99 Cents Only Stores 10-Q 2009 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

T QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended December 27, 2008

Or

£ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 1-11735

99¢ ONLY STORES

(Exact name of registrant as specified in its charter)

California	95-2411605
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
4000 Union Pacific Avenue, City of Commerce, California	90023 (Zip Code)
(Address of principal executive offices)

Registrant's telephone number, including area code: (323) 980-8145

Former name, address and fiscal year, if changed since last report

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes T         No £

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

Large accelerated filer £ Accelerated filer T Non-accelerated filer £ Smaller reporting company £

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes £         No T

Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date.

Common Stock, No Par Value 69,948,631 Shares as of February 1, 2009

1

99¢ ONLY STORES

Form 10-Q

Table of Contents

Part I- Financial Information

		Page
Item 1.	Financial Statements	4
	Consolidated Balance Sheets as of December 27, 2008 (unaudited) and March 29, 2008	4
	Consolidated Statements of  Income for the third quarter and the three quarters ended December 27, 2008 and December 31, 2007 (unaudited)	5
	Consolidated Statements of Cash Flows for the three quarters ended December 27, 2008 and December 31, 2007 (unaudited)	6
	Notes to Consolidated Financial Statements	7
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	29
Item 4.	Controls and Procedures	29
Part II – Other Information
Item 1.	Legal Proceedings	30
Item 1A.	Risk Factors	30
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	30
Item 3.	Defaults Upon Senior Securities	30
Item 4.	Submission of Matters to a Vote of Security Holders	31
Item 5.	Other Information	31
Item 6.	Exhibits	31
	Signatures	32

2

FORWARD-LOOKING INFORMATION

This Report on Form 10-Q contains statements that constitute “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act and Section 27A of the Securities Act.  The words “expect,” “estimate,” “anticipate,” “predict,” “believe” and similar expressions and variations thereof are intended to identify forward-looking statements. Such statements appear in a number of places in this filing and include statements regarding the intent, belief or current expectations of 99¢ Only Stores (the “Company”) and its directors or officers with respect to, among other things, (a) trends affecting the financial condition or results of operations of the Company, and (b) the business and growth strategies of the Company (including the Company’s store opening growth rate).  Readers are cautioned not to put undue reliance on such forward-looking statements.  Such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and actual results may differ materially from those projected in this Report, for the reasons, among others, discussed in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” Sections.  The Company undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof.  Readers should carefully review the risk factors described in other documents the Company files from time to time with the Securities and Exchange Commission, including the Company’s Annual Report on Form 10-K for the fiscal year ended March 29, 2008.

3

PART I.  FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

99¢ ONLY STORES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

	December 27, 2008			March 29, 2008
	(Unaudited)
ASSETS
Current Assets:
Cash	$	15,742		$	9,462
Short-term investments		89,285			80,393
Accounts receivable, net for allowance of doubtful accounts of $100 and $159 at December 27, 2008 and March 29, 2008, respectively		1,955			2,144
Income taxes receivable		2,845			2,712
Deferred income taxes		29,221			29,221
Inventories, net		176,534			138,167
Assets held for sale		7,521			8,724
Other		3,532			7,217
Total current assets		326,635			278,040
Property and equipment, net		275,250			287,082
Long-term deferred income taxes		29,039			27,906
Long-term investments in marketable securities		30,126			41,852
Deposits and other assets		14,130			14,530
Total assets	$	675,180		$	649,410
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Accounts payable	$	48,715		$	25,048
Payroll and payroll-related		12,414			10,181
Sales tax		6,979			5,527
Other accrued expenses		21,139			16,511
Workers’ compensation		42,892			42,814
Current portion of capital lease obligation		63			59
Construction loan, current		—			7,319
Total current liabilities		132,202			107,459
Deferred rent		10,215			10,663
Deferred compensation liability		3,163			4,213
Capital lease obligation, net of current portion		535			584
Other liabilities		454			—
Total liabilities		146,569			122,919
Commitments and contingencies
Shareholders’ Equity:
Preferred stock, no par value – authorized, 1,000,000 shares; no shares issued or outstanding		—			—
Common stock, no par value – authorized, 200,000,000 shares; issued and outstanding, 69,947,313 shares at December 27, 2008 and 70,060,491 shares at March 29, 2008		231,865			228,673
Retained earnings		299,105			298,478
Other comprehensive loss		(2,359	)		(660	)
Total shareholders’ equity		528,611			526,491
Total liabilities and shareholders’ equity	$	675,180		$	649,410

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

4

99¢ ONLY STORES

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

(Unaudited)

	For the Third Quarter Ended						For the Three Quarters Ended
	December 27, 2008			December 31, 2007			December 27, 2008			December 31, 2007
Net Sales:
99¢ Only Stores	$	340,988		$	314,630		$	943,105		$	878,104
Bargain Wholesale		10,093			10,345			30,676			30,753
Total sales		351,081			324,975			973,781			908,857
Cost of sales (excluding depreciation and amortization expense shown separately below)		208,248			194,470			591,385			556,121
Gross profit		142,833			130,505			382,396			352,736
Selling, general and administrative expenses:
Operating expenses		117,109			110,021			353,010			324,965
Depreciation and amortization		8,835			8,297			26,236			24,761
Total selling, general and administrative expenses		125,944			118,318			379,246			349,726
Operating income		16,889			12,187			3,150			3,010
Other (income) expense:
Interest income		(835	)		(1,746	)		(3,067	)		(5,612	)
Interest expense		370			186			778			581
Other		227			—			1,582			(345	)
Total other (income), net		(238	)		(1,560	)		(707	)		(5,376	)
Income before provision for income taxes and minority interest		17,127			13,747			3,857			8,386
Provision for income taxes		4,674			4,225			972			1,071
Net income before minority interest		12,453			9,522			2,885			7,315
Minority interest		—			—			(1,357	)		—
Net income	$	12,453		$	9,522		$	1,528		$	7,315
Earnings per common share:
Basic	$	0.18		$	0.14		$	0.02		$	0.10
Diluted	$	0.18		$	0.14		$	0.02		$	0.10
Weighted average number of common shares outstanding:
Basic		69,985			70,060			70,021			70,038
Diluted		70,177			70,060			70,084			70,136

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

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99¢ ONLY STORES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)

(Unaudited)

	For the Three Quarters Ended
	December 27, 2008			December 31, 2007
Cash flows from operating activities:
Net income	$	1,528		$	7,315
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		26,236			24,761
Loss on disposal of fixed assets		341			42
Gain on sale of partnerships		(760	)		—
Fixed assets impairment		10,355			531
Investments impairment		1,677			—
Minority interest in partnership		1,357			—
Excess tax deficiency (benefit) from share-based payment arrangements		7			(130	)
Deferred income taxes		(1,133	)		—
Stock-based compensation expense		2,488			3,567
Tax benefit from exercise of non qualified employee stock options		—			247
Changes in assets and liabilities associated with operating activities:
Accounts receivable		189			798
Inventories		(36,981	)		(11,603	)
Deposits and other assets		788			1,352
Accounts payable		22,259			(729	)
Accrued expenses		9,894			3,164
Accrued workers’ compensation		78			(746	)
Income taxes		(133	)		(3,273	)
Deferred rent		(448	)		1,541
Net cash provided by operating activities		37,742			26,837
Cash flows from investing activities:
Purchases of property and equipment		(26,797	)		(34,553	)
Sale of fixed assets		257			—
Purchases of investments		(50,158	)		(242,696	)
Sales and maturity of available for sale securities		48,483			250,456
Proceeds from sale of partnership asset		2,218			—
Acquisition of partnership assets		(4,566	)		—
Net cash used in investing activities		(30,563	)		(26,793	)
Cash flows from financing activities:
Repurchases of common stock		(901	)		—
Payments of capital lease obligation		(45	)		(42	)
Proceeds from exercise of stock options		54			812
Proceeds from the consolidation of construction loan		—			20
Excess tax (deficiency) benefit from share-based payment arrangements		(7	)		130
Net cash (used in) provided by financing activities		(899	)		920
Net increase in cash		6,280			964
Cash and cash equivalents - beginning of period		9,462			983
Cash and cash equivalents - end of period	$	15,742		$	1,947

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

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99¢ ONLY STORES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.  Basis of Presentation and Summary of Significant Accounting Policies

The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”).  However, certain information and footnote disclosures normally included in financial statements prepared in conformity with GAAP have been omitted or condensed pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  These statements should be read in conjunction with the Company's audited financial statements for the fiscal year ended March 29, 2008 and notes thereto included in the Form 10-K of 99¢ Only Stores (“the Company”) for the fiscal year ended March 29, 2008 (“fiscal 2008”).  In the opinion of the Company’s management, these interim consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary for a fair statement of the consolidated financial position and results of operations for each of the periods presented.  The results of operations and cash flows for such periods are not necessarily indicative of results to be expected for the full year ending March 28, 2009 (“fiscal 2009”).

