SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 29, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________ TO ___________
COMMISSION FILE NUMBER 0-24543
COST-U-LESS, INC.
(Exact name of registrant as specified in its charter)
Washington 91-1615590
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
8160 304th Avenue S.E., Bldg. 3, Suite A
PRESTON, WASHINGTON 98050
(Address of principal executive office) (Zip Code)
(425) 222-5022
(Registrant's telephone number, including area code)
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. |X| YES |_| NO.
The registrant had 3,606,376 common shares, par value $0.001, outstanding at
November 5, 2002.
COST-U-LESS, INC.
INDEX TO FORM 10-Q
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Statements of Operations............ 3
Condensed Consolidated Balance Sheets...................... 4
Condensed Consolidated Statements of Shareholders'
Equity..................................................... 5
Condensed Consolidated Statements of Cash Flows............ 6
Notes to Condensed Consolidated Financial Statements....... 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................ 11
Item 3. Quantitative and Qualitative Disclosures About Market
Risk....................................................... 20
Item 4. Controls and Procedures.................................... 20
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K........................... 21
SIGNATURES .................................................................. 22
CERTIFICATIONS............................................................... 23
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
COST-U-LESS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
(Unaudited)
13 Weeks Ended 39 Weeks Ended
-------------- --------------
September 29, September 30, September 29, September 30,
2002 2001 2002 2001
---- ---- ---- ----
(Restated) (Restated)
Net sales ............................................. $ 43,215 $ 42,828 $ 130,878 $ 131,189
Merchandise costs ..................................... 35,787 35,659 109,471 109,934
---------- ---------- ---------- ----------
Gross profit .......................................... 7,428 7,169 21,407 21,255
Operating expenses:
Store ........................................... 5,533 5,321 16,627 15,777
General and administrative ...................... 1,364 1,382 4,421 4,254
Store openings .................................. 2 10 14 44
Store closings .................................. 0 0 0 (3)
---------- ---------- ---------- ----------
Total operating expenses .............................. 6,899 6,713 21,062 20,072
---------- ---------- ---------- ----------
Operating income ...................................... 529 456 345 1,183
Other income (expense):
Interest expense, net ........................... (84) (134) (287) (474)
Other ........................................... (103) 3 91 (120)
---------- ---------- ---------- ----------
Income before income taxes ............................ 342 325 149 589
Income tax provision .................................. 135 175 60 335
---------- ---------- ---------- ----------
Net income ............................................ $ 207 $ 150 $ 89 $ 254
========== ========== ========== ==========
Earnings per common share:
Basic ........................................... $ 0.06 $ 0.04 $ 0.02 $ 0.07
========== ========== ========== ==========
Diluted ......................................... $ 0.06 $ 0.04 $ 0.02 $ 0.07
========== ========== ========== ==========
Weighted average common shares outstanding, basic ..... 3,606,376 3,606,376 3,606,376 3,606,376
========== ========== ========== ==========
Weighted average common shares outstanding, diluted ... 3,630,341 3,614,986 3,611,129 3,612,839
========== ========== ========== ==========
The accompanying Notes to the Condensed Consolidated Financial Statements
are an integral part of these statements.
3
COST-U-LESS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
September 29, December 30,
2002 2001
---- ----
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents .......................... $ 1,527 $ 2,660
Receivables, net ................................... 2,112 2,117
Inventories, net ................................... 19,918 19,360
Other current assets ............................... 1,417 1,104
------- -------
Total current assets ......................... 24,974 25,241
Property and equipment, net .............................. 14,468 15,464
Deposits and other assets ................................ 879 901
------- -------
Total assets ................................. $40,321 $41,606
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Line of credit ..................................... $ 3,322 $ 2,173
Accounts payable ................................... 15,021 15,885
Accrued expenses and other liabilities ............. 2,902 4,348
Current portion of long-term debt .................. 267 267
------- -------
Total current liabilities .................... 21,512 22,673
Deferred rent ............................................ 523 515
Long-term debt, less current portion ..................... 2,877 3,077
------- -------
Total liabilities ............................ 24,912 26,265
Commitments and Contingencies
Shareholders' equity ..................................... 15,409 15,341
------- -------
Total liabilities and shareholders' equity ... $40,321 $41,606
======= =======
The accompanying Notes to the Condensed Consolidated Financial Statements
are an integral part of these statements.
