estimated lease termination costs accrual of approximately $1.3 and $2.9 million, respectively. During fiscal 2011, the Company increased the estimated lease termination costs accrual by approximately $0.4 million and paid approximately $1.8 million related to these costs. The initial impairment charges, severance pay accrual, lease termination cost and the additional accretion expenses recorded in fiscal 2010 and fiscal 2011 were included within selling, general and administrative expenses in the consolidated statement of operations. As of April 2, 2011, the remaining balance of the Company’s estimated lease termination costs accrual was $1.5 million and is expected to be paid by the end of fiscal 2012. As of April 2, 2011, the Company operated 35 stores in Texas.
The following table summarizes the Texas store closures remaining obligations as of April 2, 2011:
11.
Operating Segments
The Company manages its business on the basis of one reportable segment. The Company’s sales through Bargain Wholesale are not material to the Company’s consolidated financial statements; therefore, in accordance with ASC 280, “Segment Reporting” Bargain Wholesale is not presented as a separate operating segment in fiscal 2011.
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.
12.
Employee Benefit Plans
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 30 days of service and are eligible to receive matching contributions from the Company after one year of service. The Company contributed approximately $1.6 million in each of fiscal years 2011, 2010 and 2009, in matching cash contributions to the Plan. The Plan was amended in fiscal 2007 and currently the Company matches 100% of the first 3% of compensation that an employee contributes and 50% of the next 2% of compensation that the employee contributes with immediate vesting.
Deferred Compensation Plan
The Company has a deferred compensation plan to provide certain key management employees the ability to defer a portion of their base compensation and/or bonuses. The plan is an unfunded nonqualified plan. The deferred amounts and earnings thereon are payable to participants, or designated beneficiaries, at specified future dates, upon retirement or death. The Company does not make contributions to this plan or guarantee earnings. Funds in the plan are held in a rabbi trust. In accordance with ASC 710-05-8, “Compensation-Deferred Compensation-Rabbi Trusts,” the assets and liabilities of a rabbi trust must be accounted for as if they are assets and liabilities of the Company. The assets held in the rabbi trust are not available for general corporate purposes. The rabbi trust is subject to creditor claims in the event of insolvency. The deferred compensation liability and related long-term asset was $4.9 million and $4.3 million as of April 2, 2011 and March 27, 2010, respectively.
13.
Assets Held for Sale
Assets held for sale consist of the Company’s warehouse in Eagan, Minnesota. The book value of the warehouse at April 2, 2011 was $7.4 million. Due to market conditions and the size of the warehouse, the Company has classified the warehouse as long-term asset on its consolidated balance sheets. Although the Company anticipates selling the warehouse in excess of its book value, no assurance can be given as to how much the warehouse will be sold for.
14.
Other Current Liabilities
Other current liabilities as of April 2, 2011 and March 27, 2010 are as follows:
15.
Going Private Proposal
On March 11, 2011, the Company announced that its Board of Directors had received a proposal from members of the Schiffer/Gold family, together with Leonard Green & Partners, L.P. to acquire the Company in a “going private” transaction for $19.09 per share in cash. The Company's Board of Directors formed a special committee of independent directors to consider the proposal. The Special Committee, which has engaged independent financial and legal advisors, is also authorized to consider other proposals and strategic alternatives. There is no assurance that a definitive offer for a change of control transaction will be made or, if made, that such a transaction would be consummated.
16.
Quarterly Financial Information (Unaudited)
The following table sets forth certain unaudited results of operations for each quarter during fiscal years 2010 and 2009. The unaudited information has been prepared on the same basis as the audited financial statements 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. The Company’s fiscal year 2011 (“fiscal 2011”) which began on March 28, 2010 and ended on April 2, 2011, consisted of 53 weeks with one additional week included in the fourth quarter. The Company’s fiscal year 2010 (“fiscal 2010”), which began on March 29, 2009 and ended March 27, 2010 consisted of 52 weeks.
During the fourth quarter of fiscal 2010, the Company recognized an additional charge of approximately $1.1 million related to lease termination costs and stores closing costs associated with some of the closed Texas stores.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company evaluated the effectiveness of its disclosure controls and procedures as of the end of the period covered by this Report, under the supervision and with the participation of the Company’s management, pursuant to Rule 13a-15(b) of the Securities Exchange Act. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer each concluded that the Company’s disclosure controls and procedures were effective as of April 2, 2011.