Fiscal Periods

On February 1, 2008, the Company changed its fiscal year end from March 31 to the Saturday nearest March 31 of each year. The Company now follows a fiscal calendar consisting of four quarters with 91 days, each ending on the Saturday closest to the calendar quarter-end and a 52-week fiscal year with 364 days, with a 53-week year every five to six years. Unless otherwise stated, references to years in this report relate to fiscal years rather than calendar years.  The Company’s fiscal year 2009 (“fiscal 2009”) began on March 30, 2008 and will end on March 28, 2009 and fiscal year 2008 (“fiscal 2008”) began on April 1, 2007 and ended March 29, 2008. The third quarter ended December 27, 2008 (“third quarter of fiscal 2009”) had 91 days while the third quarter ended December 31, 2007 (“third quarter of fiscal 2008”) had 92 days. The period ended December 27, 2008 (“the first three quarters of fiscal 2009”) had 273 days while the period ended December 31, 2007 (“the first three quarters of fiscal 2008”) had 275 days.

Nature of Business

The Company is incorporated in the State of California. The Company is an extreme value retailer of primarily consumable general merchandise with an emphasis on name-brand products.  As of December 27, 2008, the Company operated 281 retail stores with 198 in California, 47 in Texas, 24 in Arizona, and 12 in Nevada.  The Company is also a wholesale distributor of various consumable 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 GAAP.  Intercompany accounts and transactions between the consolidated companies have been eliminated in consolidation.

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.

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 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. The Company believes no significant concentration of credit risk exists with respect to these cash investments.

7

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, 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, auction rate securities, asset-backed securities, commercial paper, money market funds, and certain perpetual preferred stocks with periodic recurring dividend payments that are less than 2% of the Company’s cash and investment portfolio.  The auction rate securities have stated interest rates, which typically reset to prevailing market rates every 35 days or less.  The Company has included its auction rate securities in non-current assets on the Company’s consolidated balance sheets as of December 27, 2008 and March 29, 2008.  See Note 3, “Investments.”  Investment securities are recorded as required by Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” Investments are adjusted for amortization of premiums or discounts to maturity and such amortization is included in interest income. Realized gains and losses and declines in values judged to be other than temporary are determined based on the specific identification methods and are reported in the statements of income.

Available for sale securities are initially recorded at cost and periodically adjusted to fair value with any changes in fair value during a period excluded from earnings and reported as a charge or credit, net of tax effects, to other comprehensive income or loss in the Consolidated Statements of Shareholders’ Equity.  A decline in the fair value of any available for sale security below cost deemed to be other than temporary will be reported as a reduction of the carrying amount to fair value.  The impairment is charged to earnings and a new cost basis of the security is established.  Cost basis is established and maintained utilizing the specific identification method.

Inventories

Inventories are valued at the lower of cost (first in, first out) or market. Valuation allowances for obsolete and excess inventory and shrinkage are also recorded. Shrinkage is estimated as a percentage of sales for the period from the last physical inventory date to the end of the applicable period. Such estimates are based on experience and the most recent physical inventory results. The valuation allowances for obsolete and excess inventory in many locations (including various warehouses, store backrooms, and sales floors of all its stores) require management judgment and estimates that may impact the ending inventory valuation and valuation allowances may affect the reported gross margin for the period.

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 December 27, 2008 and March 29, 2008, the Company held inventory of specific products identified that it expected to sell over a period that exceeds twelve months of approximately $3.5 million and $2.1 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	3-5 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.

8

Long-Lived Assets

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets,” 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. 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 the first three quarters of 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 $10.1 million related to the Company’s decision to exit the Texas market and an impairment charge of approximately $0.2 million related to the underperformance of a store in California.  See Note 12 to Consolidated Financial Statements and the Company’s Form 8-K filed on September 18, 2008 for further information regarding the charges related to Company’s Texas operations.  Note that additional charges related to the Texas operations are expected to be recorded in the fourth quarter of fiscal 2009 when stores in Texas are actually closed in accordance with management’s exit plan including lease abatements and closing costs. During the first three quarters of fiscal 2008, due to the underperformance of one store in Texas, the Company concluded that the carrying value of its long-lived assets were not recoverable and accordingly recorded an asset impairment charge of $0.5 million.  During the third quarter of fiscal 2009 and 2008, the Company did not record any asset impairment charges.

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 SFAS No. 109, “Accounting for Income Taxes” (“SFAS No. 109”).  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. SFAS No. 109 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.

Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with the provision of SFAS No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”).  SFAS No. 123(R) 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 has estimated the fair value for each 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. Although the Black-Scholes model meets the requirement of SFAS No. 123(R) and SAB 107, the fair values generated by the model may not be indicative of the actual fair values of the Company’s awards, as it does not consider other factors important to those share-based payment awards, such as continued employment and periodic vesting requirements. The Company recognizes the stock-based compensation expense ratably over the requisite service periods, which is generally a vesting term of 3 years. Stock options typically have a term of 10 years.   The Company also accounts for stock based performance unit awards and stock awards based on the stock value at the time the awards are granted and performance and vesting criteria.

9

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.

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. The Company receives various cash discounts, allowances and rebates from its vendors. Such items are included as reductions of cost of sales as merchandise is sold. 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. The closing of stores in the future may result in the immediate write-off of associated deferred rent balances, if any.

Self-insured Workers’ Compensation Liability

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 December 27, 2008 and March 29, 2008.

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 $1.1 million and $1.7 million for the third quarter of fiscal 2009 and 2008, respectively.  Advertising expenses were $3.6 million and $4.3 million for the first three quarters of fiscal 2009 and 2008.

10

Statements of Cash Flows

Non-cash investing activities included $1.4 million and $0.8 million in fixed assets purchase accruals for the first three quarters of fiscal 2009 and 2008, respectively.  Non-cash investing activities also included $9.3 million of partnership foreclosure trustee sale proceeds.  Non-cash financing activities included a $7.3 million loan payment.

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 borrowings. The Company believes all of the financial instruments’ recorded values approximate fair market value because of their nature and respective durations.

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”).  SFAS 157 does not require any new fair value measurements.  SFAS 157 establishes a common definition for fair value to be applied with existing GAAP requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements.  The Company adopted SFAS 157 at the beginning of the first quarter of fiscal 2009 except for those non-recurring measurements for non-financial assets and non-financial liabilities subject to the partial deferral in FASB Statement of Position No. 157-2, “Partial Deferral of the Effective Date of Statement 157,” (“FSP 157-2”) as noted below.  The adoption of SFAS 157 did not have an impact on our financial position or operating results.

FSP 157-2 deferred the effective date of SFAS 157 for all non-financial assets and non-financial liabilities to fiscal years beginning after November 15, 2008. SFAS No. 157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy, as defined below, gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.

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 (liabilities) recorded at fair value on a recurring basis as of December 27, 2008 (in thousands):

	Total		Level 1		Level 2		Level 3
Description
Available for sale investments	$	119,411	$	69,416	$	37,763	$	12,232

Level 1 investments include money market funds and perpetual preferred stocks of $68.5 million and $0.9 million, respectively.  Level 2 investments include municipal bonds, asset-backed securities and corporate bonds of $20.0 million, $12.2 million and $5.6 million, respectively.  Level 3 investments include auction rate securities of $12.2 million.

The valuation of the auction rate securities is based on Level 3 unobservable inputs which consist of recommended fair values provided by Houlihan Smith & Company, an independent securities valuation firm.  Based on the estimated fair value, the Company recorded a temporary reduction in the valuation of these securities of $2.0 million as of December 27, 2008.  These securities are held “available-for-sale” in conformity with SFAS No. 115 and the unrealized loss of $1.2 million, net of tax, related to these securities is included in other comprehensive loss in the current period.  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 the condensed consolidated balance sheets.

11

The following table summarizes the activity for the period of changes in fair value of the Company’s Level 3 investments (in thousands):

	Fair Value Measurements Using Significant Unobservable Inputs (Level 3) as of December 27, 2008
Auction Rate Securities	Third quarter			First three quarters
Description
Beginning balance	$	14,070		$	—
Transfers into Level 3		—			15,492
Total realized/unrealized losses:
Included in earnings		—			—
Included in other comprehensive loss		(1,258	)		(1,975	)
Sales and redemptions		(580	)		(1,285	)
Ending balance	$	12,232		$	12,232
Total amount of unrealized losses for the period included in other comprehensive loss attributable to the change in fair market value relating to assets still held at the reporting date	$	(1,258	)	$	(1,975	)

Comprehensive Income

SFAS No. 130, “Reporting Comprehensive Income,” establishes standards for reporting and displaying comprehensive income and its components in the consolidated financial statements. Accumulated other comprehensive income includes unrealized gains or losses on investments.