4
COST-U-LESS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands, except share data)
(Unaudited)
Accumulated
Common Common Other
Stock-- Stock-- Retained Comprehensive
Shares Amount Earnings Loss Total
------ ------ -------- ---- -----
Balance at December 31, 2000 (Restated) .................... 3,606,376 $12,446 $3,001 $(653) $14,794
Net income (Restated) ................................ -- -- 254 -- 254
Foreign currency translation adjustments (Restated) .. -- -- -- 6 6
-------
Comprehensive income (Restated) .................. 260
-------
--------- ------- ------ ----- -------
Balance at September 30, 2001 (Restated) ................... 3,606,376 $12,446 $3,255 $(647) $15,054
========= ======= ====== ===== =======
Balance at December 30, 2001 ............................... 3,606,376 $12,446 $3,557 $(662) $15,341
Net income ........................................... -- -- 89 -- 89
Foreign currency translation adjustments ............. -- -- -- (21) (21)
-------
Comprehensive income ............................. 68
-------
--------- ------- ------ ----- -------
Balance at September 29, 2002 .............................. 3,606,376 $12,446 $3,646 $(683) $15,409
========= ======= ====== ===== =======
The accompanying Notes to the Condensed Consolidated Financial Statements
are an integral part of these statements.
5
COST-U-LESS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
39 Weeks Ended
--------------
September 29, September 30,
2002 2001
---- ----
(Restated)
OPERATING ACTIVITIES:
Net income ..................................................... $ 89 $ 254
Adjustments to reconcile net income to net cash provided
(used) by operating activities:
Depreciation and amortization ............................ 1,385 1,413
Writedown of property and equipment ...................... 34 0
Deferred tax provision (benefit) ......................... (65) 41
Changes in operating assets and liabilities:
Receivables .............................................. 5 914
Inventories .............................................. (558) (1,927)
Other current assets ..................................... (248) (374)
Deposits and other assets ................................ 22 211
Accounts payable ......................................... (864) 672
Accrued expenses and other liabilities ................... (1,446) (1,188)
Deferred rent ............................................ 8 15
------- -------
Net cash provided (used) by operating activities ... (1,638) 31
INVESTING ACTIVITY:
Cash used to purchase property and equipment ................... (423) (471)
FINANCING ACTIVITIES:
Net borrowings under line of credit ............................ 1,149 800
Principal payments on long-term debt ........................... (200) (201)
------- -------
Net cash provided by financing activities .......... 949 599
Foreign currency translation adjustments ....................... (21) 44
------- -------
Net increase (decrease) in cash and cash equivalents ................. (1,133) 203
Cash and cash equivalents:
Beginning of period ............................................ 2,660 2,525
------- -------
End of period .................................................. $ 1,527 $ 2,728
======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest ................................................. $ 296 $ 482
Income taxes ............................................. $ 170 $ 371
The accompanying Notes to the Condensed Consolidated Financial Statements
are an integral part of these statements.
6
COST-U-LESS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Summary of Significant Accounting Policies
Nature of Business
Cost-U-Less, Inc. (the "Company") operates mid-sized warehouse club-style
stores in the United States Territories ("U.S. Territories"), foreign island
countries in the Pacific and the Caribbean, the Hawaiian Islands and Sonora,
California. At September 29, 2002, the Company operated eleven stores located in
Hawaii, California, the U.S. Virgin Islands, Netherlands Antilles, Guam,
American Samoa and the Republic of Fiji (Fiji).
Restatement of Financial Information
The Company has determined that the previous accounting treatment
historically afforded its foreign currency translation adjustment associated
with New Zealand was not consistent with paragraph 14 of Statement of Financial
Accounting Standard No.52 (SFAS 52).
In June 2000 the Company discontinued all major business activity in New
Zealand upon the closure of its two stores and its Auckland buying office.