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining an adequate system of internal control over financial reporting, pursuant to Rule 13a-15(c) of the Securities Exchange Act. This system is intended to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States.
A company’s internal control over financial reporting includes policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company, (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company, and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Management uses the framework in Internal Control - Integrated Framework, issued by the Committee of Sponsoring Organizations (“COSO”) of the Treadway Commission, for evaluating the effectiveness of the Company’s internal control over financial reporting. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements, and projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with policies or procedures may deteriorate.
Based on its assessment, management concluded that the Company’s internal control over financial reporting was effective as of April 2, 2011. The Company’s independent registered public accounting firm, BDO USA LLP, has audited the Company’s consolidated financial statements and has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting, which is included in this report.
Changes in Internal Control Over Financial Reporting
During the fourth quarter of fiscal 2011, the Company did not make any changes that materially affected or are reasonably likely to materially affect its internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
99¢ Only Stores
City of Commerce, California
We have audited 99¢ Only Stores’ (the “Company”) internal control over financial reporting as of April 2, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Item 9A, Management’s Report on Internal Control Over Financial Reporting”. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, 99¢ Only Stores maintained, in all material respects, effective internal control over financial reporting as of April 2, 2011, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of 99¢ Only Stores as of April 2, 2011 and March 27, 2010, and the related consolidated statements of income, stockholders’ equity, and cash flows for the years ended April 2, 2011, March 27, 2010 and March 28, 2009 and our report dated May XX, 2011 expressed an unqualified opinion thereon.
/s/ BDO USA, LLP
Los Angeles, California
May 26, 2011
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Information regarding Directors and Executive Officers of the registrant required by Item 401 of Regulation S-K, information regarding Directors and Executive Officers of the registrant required by Item 405 of Regulation S-K, information regarding Directors and Executive Officers of the registrant required by Item 406 of Regulation S-K, and information regarding Directors and Executive Officers of the registrant required by Item 407 (c)(3), (d)(4) and (d)(5) of Regulation S-K is presented under the captions "Election of Directors," "Information with Respect to Nominees and Executive Officers," "Code of Business Conduct and Ethics," "Further Information Concerning the Board of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the definitive Proxy Statement for the Company's 2011 Annual Meeting of Shareholders, which will be filed with the Commission no later than 120 days after the end of the Company’s 2011 fiscal year and which is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
The information required by Item 402 of Regulation S-K and paragraphs (e)(4) and (e)(5) of Item 407 of Regulation S-K is presented under the captions "Executive Compensation", “Compensation Committee Interlocks and Insider Participation,” and “Compensation Committee Report” in the definitive Proxy Statement for the Company's 2011 Annual Meeting of Shareholders, and is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by Item 403 of Regulation S-K is presented under the captions "Principal Shareholders" in the definitive Proxy Statement for the Company's 2011 Annual Meeting of Shareholders, and is incorporated herein by reference.
See “Part II, Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” for information regarding the securities authorized for issuance under the Company’s equity compensation plans.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by Item 404 of Regulation S-K and Item 407(a) of Regulation S-K is presented under the captions "Related Person Transactions" and “Further Information Concerning the Board of Directors” in the definitive Proxy Statement for the Company's 2011 Annual Meeting of Shareholders, and is incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
The information required by Item 9(e) of Schedule 14A is presented under the caption "Independent Registered Public Accountants" in the definitive Proxy Statement for the Company's 2011 Annual Meeting of Shareholders, and is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
a) Financial Statements. Reference is made to the Index to the Financial Statements set forth in item 8 on page 41 of this Form 10-K.
Financial Statement Schedules. All Schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are included herein.
b) The Exhibits listed on the accompanying Index to Exhibits are filed as part of, or incorporated by reference into, this report.