2. Property and Equipment, net

The following table provides details of property and equipment (in thousands):

	December 27, 2008			March 29, 2008
Property and equipment
Land	$	69,590		$	64,442
Buildings		86,319			86,970
Building improvements		61,139			46,938
Leasehold improvements		128,727			136,366
Fixtures and equipment		117,129			108,357
Transportation equipment		5,036			3,625
Construction in progress		15,474			32,886
Total property and equipment		483,414			479,584
Less: accumulated depreciation and amortization		(208,164	)		(192,502	)
Property and equipment, net	$	275,250		$	287,082

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3. Investments

The following tables summarize the investments in marketable securities (in thousands):

	December 27, 2008
	Cost or Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Available for sale:
Commercial paper and money market	$	68,525	$	—	$	—		$	68,525
Auction rate securities		14,207		—		(1,975	)		12,232
Municipal bonds		19,983		42		—			20,025
Asset-backed securities		12,932		23		(756	)		12,199
Corporate securities		7,695		—		(1,265	)		6,430
Total	$	123,342	$	65	$	(3,996	)	$	119,411
Reported as:
Short-term investments								$	89,285
Long-term investments in marketable securities									30,126
Total								$	119,411

	March 29, 2008
	Cost or Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Available for sale:
Commercial paper and money market	$	54,938	$	—	$	—		$	54,938
Auction rate securities		18,202		—		—			18,202
Municipal bonds		24,158		23		(5	)		24,176
Asset-backed securities		18,338		37		(249	)		18,126
Corporate securities		7,708		276		(1,181	)		6,803
Total	$	123,344	$	336	$	(1,435	)	$	122,245
Reported as:
Short-term investments								$	80,393
Long-term investments marketable securities									41,852
Total								$	122,245

The auction rate securities the Company holds generally are long-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 $12.2 million and $15.5 million of its auction rate securities in non-current assets on the Company’s balance sheet as of December 27, 2008 and March 29, 2008, respectively.  The Company has classified these securities as Level 3 securities, and has not recognized any impairment charges related to these securities because it believes that based on the credit ratings of the issuers, the decline in the fair market value is temporary, and the Company has the ability to hold these securities until the full value is realized, for years if necessary.

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The following table summarizes maturities of marketable fixed-income securities classified as available for sale as of December 27, 2008 (in thousands):

	Amortized Cost		Estimated Fair Value
Due within one year	$	20,714	$	20,771
Due after one year through five years		19,137		17,393
Due after five years		12,581		11,842
	$	52,432	$	50,006

Non-tax effected net unrealized losses relating to securities that were recorded as available for sale securities were $3.9 million as of December 27, 2008.  Non-tax effected net unrealized losses relating to securities that were recorded as available for sale securities were $1.1 million as of March 29, 2008.  The tax effected losses on net unrealized holdings of available for sale securities were $0.8 million and $1.7 million for the third quarter and the first three quarters of fiscal 2009, respectively.  The tax effected losses on net unrealized holdings of available for sale securities were $0.5 million and $0.9 million for the third quarter and the first three quarters of fiscal 2008.  The tax effected gains and losses are included in other comprehensive loss.  The Company has not recognized any impairment charges related to these unrealized losses in the third quarter because it believes that based on the credit ratings of the issuers, the decline in the fair market value is temporary, and the Company has the ability to hold these securities until the full value is realized, for years if necessary.

There were no realized gains from sales of available for sale securities for the third quarter of fiscal 2009.  Realized gains from sales of available for sale securities for the first three quarters of fiscal 2009 were $0.3 million.  Realized gains from sales of available for sale securities were $0.3 million for the third quarter and the first three quarters of fiscal 2008.  There were no gross realized losses from sales of available for sale securities for the third quarter and the first three quarters of fiscal 2009.  There were no gross realized losses for the third quarter of fiscal 2008 while the gross realized losses from sales of available for sale securities for the first three quarters of fiscal 2008 were $3,000 (three thousand dollars).

During the second quarter of fiscal 2009, the Company determined that the decline in the fair value of certain of its available for sale securities were other than temporary due to a bankruptcy filing.  As result, during the first three quarters of fiscal 2009, the Company recognized $1.7 million in impairment charges due to Lehman Brothers’ securities held by the Company.  The impairment charge of $1.7 million is reported as other expense on the Company’s consolidated statements of income.

Proceeds from the sales of available for sale securities were $18.9 million and $48.5 million for the third quarter and the first three quarters of fiscal 2009, respectively.  Proceeds from the sales of available for sale securities were $148.3 million and $250.5 million for the third quarter and the first three quarters of fiscal 2008, respectively.  

4. Comprehensive Income (Loss)

The following table sets forth the calculation of comprehensive income (loss), net of tax effects for the periods indicated (in thousands):

	For the Third Quarter Ended						For the Three Quarters Ended
	December 27, 2008			December 31, 2007			December 27, 2008			December 31, 2007
Net income	$	12,453		$	9,522		$	1,528		$	7,315
Unrealized holding losses on marketable securities, net of tax effects		(760	)		(517	)		(2,441	)		(762	)
Reclassification adjustment, net of tax effects		(70	)		—			742			(206	)
Total unrealized holding losses, net		(830	)		(517	)		(1,699	)		(968	)
Total comprehensive income (loss)	$	11,623		$	9,005		$	(171	)	$	6,347

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5.  Earnings Per Share

“Basic” earnings per share is computed by dividing net income by the weighted average number of shares outstanding for the period. “Diluted” earnings per share is computed by dividing net income by the total of the weighted average number of shares outstanding plus the dilutive effect of outstanding equity awards (applying the treasury stock method).

The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts):

	For the Third Quarter Ended				For the Three Quarters Ended
	December 27, 2008		December 31, 2007		December 27, 2008		December 31, 2007
Net income	$	12,453	$	9,522	$	1,528	$	7,315
Weighted average number of common shares outstanding – basic		69,985		70,060		70,021		70,038
Dilutive effect of outstanding stock options		192		—		63		98
Weighted average number of common shares outstanding – diluted		70,177		70,060		70,084		70,136
Basic earnings per share	$	0.18	$	0.14	$	0.02	$	0.10
Diluted earnings per share	$	0.18	$	0.14	$	0.02	$	0.10

For the third quarter of fiscal 2009 and 2008, stock options of 3.1 million and 6.0 million shares, respectively, were excluded from the calculation of the weighted average number of common shares outstanding because they were anti-dilutive. For the first three quarters of fiscal 2009 and 2008, stock options of 5.3 million and 3.3 million shares, respectively, were excluded from the calculation of the weighted average number of common shares outstanding because they were anti-dilutive.

6. Stock-Based Compensation

The Company has one plan that provides for stock-based compensation (the 1996 Stock Option Plan, as amended). The plan is a fixed plan, which provides for the granting of non-qualified and incentive stock options as well as other types of equity-based awards.  An aggregate of 17,000,000 shares of the Company’s common stock may be issued pursuant to all awards under the plan, of which 1.5 million were available as of December 27, 2008 for future awards. Awards may be granted to officers, employees, non-employee directors and consultants of the Company. All stock option 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 thereafter, though an exception was made by the  Compensation Committee on June 6, 2006, when it granted stock options that vested in equal halves over a two year period. Stock options typically expire ten years from the date of grant.  The plan will expire in 2011.   The Compensation Committee has also approved grants of Performance Stock Units discussed further below (see also Form 8-K filed on January 16, 2008).

Valuation Information Under SFAS No. 123(R)

The weighted average fair values per share of stock options granted have been estimated using the Black-Scholes pricing model with the following assumptions:

	For the Three Quarters Ended
	December 27, 2008		December 31, 2007
Risk-free interest rate		3.0%		4.5%
Expected life (in years)		5.0		4.9
Expected volatility		55.1%		43.9%
Expected dividend yield		None		None

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 currently plan to pay dividends in the near future.  Compensation expense is recognized only for those stock options expected to vest, with forfeitures estimated based on the Company’s historical experience and future expectations.

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Stock Option Activity

Option activity under the Company’s stock option plan in the first three quarters of fiscal 2009 is set forth below:

	Number of Shares			Weighted-Average Exercise Price		Weighted-Average Remaining Contractual Life		Aggregate Intrinsic Value
Options outstanding at the beginning of the period		6,471,000		$	16.02
Granted		122,000		$	9.76
Exercised		(5,000	)	$	10.44			$	6,000
Cancelled		(705,000	)	$	13.52
Outstanding at the end of the period		5,883,000		$	16.20		5.28	$	2,759,000
Exercisable at the end of the period		4,751,000		$	18.02		4.49	$	345,000

For the third quarter and the first three quarters of fiscal 2009, the Company incurred non-cash stock-based compensation expense of $0.7 million and $2.5 million, respectively, which was recorded as operating expense. For the third quarter and the first three quarters of fiscal 2008, the Company incurred non-cash stock-based compensation expense of $1.1 million and $3.6 million, respectively, which was recorded as operating expense.  As of December 27, 2008, there was $2.8 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 1.2 years. The total fair value of shares vested during the first three quarters of fiscal 2009 and 2008 was $4.2 million, and $6.8 million, respectively.

Performance Stock Units

During 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.  The PSUs will be 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 years 2008 through 2012), (2) continuous employment with the Company, and (3) certain vesting requirements.  As of December 27, 2008 the Company had 1.6 million PSUs issued and outstanding.The following table summarizes the PSUs activity in the first three quarters of fiscal 2009:

	Number of Shares			Weighted Average Fair Value
PSUs outstanding at the beginning of the period		1,627,000		$	6.75
Granted		127,000		$	9.21
Forfeited		(115,000	)	$	6.58
Outstanding at the end of the period		1,639,000		$	6.95
Vested at the end of the period		—			—

For PSUs, compensation expense is recognized only when it is probable that the performance criteria will be met. The fair value of the PSUs is based on the stock price on the grant date. No PSUs vested during the first three quarters of fiscal 2009 as none of the performance criteria were met.  As of December 27, 2008 the unvested future compensation expense, assuming all the performance criteria will be met within the specified time frames, was $11.4 million.

7. Variable Interest Entities

The Company is the primary beneficiary of a variable interest entity to develop a shopping center in La Quinta, California, in which the Company leases a store (the “La Quinta Partnership”).  As of March 29, 2008, this entity had $9.0 million in assets and $7.4 million in liabilities, including a bank loan for $7.3 million. These amounts are shown on the Company’s consolidated balance sheets as of March 29, 2008.  In January 2008, the Company received a buy-sell offer from the managing member of the La Quinta partnership.  After the timeline for completion of the sale passed, the Company notified the managing member that the managing member was in default of closing the transaction within the agreed-upon timeframe.  In addition, the partnership had a $7.5 million loan, including principal of $7.3 million and accrued interest of $0.2 million, due to a bank on June 1, 2008, in which the partnership was in default.  During the third quarter of fiscal 2009, the bank foreclosed on the shopping center.   Eighty-nine percent of the land and all of the buildings were sold in the foreclosure sale for $9.3 million.  The $9.3 million included the Company’s purchase of land and building related to its store for approximately $2.9 million and the rest of the center was sold for $6.4 million to a third party, except for a small parcel of undeveloped land which remains in the partnership at this time.  As a result of the foreclosure, the bank received $7.9 million including principal, interest and penalties.The partnership’s loss from the foreclosure sales of the shopping centerwas $0.8 million.  Of the $0.8 million loss, the Company recognized its share of the loss of approximately $0.5 million in the third quarter of fiscal 2009.  In accordance with FIN 46(R), the Company has included the partner’s share of the loss of approximately $0.3 million in its operating expenses.  As a result of the foreclosure of the shopping center, the Company is now managing the partnership.

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The Company also has an interest in a partnership which the Company consolidated at March 29, 2008 in accordance with FIN 46(R). The assets of the partnership consisted of real estate with a carrying value of approximately $1.5 million and there was no mortgage debt or other significant liabilities associated with the entities, other than notes payable to the Company.  The balance sheet effect of consolidating this entity at March 29, 2008 was a reclassification of approximately $1.5 million from investments to property and equipment with no corresponding impact on the Company’s recorded liabilities.  In November 2008, the Company purchased its partner’s share of this partnership, consisting of one of the Company’s leased stores with an approximate carrying value of $1.5 million. The Company paid approximately $1.6 million, including estimated selling costs, to acquire its partner’s share in the partnership. The Company increased its building and land value for approximately $1.6 million as result of this purchase. Due to the purchase of the primary asset of the partnership, the Company is no longer a primary beneficiary and therefore has not consolidated the remaining immaterial assets of the partnership in the quarter ended December 27, 2008.

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

8. New Authoritative Pronouncements

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 does not require any new fair value measurements. SFAS 157 establishes a common definition for fair value to be applied with existing GAAP requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. The Company adopted SFAS 157 at the beginning of the first quarter of fiscal 2009 except for those non-recurring measurements for non-financial assets and non-financial liabilities subject to the partial deferral in FASB Statement of Position No. 157-2, “Partial Deferral of the Effective Date of Statement 157,” (“FSP 157-2”) as noted below. The adoption of SFAS 157 did not have an impact on the Company’s financial position or operating results.  FSP 157-2 deferred the effective date of SFAS 157 for all non-financial assets and non-financial liabilities to fiscal years beginning after November 15, 2008.  The adoption of this statement for non-financial assets and liabilities is not expected to have a material impact on the Company’s consolidated financial position or results of operations.

In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115" (“SFAS No. 159”).  SFAS No. 159 permits companies to choose to measure many financial instruments and certain other items at fair value at specified election dates. Upon adoption, an entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. Most of the provisions apply only to entities that elect the fair value option. However, the amendment to SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," applies to all entities with available for sale and trading securities. SFAS No. 159 is effective as of the beginning of an entity's first fiscal year that begins after November 15, 2007.

The Company adopted SFAS 159 at the beginning of the first quarter of fiscal 2009, and the adoption had no impact on the Company’sconsolidated financial position or results of operations.

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In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141(R)”).  SFAS No. 141(R) changes the requirements for an acquirer’s recognition and measurement of the assets acquired and liabilities assumed in a business combination. SFAS No. 141(R) replaces SFAS No. 141, “Business Combinations.” SFAS No. 141(R) is effective in fiscal years beginning after December 15, 2008.  The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial position or results of operations.

In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements” (“SFAS No. 160”).  SFAS No. 160 requires that non-controlling (minority) interests be reported as a component of equity, that net income attributable to the parent and to the non-controlling interest be separately identified in the income statement, that changes in a parent’s ownership interest while the parent retains its controlling interest be accounted for as equity transactions, and that any retained non-controlling equity investment upon the deconsolidation of a subsidiary be initially measured at fair value.  SFAS No. 160 is an amendment of Accounting Research Bulletin No. 51, “Consolidated Financial Statements” and related interpretations. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008. The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial position or results of operations.

In March 2008, the FASB issued SFAS No. 161, “Disclosures About Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133” (“SFAS 161”), which expands the disclosure requirements in SFAS 133 about an entity’s derivative instruments and hedging activities. SFAS 161’s disclosure provisions apply to all entities with derivative instruments subject to SFAS 133 and its related interpretations. The provisions also apply to related hedged items, bifurcated derivatives, and non-derivative instruments that are designated and qualify as hedging instruments. Entities with instruments subject to SFAS 161 must provide more robust qualitative disclosures and expanded quantitative disclosures. Such disclosures, as well as existing SFAS 133 required disclosures, generally will need to be presented for every annual and interim reporting period. This statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial position or results of operations.

In April 2008, the FASB issued FASB Staff Position (“FSP”) No. SFAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP SFAS 142-3”). FSP SFAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). The intent of FSP SFAS 142-3 is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141R (revised 2007), “Business Combinations” (“SFAS 141R”) and other applicable accounting literature. FSP SFAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and must be applied prospectively to intangible assets acquired after the effective date. The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial position or results of operations.

In May 2008, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 162, “Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”). This statement is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements of nongovernmental entities that are presented in conformity with GAAP. This statement will be effective 60 days following the U.S. Securities and Exchange Commission’s approval of the Public Company Accounting Oversight Board amendment to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles.”  The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial position or results of operations.

In May of 2008, FASB issued SFASB No. 163, Accounting for Financial Guarantee Insurance Contracts-an interpretation of FASB Statement No. 60.  The scope of the statement is limited to financial guarantee insurance (and reinsurance) contracts.  The pronouncement is effective for fiscal years beginning after December 31, 2008.  The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial position or results of operations.

9. Commitments and Contingencies

Credit Facilities

The Company’s debt includes a construction loan of $7.3 million as of March 29, 2008 as a result of the consolidation of a variable interest partnership entity. The loan bore a fixed interest rate of 8.75%.  For the third quarter and the first three quarters of fiscal 2009, the partnership paid interest costs in the amount of $0.3 million and $0.7 million, respectively.  For the third quarter and the first three quarters of fiscal 2008, the partnership paid interest costs in the amount of $0.2 million and $0.5 million, respectively.   The minority partner had guaranteed the bank loan, and the Company did not make any guarantees or incur direct liability outside the partnership for this loan.  The assets of the partnership were collateralized under the construction loan.  During the third quarter of fiscal 2009, the bank foreclosed on the shopping center related to this partnership. The bank’s loan was recovered due to the sale of the partnership’s property in a foreclosure sale.  As a result, the Company does not have any outstanding debt as of December 27, 2008.  See Note 7 to Consolidated Financial Statements above for further information.

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The Company does not maintain any credit facilities with any financial institutions.

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.  At December 27, 2008 and March 29, 2008, the Company had recorded a liability of $42.8 million and $42.7 million, respectively, for estimated workers’ compensation claims in California.  The Company has limited self-insurance exposure and had recorded a liability less than $0.1 million at December 27, 2008 and March 29, 2008 for workers’ compensation claims in Texas, and purchases workers’ compensation insurance coverage in Arizona and Nevada.

Legal Matters

The Company is named as a defendant in numerous legal matters arising in the normal course of business. In management’s opinion, none of these matters are expected to have a material adverse effect on the Company’s financial position, results of operations, or overall liquidity.

10. Stock Repurchase Program

The Company had no share purchases during the third quarter ended December 27, 2008. As of December 27, 2008 the Company had approximately $29.1 million remaining under Board approved repurchase authorizations.