99¢ Only Stores
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(Amounts in thousands)
Exhibit Index
Exhibit Description
3.1
Amended and Restated Articles of Incorporation of the Registrant.(2)
3.2
Amended and Restated Bylaws of the Registrant.(10)
4.1
Specimen certificate evidencing Common Stock of the Registrant.(3)
10.1
Form of Amended and Restated Indemnification Agreement and Schedule of Indemnified Parties.(10)
10.2
Indemnification Agreement with David Gold.(4)
10.3
Form of Tax Indemnification Agreement, between and among the Registrant and the Existing Shareholders.(3)
10.4
1996 Stock Option Plan, as Amended. (8)
10.5
1996 Stock Option Plan: Performance Stock Unit Award - Fiscal 2008 to 2012 (9)
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 (“6161 Atlantic Blvd. Lease”).(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
[Reserved]
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 (“6121 Wilshire Blvd. Lease”), 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 (“8625 Woodman Avenue Lease”).(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 (“2566 East Florence Avenue Lease”), 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
[Reserved]
10.19
Lease for 12123-12125 Carson Street, Hawaiian Gardens, California dated February 14, 1995, as amended.(7)
10.20
North Broadway Indemnity Agreement, dated as of May 1, 1996, by and between HKJ Gold, Inc. and the Registrant.(6)
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.(6)
10.22
Agreement with Gold family and affiliates related to nonpayment of rent increases.(7)
10.23
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.(3)
10.24
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.(3)
10.25
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.(3)
10.26
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.(3)
10.27
[Reserved]
10.28
1996 Stock Option Plan: Stock Option Award Agreement (9)
10.29
[Reserved]
10.30
Second Amendment to 6161 Atlantic Blvd. Lease, dated January 1, 2005. (7)
10.31
99¢ Only Stores 2010 Equity Incentive Plan (11)
10.32
Form of 2010 Equity Incentive Plan Stock Option Award Agreement (11)
10.33
Form of 2010 Equity Incentive Plan Non-Employee Director Stock Option Award Agreement (11)
21.0
Subsidiaries*
23.1
Consent of BDO USA, LLP*
23.2
Consent of Independent Valuation Firm*
31(a)
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
31(b)
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
32(a)
Certification of Chief Executive Officer pursuant to section 906 of the Sarbanes-Oxley Act of 2002.*
32(b)
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *
* 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 March 26, 1996.
(2) Incorporated by reference from the Company’s 2002 Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 31, 2003.
(3) Incorporated by reference from the Company’s Amendment No. 2 to Registration Statement on Form S-1/A as filed with the Securities and Exchange Commission on May 21, 1996.
(4) Incorporated by reference from the Company’s 2004 Annual Report on Form 10-K as filed with the Securities and Exchange Commission on September 9, 2005.
(5) Incorporated by reference from the Company’s Current Report on Form 8-K as filed with Securities and Exchange Commission on November 17, 2005.
(6) Incorporated by reference from the Company’s Amendment No. 1 to Registration Statement on Form S-1/A as filed with the Securities and Exchange Commission on May 3, 1996.
(7) Incorporated by reference from the Company’s 2006 Annual Report on Form 10-K as filed with the Securities and Exchange Commission on April 2, 2007.
(8) Incorporated by reference from the Company’s Quarterly Report on Form 10-Q as filed with the Securities and Exchange Commission on February 11, 2008.
(9) Incorporated by reference from the Company’s Current Report on Form 8-K as filed with Securities and Exchange Commission on January 16, 2008.
(10) Incorporated by reference from the Company’s 2009 Annual Report on Form 10-K as filed with Securities and Exchange Commission on June 10, 2009.
(11) Incorporated by reference from the Company’s Current Report on Form 8-K as filed with Securities and Exchange Commission on September 17, 2010.
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¢ Only Stores
/s/ Eric Schiffer
By: Eric Schiffer
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934 this Annual Report on Form 10-K 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
David Gold
Chairman of the Board
May 26, 2011
/s/ Eric Schiffer
Eric Schiffer
Chief Executive Officer and Director (principal executive officer)
May 26, 2011
/s/ Jeff Gold
Jeff Gold
President, Chief Operating Officer and Director
May 26, 2011
/s/ Howard Gold
Howard Gold
Executive Vice President of Special Projects
May 26, 2011
/s/ Robert Kautz
Robert Kautz
Executive Vice President and Chief Financial Officer (principal financial officer and principal accounting officer)
May 26, 2011
/s/ Eric Flamholtz
Eric Flamholtz
Director
May 26, 2011
/s/ Lawrence Glascott
Lawrence Glascott
Director
May 26, 2011
/s/ Marvin L. Holen
Marvin L. Holen
Director
May 26, 2011
/s/ Peter Woo
Peter Woo
Director
May 26, 2011