The following table relates to purchases of the Company’s shares by the Company or any of its “affiliated purchasers” (as such term is defined in Rule 10b-18(b)(3) under the Securities Exchange Act) during the first three quarters ended December 27, 2008:

Period	Total Number of Shares Purchased (1)(2)		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased under the Plans or Programs
							(In thousands)
(7/27/08 - 8/23/08)		193,577	$	7.79		93,578	$	29,297
(8/24/08 - 9/27/08)		98,499	$	8.08		24,800	$	29,099
Total		292,076	$	7.89		118,378	$	29,099

(1)  On June 11, 2008, the Company announced that our Board of Directors had approved a share repurchase program for the purchase of up to $30 million of shares of our 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.  The Company has used and plans to continue to use existing cash to fund any repurchases.  All of the shares repurchased by the Company during the second quarter ended September 27, 2008 were purchased in open market transactions through this program.  The average price for shares purchased by the Company during the second quarter was $7.61.  The program has no expiration date.

(2)  Includes 173,698 shares acquired by our Chairman, Dave Gold, an affiliated purchaser, in open market purchases.

11. Operating Segments

The Company had presented Bargain Wholesale as a separate operating segment in the past.  Bargain Wholesale is not material to the Company’s consolidated financial statements and, starting with the first quarter of fiscal 2009, the Company has determined not to disclose Bargain Wholesale as a separate operating segment.

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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. Texas Market Plans

As announced on September 17, 2008, the Company’s Board of Directors, together with its management team, made a decision to exit the Company’s Texas market.  The Company’s exit plan anticipated that it would cease all operations and complete the sale of its assets within one year.  The determination to take this action resulted after a thorough review of sales and profit performance of the Company’s Texas stores.  As a result of the decision to close its Texas operations, the Company recognized an impairment charge of approximately $10.1 million related to leasehold improvements associated with leased stores during the first three quarters of fiscal 2009.  This non-cash charge is recorded within selling, general and administrative expenses in the consolidated statements of operations.  The Company did not record any impairment charges related to leasehold improvements during the third quarter of fiscal 2009.  During the third quarter of fiscal 2009, the Company also recognized severance expenses of approximately $1.4 million related to Texas operations of which approximately $1.3 million was paid during the third quarter of fiscal 2009.

On September 29, 2008, the Company announced that in response to a proposal by the Company’s Chairman Dave Gold to acquire the Company’s Texas operations, the Company’s Board of Directors formed a special committee of independent board members to consider this proposal as well as other proposals or alternatives to accomplish the exit plan.  On January 31, 2009, following evaluation of Dave Gold’s proposal by a Special Committee of independent directors of the Company’s Board, the Board adopted the recommendation of the Special Committee to reject the proposal.

In the course of the Board’s deliberations, the Board noted that same-store sales in Texas had increased at a rate of 8.6% during the four week period ended January 24, 2009, compared to a rate of 0.8% during the five week period ended December 27, 2008.  In light of this significant improvement in sales results and the state of the economy, the Board concluded it would be prudent to continue to observe sales and other financial results in Texas for a limited period before taking permanent actions that would effectively close off any opportunity to continue the Texas operations.  After additional discussion following the January 31st Board meeting, the Board voted on February 2nd  to continue operations in approximately two thirds of its Texas stores, and continue to operate its Texas distribution center to support these stores, in order to allow the Board to continue to monitor sales trends and other financial results in those stores. Depending on future sales and other financial results in Texas, the Board could permanently reverse its September decision and decide to maintain operations in Texas.

The actual amount of non-cash and cash charges incurred by the Company in connection with the Texas exit plan may be different than the estimated amounts set forth in the Company’s Form 8-K filed on September 18, 2008.  The Company can not predict with certainty the actual costs of continued operations in Texas or potential exit plans or precisely when these costs will be incurred over the course of the upcoming evaluation period.

13. Assets Held for Sale

Assets held for sale consist primarily of the Company’s warehouse in Eagan, Minnesota.  The book value of the warehouse at December 27, 2008 was $7.4 million.  The Company commenced marketing the sale of the warehouse during the fourth quarter of fiscal 2008 and anticipates selling the warehouse in excess of the book value and the selling costs.  No assurance can be given as to when and for how much the warehouse will be sold.

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

99¢ Only Stores (the “Company”) is an extreme value retailer of primarily consumable general merchandise with an emphasis on name-brand products.  The Company’s stores offer a wide assortment of regularly available consumer goods as well as a broad variety of first-quality closeout merchandise.

For the third quarter of fiscal 2009, the Company had net sales of $351.1 million, operating income of $16.9 million and net income of $12.5 million.  Sales increased during the third quarter of fiscal 2009, primarily due to a 4.2% increase in same-store sales, the full quarter effect of nine new stores opened in fiscal 2008 and 17 new stores opened in fiscal 2009.  For the first three quarters of fiscal 2009, the Company had net sales of $973.8 million, operating income of $3.2 million and net income of $1.5 million. Sales increased during the first three quarters of fiscal 2009, primarily due to a 2.9% increase in same-store sales, the full year effect of 14 new stores opened in fiscal 2008 and 17 new stores opened in fiscal 2009.

For the first three quarters of fiscal 2009, the Company opened 12 stores in California, two stores in Texas, two in Arizona, and one in Nevada.  The Company plans to open approximately two additional stores during the balance of fiscal 2009.

The Company believes that growth in sales for the remainder of fiscal 2009 will result from new store openings in its existing states and increases in same-store sales.

Critical Accounting Policies and Estimates

The Company’s critical accounting policies reflecting management’s estimates and judgments are described in Item 7 (Management’s Discussion and Analysis of Financial Condition and Results of Operations) of its Annual Report on Form 10-K for the year ended March 29, 2008, filed with the Securities and Exchange Commission on June 11, 2008.

Results of Operations

The following discussion defines the components of the statement of income.

Net Sales: Revenue is recognized at the point of sale for retail sales. Bargain Wholesale revenue is recognized on the date merchandise is shipped. Bargain Wholesale sales are shipped free on board shipping point.

Cost of Sales: Cost of sales includes the cost of inventory, freight in, inter-state warehouse transportation costs, obsolescence, spoilage, and inventory shrinkage, and is net of discounts and allowances. The Company receives various cash discounts, allowances and rebates from its vendors. Such items are included as reductions of cost of sales as merchandise is sold. The Company does not include purchasing, receiving, distribution warehouse costs and transportation to and from stores in its cost of sales, which totaled $19.4 million and $18.4 million for the third quarter of fiscal 2009 and 2008, respectively and totaled $56.8 million and $54.2 million for the first three quarters of fiscal 2009 and 2008, respectively.  Due to this classification, the Company's gross profit rates may not be comparable to those of other retailers that include costs related to their distribution network in cost of sales.

Selling, General and Administrative Expenses: Selling, general, and administrative expenses include purchasing, receiving, inspection and warehouse costs, the costs of selling merchandise in stores (payroll and associated costs, occupancy and other store level costs), distribution costs (payroll and associated costs, occupancy, transportation to and from stores, and other distribution related costs), and corporate costs (payroll and associated costs, occupancy, advertising, professional fees, stock-based compensation expense and other corporate administrative costs). Depreciation and amortization is also included in selling, general and administrative expenses.

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 construction loan.

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

	For the Third Quarter Ended						For the Three Quarters Ended
	December 27, 2008			December 31, 2007			December 27, 2008			December 31, 2007
NET SALES:
99¢ Only Stores		97.1	%		96.8	%		96.8	%		96.6	%
Bargain Wholesale		2.9			3.2			3.2			3.4
Total sales		100.0			100.0			100.0			100.0
COST OF SALES (excluding depreciation and amortization expense as shown separately below)		59.3			59.8			60.7			61.2
Gross profit		40.7			40.2			39.3			38.8
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES:
Operating expenses		33.4			33.9			36.3			35.8
Depreciation and amortization		2.5			2.6			2.7			2.7
Total selling, general and administrative		35.9			36.4			38.9			38.5
Operating income		4.8			3.8			0.3			0.3
OTHER (INCOME) EXPENSE:
Interest income		(0.2	)		(0.5	)		(0.3	)		(0.6	)
Interest expense		0.1			0.1			0.1			0.1
Other		0.1			0.0			0.2			0.0
Total other (income), net		(0.1	)		(0.5	)		(0.1	)		(0.6	)
Income before provision for income taxes and minority interest		4.9			4.2			0.4			0.9
Provision for income taxes		1.3			1.3			0.1			0.1
Minority interest		—			—			(0.1	)		—
NET INCOME		3.5	%		2.9	%		0.2	%		0.8	%

For the Third Quarter Ended December 27, 2008 Compared to the Third Quarter Ended December 31, 2007

Net Sales: Net sales increased $26.1 million, or 8.0%, to $351.1 million for the third quarter of fiscal 2009 compared to $325.0 million for the third quarter of fiscal 2008.  Retail sales increased $26.4 million, or 8.4%, to $341.0 million for the third quarter of fiscal 2009 compared to $314.6 million for the third quarter of fiscal 2008. The full quarter effect of nine stores opened in fiscal 2008 increased sales by $3.0 million for the third quarter of fiscal 2009 and the effect of 17 new stores opened in fiscal 2009 increased retail sales by $15.5 million.  In addition, same-store sales were up 4.2% for the third quarter of fiscal 2009 compared to the third quarter of fiscal 2008, primarily due to food and grocery category growth.  This included an approximate 1.3% increase in transaction counts as well as 2.8% increase in average ticket size to $9.83 from $9.56.

Gross Profit: Gross profit increased $12.3 million, or 9.4%, to $142.8 million for the third quarter of fiscal 2009 compared to $130.5 million for the third quarter of fiscal 2008.  As a percentage of net sales, overall gross margin increased to 40.7% for the third quarter of fiscal 2009 compared to 40.2% for the third quarter of fiscal 2008.  The increase in gross profit margin was primarily due to a decrease in spoilage/shrink to 3.0% of net sales in the third quarter of fiscal 2009 from 3.4% of net sales in the third quarter of fiscal 2008, primarily due to a decrease in recorded scrap from perishables and a reduction in the shrink reserves based on the trend of physical inventories taken during the third quarter of fiscal 2009.  In addition, the increase in gross profit margin was also due to a decrease in cost of products sold to 55.6% for the third quarter of fiscal 2009 compared to 56.2% for the third quarter of fiscal 2008, due to the full effect of the retail pricing strategy implemented in the second half of fiscal 2008 as well as due to the Company’s decision on September 8, 2008, to increase its price to 99.99 cents from 99 cents.  The remaining change is primarily due to higher in-bound freight costs and lower card board recycled revenue, included in cost of sales.

Operating Expenses:  Operating expenses increased by $7.1 million, or 6.4%, to $117.1 million for the third quarter of fiscal 2009 compared to $110.0 million for the third quarter of fiscal 2008.  As a percentage of net sales, operating expenses decreased to 33.4% for the third quarter of fiscal 2009 from 33.9% for the third quarter of fiscal 2008. Of the 50 basis points decrease in operating expenses as a percentage of sales, retail operating expenses decreased by 80 basis points, distribution and transportation decreased by 20 basis points while corporate expenses were flat. These decreases were offset by 50 basis points increase in other items included in other operating expenses.

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Retail operating expenses decreased as a percentage of sales by 80 basis points to 23.0% of net sales, increasing by $3.2 million for the third quarter of fiscal 2009 compared to the third quarter of fiscal 2008.  The decrease as a percentage of sales was primarily due to lower payroll-related expenses as a result of improvement in labor productivity and due to leveraging the comparable same-stores sales as well as lower advertising expenses during the third quarter of fiscal 2009.  These decreases were partially offset by slight increases in costs related to utilities and repairs and maintenance as a percentage of net of sales.

Distribution and transportation expenses decreased as a percentage of sales by 20 basis points, increasing by $1.0 million for the third quarter of fiscal 2009 compared to the third quarter of fiscal 2008. The decrease as a percentage of sales, despite year over year increases in minimum wage and freight rates, was primarily due to the improvements in labor productivity derived from utilization of more automated methods in conjunction with new racking systems and due to increased efficiencies in transportation.

Corporate operating expenses were flat as a percentage of sales to 3.8% of net sales, increasing by $1.1 million for the third quarter of fiscal 2009 compared to the third quarter of fiscal 2008.

The remaining operating expenses increased as a percentage of sales by 50 basis points, increasing by $1.8 million for the third quarter of fiscal 2009 compared to the third quarter of fiscal 2008.   The increase in the other operating expenses was primarily due to a severance charge of approximately $1.4 million during the third quarter of fiscal 2009, related to the Company’s Texas operations due to the Company’s decision to exit the Texas Market during the second quarter of fiscal 2009.  The increase was also due to a loss on a foreclosure sale of the shopping center of a Company’s partnership of approximately $0.5 million and inclusion of the partner’s loss of approximately $0.3 million as discussed in Note 7 to Consolidated Financial Statements.  These increases were partially offset by a reduction in stock based expense of $0.4 million in the third quarter of fiscal 2009 compared to third quarter of fiscal 2008.

Depreciation and Amortization: Depreciation and amortization increased $0.5 million, or 6.5%, to $8.8 million for the third quarter of fiscal 2009 compared to $8.3 million for the third quarter of fiscal 2008, primarily as a result of three new stores opened during the third quarter of fiscal 2009, the full quarter effect of nine new stores opened in fiscal 2008, and additions to existing stores, distribution centers and information technology systems.  Depreciation as a percentage of sales decreased to 2.5% from 2.6%, primarily due to same-stores sales increases.

Operating Income: Operating income was $16.9 million for the third quarter of fiscal 2009 compared to operating income of $12.2 million for the third quarter of fiscal 2008, due to increase in gross profit as a result of higher sales and lower cost of sales as well as lower operating expenses as a percentage of sales.  Operating income as a percentage of net sales increased to 4.8% for the third quarter of fiscal 2009 from 3.8% for the third quarter of fiscal 2008.

Other Income, net: Other income decreased $1.4 million to $0.2 million for the third quarter of fiscal 2009 compared to $1.6 million for the third quarter of fiscal 2008.  The decrease was primarily due to lower interest income which decreased to $0.8 million for the third quarter of fiscal 2009 from $1.7 million for the third quarter of fiscal 2008, due to lower interest rates and slightly lower investment balances.  The remaining decrease in other income is due to increases and decreases in other less significant items included in other income.

Provision for Income Taxes: The provision for income taxes was $4.7 million for the third quarter of fiscal 2009 compared to $4.2 million for the third quarter of fiscal 2008, due to the increase in pre-tax income.  The effective rate of the provision for income taxes was approximately 27.2% and 30.7% for the third quarter of fiscal 2009 and 2008, respectively.  There was no material change in the net amount of unrecognized tax benefits in the third quarter of fiscal 2009.

Net Income: As a result of the items discussed above, net income increased $3.0 million to $12.5 million for the third quarter of fiscal 2009 compared to net income of $9.5 million for the third quarter of fiscal 2008.

For the First Three Quarters Ended December 27, 2008 Compared to the First Three Quarters Ended December 31, 2007

Net Sales: Net sales increased $64.9 million, or 7.1%, to $973.8 million for the first three quarters of fiscal 2009 compared to $908.9 million for the first three quarters of fiscal 2008.  Retail sales increased $65.0 million, or 7.4%, to $943.1 million for the first three quarters of fiscal 2009 compared to $878.1 million for the first three quarters of fiscal 2008.  The full year effect of 14 stores opened in fiscal 2008 increased sales by $21.8 million for the first three quarters of fiscal 2009 and the effect of 17 new stores opened in the first three quarters of fiscal 2009 increased retail sales by $29.2 million.  In addition, same-store sales were up 2.9% for the first three quarters of fiscal 2009 compared to the first three quarters of fiscal 2008 due to an approximately 1.3% increase in transaction counts, as well as a 1.5% increase in average ticket size to $9.61 from $9.47 primarily driven by strong sales of produce.

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Gross Profit: Gross profit increased $29.7 million, or 8.4%, to $382.4 million for the first three quarters of fiscal 2009 compared to $352.7 million for the first three quarters of fiscal 2008.  As a percentage of net sales, overall gross margin increased to 39.3% for the first three quarters of fiscal 2009 compared to 38.8% for the first three quarters of fiscal 2008.  The increase in gross profit margin was primarily due to a decrease in cost of products sold to 57.2% for the first three quarters of fiscal 2009 compared to 57.7% for the first three quarters of fiscal 2008, due to the full effect of the retail pricing strategy implemented in the second half of fiscal 2008 as well as due to the Company’s decision on September 8, 2008, to increase its price to 99.99 cents from 99 cents.  The spoilage/shrink was flat at 3.1% of net sales in the first three quarters of fiscal 2009.  The remaining change was made up of increases and decreases in other less significant items included in cost of sales.

Operating Expenses:  Operating expenses increased by $28.0 million, or 8.6%, to $353.0 million for the first three quarters of fiscal 2009 compared to $325.0 million for the first three quarters of fiscal 2008.  As a percentage of net sales, operating expenses increased to 36.3% for the first three quarters of fiscal 2009 from 35.8% for the first three quarters of fiscal 2008.  Of  the 50 basis points increase in operating expenses as a percentage of sales, corporate expenses increased by 10 basis points, distribution and transportation decreased by 10 basis points and retail operating expenses decreased by 40 basis points.  The decreases are offset by a 90 basis points increase in other items included in other operating expenses.

Retail operating expenses decreased as a percentage of sales by 40 basis points to 24.6%, increasing by $12.7 million for the first three quarters of fiscal 2009 compared to the first three quarters of fiscal 2008.  The decrease as a percentage of sales was primarily due to lower payroll-related expenses as a result of improvement in labor productivity and due to leveraging the comparable same-stores sales as well as lower advertising expenses during the first three quarter of fiscal 2009.  These decreases were partially offset by slight increases in costs related to various services and fees as well as repairs and maintenance as a percentage of net of sales.

Distribution and transportation costs decreased as a percentage of sales by 10 basis points to 5.8% of net sales, increasing by $2.6 million for the first three quarters of fiscal 2009 compared to the first three quarters of fiscal 2008.  The decrease as a percentage of sales was primarily due to the overall improvements in productivity.

Corporate operating expenses increased as a percentage of sales by 10 basis points to 4.2% of net sales, increasing $3.3 million for the first three quarters of fiscal 2009 compared to the first three quarters of fiscal 2008. The increase as a percentage of net sales was primarily due to higher salaries, benefits and legal costs.  These increases were partially offset by lower consulting and professional fees as a percentage of net sales.

The remaining operating expenses increased as a percentage of sales by 90 basis points to 1.6% of net sales, increasing by $9.4 million.  The increase during the first three quarters of fiscal 2009 was primarily due to an impairment charge of approximately $10.1 million related to leasehold improvements associated with leased stores of the Company’s Texas operations and a $1.4 million severance charge due to the Company’s decision to exit the Texas Market.   The increase was also due to a loss on a foreclosure sale of the shopping center of a Company’s partnership of approximately $0.5 million and inclusion of the partner’s loss of approximately $0.3 million during the first three quarter of fiscal 2009.  These increases are partially offset by the gain on a sale of the primary asset of a partnership of approximately $0.2 million and inclusion of the partner’s gain of approximately $1.4 million during the first three quarters of fiscal 2009.  See Note 7 to Consolidated Financial Statements for further discussion of gains and losses related to the Company’s partnerships during the first three quarters of fiscal 2009.  In addition, there was a reduction in stock based compensation expense of $1.1 million in the first three quarters of fiscal 2009 compared to the first three quarters of fiscal 2008.  The remaining change of $0.2 million was made up of increases and decreases in other less significant items included in other operating expenses.

Depreciation and Amortization: Depreciation and amortization increased $1.4 million, or 5.6%, to $26.2 million for the first three quarters of fiscal 2009 compared to $24.8 million for the first three quarters of fiscal 2008, primarily as a result of 17 new stores opened through December 27, 2008, the full year effect of 14 new stores opened in fiscal 2008, and additions to existing stores and distribution centers.  Depreciation and amortization as a percentage of net sales was flat at 2.7%.

Operating Income: Operating income was $3.2 million for the first three quarters of fiscal 2009 compared to operating income of $3.0 million for the first three quarters of fiscal 2008.

Other Income, Net: Other income decreased $4.7 million to $0.7 million for the first three quarters of fiscal 2009 compared to $5.4 million for the first three quarters of fiscal 2008. The decrease was primarily due to lower interest income which decreased to $3.1 million for the first three quarters of fiscal 2009 from $5.6 million for the first three quarters of fiscal 2008, primarily due to lower interest rates and slightly lower investment balances.  The decrease was also due to an impairment charge of approximately $1.7 million related to the Company’s available for sales securities during the first three quarters of fiscal 2009.  The remaining decrease in other income is due to increases and decreases in other less significant items included in other income.

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Provision for Income Taxes: The provision for income taxes was $1.0 million for the first three quarters of fiscal 2009 compared to a provision of $1.1 million for the first three quarters of fiscal 2008.  Excluding the discrete tax expense described below, the effective rate of the provision for income taxes was a benefit of approximately 21.0% for the first three quarters of fiscal 2009.  Excluding the discrete tax benefit described below, the effective rate of the provision for income taxes was approximately 28.5% for the first three quarters of fiscal 2008.  The Company recorded a valuation allowance of approximately $1.4 million related to certain Texas tax credits during the first three quarters of fiscal 2009 compared to a discrete tax benefit of approximately $1.4 million related to a change in Texas net operating loss carryforward rules during the first three quarters of fiscal 2008.  Due to the Company’s plan to exit the Texas market, the Company does not believe that it is more likely than not that it will be able to realize this benefit.  There was no material change in the net amount of unrecognized tax benefits in the first three quarters of fiscal 2009.

Net Income: As a result of the items discussed above, net income decreased by $5.8 million, to a net income of $1.5 million for the first three quarters of fiscal 2009 compared to net income of $7.3 million for the first three quarters of fiscal 2008.

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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 operations during the first three quarters of fiscal 2009 and 2008 was $37.7 million and $26.8 million, respectively, consisting primarily of $42.1 million and $36.3 million, respectively, of net income adjusted for non-cash items. During the first three quarters of fiscal 2009, the Company used cash of $2.3 million in working capital and used cash of $2.1 million in other activities. During the first three quarters of fiscal 2008, the Company used cash of $12.4 million in working capital and provided cash of $2.9 million in other activities. Net cash used by working capital activities for the first three quarters of fiscal 2009 primarily reflects the increase in inventories and deferred rent. The increase in inventories was primarily due to the increase in sales and the number of stores.  These uses of working capital were partially offset by increases in accounts payable and accrued expenses.  Net cash used in working capital activities for the first three quarters of fiscal 2008 primarily reflects the increase in inventories and income taxes receivable, partially offset by increase in accrued expenses and decrease in accounts receivable.

Net cash used in investing activities during the first three quarters of fiscal 2009 and 2008, was $30.6 million and $26.8 million, respectively. In the first three quarters of fiscal 2009, the Company used $26.8 million and $4.6 million, respectively, for the purchase of property and equipment and acquisition of one of its partnership’s assets while the Company used $34.6 million for the purchase of property and equipment in the first three quarters of fiscal 2008.  In addition, the Company purchased $50.2 million and received proceeds of $48.5 million from sale and maturities of investments during the first three quarters of fiscal 2009.  The Company purchased $242.7 million and received proceeds of $250.5 million from sale and maturities of investments during the first three quarters of fiscal 2008.  In addition, the investing activities in the first three quarters of fiscal 2009 reflect the proceeds of $2.2 million from the sale of the assets of the Company’s partnerships as well as $0.3 million from the disposal of fixed assets.

Net cash used in financing activities during the first three quarters of fiscal 2009 was $0.9 million compared to net cash provided by financing activities $0.9 million for the first three quarters of fiscal 2008. Net cash used in financing activities during the first three quarters of fiscal 2009 is primarily composed of $0.9 million related to repurchase of Company’s common stock.  Net cash provided by financing activities during the first three quarters of fiscal 2008 is primarilycomposed of the proceeds from the exercise of stock options of $0.8 million and excess tax benefit of $0.1 million from share-based payment arrangements.

The Company estimates that total capital expenditures in fiscal 2009 will be approximately $48.6 million and will relate principally to property acquisitions of approximately $12.8 million, $24.3 million for leasehold improvements, fixtures and equipment for new store openings, and $11.5 million for other capital projects including the racking and reconfiguration of its Commerce warehouses and for information technology systems. The Company intends to fund its liquidity requirements in fiscal 2009 out of 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. During the first three quarters of fiscal 2009, the Company repurchased a total of 118,378 shares of common stock at an average price of $7.61 per share, for a total of $0.9 million. The Company had no share repurchases during the third quarter ended December 27, 2008.  The Company had approximately $29.1 million that remained authorized and available to repurchase shares of Company’s common stock under this program.

Contractual Obligations

A summary of the Company’s contractual obligations is provided in the Company’s 10-K report for the year ended March 29, 2008.  During the first three quarters of fiscal 2009, there was no material change in Company’s contractual obligations as previously disclosed.

Lease Commitments

The Company leases various facilities under operating leases (except for one location that is classified as a capital lease) which expire at various dates through 2031. The lease agreements generally 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 for the third quarter of fiscal 2009 and 2008 was $14.8 million and $13.7 million, respectively.  Rental expense charged to operations for the first three quarters of fiscal 2009 and 2008 was $44.5 million and $39.9 million, respectively.  The Company typically seeks leases with a five-year to ten-year term and with multiple five-year renewal options.  A large majority of the Company’s store leases were entered into with multiple renewal periods, which are typically five years and occasionally longer.

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Variable Interest Entities

The Company is the primary beneficiary of a variable interest entity to develop a shopping center in La Quinta, California, in which the Company leases a store (the “La Quinta Partnership”).  As of March 29, 2008, this entity had $9.0 million in assets and $7.4 million in liabilities, including a bank loan for $7.3 million. These amounts are shown on the Company’s consolidated balance sheets as of March 29, 2008.  In January 2008, the Company received a buy-sell offer from the managing member of the La Quinta partnership.  After the timeline for completion of the sale passed, the Company notified the managing member that the managing member was in default of closing the transaction within the agreed-upon timeframe.  In addition, the partnership had a $7.5 million loan, including principal of $7.3 million and accrued interest of $0.2 million, due to a bank on June 1, 2008, in which the partnership was in default.  During the third quarter of fiscal 2009, the bank foreclosed on the shopping center.   Eighty-nine percent of the land and all of the buildings were sold in the foreclosure sale for $9.3 million.  The $9.3 million included the Company’s purchase of land and building related to its store for approximately $2.9 million and the rest of the center was sold for $6.4 million to a third party, except for a small parcel of undeveloped land which remains in the partnership at this time.  As a result of the foreclosure, the bank received $7.9 million including principal, interest and penalties.The partnership’s loss from the foreclosure sales of the shopping center was $0.8 million.Of the $0.8 million loss, the Company recognized its share of the loss of approximately $0.5 million in the third quarter of fiscal 2009. In accordance with FIN 46(R), the Company has included the partner’s share of the loss of approximately $0.3 million in its operating expenses.  As a result of the foreclosure of the shopping center, the Company is now managing the partnership.

The Company also has an interest in a partnership which the Company consolidated at March 29, 2008 in accordance with FIN 46(R). The assets of the partnership consisted of real estate with a carrying value of approximately $1.5 million and there was no mortgage debt or other significant liabilities associated with the entities, other than notes payable to the Company.  The balance sheet effect of consolidating this entity at March 29, 2008 was a reclassification of approximately $1.5 million from investments to property and equipment with no corresponding impact on the Company’s recorded liabilities.  In November 2008, the Company purchased its partner’s share of this partnership, consisting of one of the Company’s leased stores with an approximate carrying value of $1.5 million.  The Company paid approximately $1.6 million, including estimated selling costs, to acquire its partner’s share in the partnership. The Company increased its building and land value for approximately $1.6 million as result of this purchase.  Due to the purchase of the primary asset of the partnership, the Company is no longer a primary beneficiary and therefore has not consolidated the remaining immaterial assets of the partnership in the quarter ended December 27, 2008.

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

Seasonality and Quarterly Fluctuations

The Company has historically experienced and expects to continue to experience some seasonal fluctuations in itsnet sales, operating income, and net income. The highest sales periods for the Company are the Christmas, Easter and Halloween seasons. A proportionately greater amount of the Company’s net sales and operating and net income is generally realized during the fiscal third quarter. The Company’s quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including the timing of certain holidays such as Easter, the timing of new store openings and the merchandise mix.

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New Authoritative Pronouncements

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 does not require any new fair value measurements. SFAS 157 establishes a common definition for fair value to be applied with existing GAAP requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. The Company adopted SFAS 157 at the beginning of the first quarter of fiscal 2009 except for those non-recurring measurements for non-financial assets and non-financial liabilities subject to the partial deferral in FASB Statement of Position No. 157-2, “Partial Deferral of the Effective Date of Statement 157,” (“FSP 157-2”) as noted below. The adoption of SFAS 157 did not have an impact on the Company’s financial position or operating results.  FSP 157-2 deferred the effective date of SFAS 157 for all non-financial assets and non-financial liabilities to fiscal years beginning after November 15, 2008.  The adoption of this statement for non-financial assets and liabilities is not expected to have a material impact on the Company’s consolidated financial position or results of operations.

In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115" (“SFAS No. 159”).  SFAS No. 159 permits companies to choose to measure many financial instruments and certain other items at fair value at specified election dates. Upon adoption, an entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. Most of the provisions apply only to entities that elect the fair value option. However, the amendment to SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," applies to all entities with available for sale and trading securities. SFAS No. 159 is effective as of the beginning of an entity's first fiscal year that begins after November 15, 2007.

The Company adopted SFAS 159 at the beginning of the first quarter of fiscal 2009, and the adoption had no impact on the Company’sconsolidated financial position or results of operations.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141(R)”).  SFAS No. 141(R) changes the requirements for an acquirer’s recognition and measurement of the assets acquired and liabilities assumed in a business combination. SFAS No. 141(R) replaces SFAS No. 141, “Business Combinations.” SFAS No. 141(R) is effective in fiscal years beginning after December 15, 2008.  The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial position or results of operations.

In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements” (“SFAS No. 160”).  SFAS No. 160 requires that non-controlling (minority) interests be reported as a component of equity, that net income attributable to the parent and to the non-controlling interest be separately identified in the income statement, that changes in a parent’s ownership interest while the parent retains its controlling interest be accounted for as equity transactions, and that any retained non-controlling equity investment upon the deconsolidation of a subsidiary be initially measured at fair value.  SFAS No. 160 is an amendment of Accounting Research Bulletin No. 51, “Consolidated Financial Statements” and related interpretations. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008. The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial position or results of operations.

In March 2008, the FASB issued SFAS No. 161, “Disclosures About Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133” (“SFAS 161”), which expands the disclosure requirements in SFAS 133 about an entity’s derivative instruments and hedging activities. SFAS 161’s disclosure provisions apply to all entities with derivative instruments subject to SFAS 133 and its related interpretations. The provisions also apply to related hedged items, bifurcated derivatives, and non-derivative instruments that are designated and qualify as hedging instruments. Entities with instruments subject to SFAS 161 must provide more robust qualitative disclosures and expanded quantitative disclosures. Such disclosures, as well as existing SFAS 133 required disclosures, generally will need to be presented for every annual and interim reporting period. This statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial position or results of operations.

In April 2008, the FASB issued FASB Staff Position (“FSP”) No. SFAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP SFAS 142-3”). FSP SFAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). The intent of FSP SFAS 142-3 is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141R (revised 2007), “Business Combinations” (“SFAS 141R”) and other applicable accounting literature. FSP SFAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and must be applied prospectively to intangible assets acquired after the effective date. The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial position or results of operations.

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In May 2008, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 162, “Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”). This statement is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements of nongovernmental entities that are presented in conformity with GAAP. This statement will be effective 60 days following the U.S. Securities and Exchange Commission’s approval of the Public Company Accounting Oversight Board amendment to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles.”  The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial position or results of operations.

In May of 2008, FASB issued SFASB No. 163, Accounting for Financial Guarantee Insurance Contracts-an interpretation of FASB Statement No. 60.  The scope of the statement is limited to financial guarantee insurance (and reinsurance) contracts.  The pronouncement is effective for fiscal years beginning after December 31, 2008.  The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial position or results of operations.

Item 3. 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 December 27, 2008, the Company had $119.4 million in securities maturing at various dates through May 2046, with approximately 75% 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, money market funds and certain perpetual preferred stocks with periodic recurring dividend payments that are less than 2% of the Company’s cash and investment portfolio.  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. At December 27, 2008, the fair value of investments approximated the carrying value.  Based on the investments outstanding at December 27, 2008, a 1.0% increase in interest rates would reduce the fair value of the Company’s total investment portfolio by approximately $1.5 million or 1.2%.

Item 4. 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 of 1934, as amended.  Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer each concluded that due to the material weakness surrounding the Company’s inventory accounts as of the end of fiscal year 2008, which was not remediated during the period covered by this Report, the Company’s disclosure controls and procedures were not effective as of December 27, 2008.

As described in the Company's Form 10-K for the fiscal year ended March 29, 2008, there was an internal control weakness surrounding the Company’s inventory accounts. The Company did not maintain accurate records of specific item quantity and location of its inventory and therefore relied primarily on physical counting of inventory and its existing transactional controls. The nature, size and number of locations make it infeasible to physically count the entire inventory every quarter. These factors in combination with control deficiencies surrounding inventory accounts related to store receiving and store returns result in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

Changes in Internal Control Over Financial Reporting

During the third quarter of fiscal 2009, the Company made changes in its internal control over financial reporting in the area of its inventory accounts that materially affected or are reasonably likely to materially affect its internal control over financial reporting.  The Company implemented a tracking report that monitors pallet movement from the distribution centers to the stores.  The Company also developed a new reconciliation process to tie the inventory sub-ledger to the general ledger during the third quarter of fiscal 2009.

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PART II    OTHER INFORMATION

Item 1. Legal Proceedings

The Company is named as a defendant in numerous legal matters arising in the normal course of business. In management’s opinion, none of these matters are expected to have a material adverse effect on the Company’s financial position, results of operations, or overall liquidity.

Item 1A. Risk Factors

Reference is made to Item 1A. Risk Factors, in the Company’s Form 10-K for the year ended March 29, 2008, for information regarding the most significant factors affecting the Company’s operations.  There have been no material changes in these factors through December 27, 2008, other than as set forth below.

Our operations are concentrated in California

As of December 27, 2008, 198 of our 281 stores were located in California (with 47 stores in Texas, 24 stores in Arizona and 12 stores in Nevada), and we have decided to exit the Texas market.  We expect to continue to open additional stores in California, as well as in Nevada and Arizona.  For the foreseeable future, our 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 worsening 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, such as newly enacted recycling laws and limitations on bags that may be used, may further pressure our margins.

Texas market uncertainties

On September 17, 2008, we announced our decision to exit the Texas market and on February 2, 2009 we announced that we will close approximately one third of the stores in Texas and have suspended the exit plan for up to six months.  We will incur cash and non-cash charges in connection with the closings of stores in Texas and may incur additional charges in connection with the exit plan, as discussed above under Note 12 to the Consolidated Financial Statements.  We cannot predict with certainty the amount of these potential charges.  

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

For information on common stock repurchases, see Note 10 to Consolidated Financial Statements for the third quarter ended December 27, 2008, which is incorporated by reference in this Item 2.

Item 3. Defaults Upon Senior Securities

None

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Item 4. Submission of Matters to a Vote of Security Holders

None

Item 5. Other Information

None

Item 6. Exhibits

23.1 Consent of Independent Valuation Firm

31.1 Certification of Chief Executive Officer as required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.

31.2 Certification of Chief Financial Officer as required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.

32.1 Certification of Chief Executive Officer as required by Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended.

32.2 Certification of Chief Financial Officer as required by Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended.

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereto duly authorized.

	99¢ ONLY STORES
Date: February 4, 2009	/s/ Robert Kautz
	Robert Kautz
	Chief Financial Officer

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