Although the Company had discontinued store and corporate buying activities in
June 2000, for the remainder of 2000 and through the first three quarters of
2001, it continued to base its conclusion that the New Zealand operations were
not substantially liquidated on the fact that the Company was still purchasing
inventory through the New Zealand subsidiary and negotiating final lease terms
on the closed store leases. The Company now believes that, because the level of
the ongoing New Zealand activities was so small relative to activities prior to
the closures, that "substantial liquidation", as interpreted in paragraph 14 of
SFAS 52, had in fact occurred in June 2000, and therefore the New Zealand
foreign currency translation account should have been written off at that time.
As a result, the New Zealand foreign currency translation adjustments,
which were previously recorded within Other Comprehensive Income (Loss), were
written off at June 25, 2000, and included in Store Closure Expense in fiscal
2000.
Concurrent with this reassessment, other related foreign currency
translation adjustments have also been restated to reclassify that portion of
intercompany transactions that represent transactions and balances that are not
considered to be part of the net investment in the foreign entity, and
accordingly, related transaction gains and losses are recorded for that portion
representing non-permanent investments. The restatement resulted in additional
foreign currency transaction gains of $14,000 and losses of $88,000 for the 13
weeks and 39 weeks ended September 30, 2001, respectively, to be included in
Other Income (Expense). Refer to the Company's Form 10-K/A for the year ended
December 31, 2000, filed with the Securities and Exchange Commission (SEC) on
April 1, 2002, for further discussion of the impact of the restatement.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States of America for interim financial reporting and pursuant to
the rules and regulations of the SEC. In the opinion of management, the
financial information includes all adjustments that the Company considers
necessary for a fair presentation of the financial position at such dates and
the operations and cash flows for the periods then ended. The balance sheet at
December 30, 2001 has been derived from the audited financial statements at that
date. Certain information and footnote disclosures normally included in the
financial statements prepared in accordance with accounting principles generally
accepted in the United States have been condensed or omitted pursuant to SEC
rules and regulations on quarterly reporting. Operating results for the 13 and
39 weeks ended September 29, 2002, are not necessarily indicative of results
that may be expected for the entire year. All quarterly periods reported consist
of 13 weeks. For further information, refer to the financial statements and
footnotes included in the Company's Form 10-K filed with the SEC on April 1,
2002.
Fiscal Year
The Company reports on a 52/53-week fiscal year, consisting of four
thirteen-week periods and ending on the Sunday nearest to the end of December.
Fiscal 2002, ending on December 29, 2002, and fiscal 2001, which ended on
December 30, 2001, are 52-week years.
7
COST-U-LESS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries in the U.S. Virgin Islands, Netherlands
Antilles, Guam, American Samoa, Nevada, Fiji and New Zealand. All significant
inter-company accounts and transactions have been eliminated in consolidation.
Foreign Currency Translations and Comprehensive Income
The U.S. dollar is the functional currency for all locations, except for
Fiji and Netherlands Antilles, where the local currency is the functional
currency. Prior to the closure of the New Zealand stores in June 2000, the
functional currency for New Zealand was its local currency. Assets and
liabilities denominated in foreign currencies are translated at the applicable
exchange rate on the balance sheet date. Net sales costs and expenses are
translated at the average rates of exchange prevailing during the period.
Adjustments resulting from this process are reported, net of taxes, as
Accumulated Other Comprehensive Income (Loss), a component of Shareholders'
Equity. Realized and unrealized gains on foreign currency transactions are
included in Other Income (Expense). The cumulative translation adjustment
resulting from a net investment in a country is recognized as income or expense
in the period the Company has substantially liquidated operations in that
country.
Use of Estimates
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the 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. Estimates are used for, but not limited to:
allowance for doubtful accounts; depreciable lives of assets; reserves for store
closure expenses; and tax valuation allowances. Future events and their effects
cannot be determined with certainty. Accordingly, the accounting estimates
require the exercise of judgment. The accounting estimates used in the
preparation of the consolidated financial statements may change as new events
occur, as more experience is acquired, as additional information is obtained and
as the Company's operating environment changes. Actual results could differ from
those estimates.
Reclassifications
Certain reclassifications of prior years' balances have been made for
consistent presentation with the current year.
New Accounting Pronouncements
During 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) Nos.141, "Business
Combinations", 142 "Goodwill and Other Intangible Assets", 143 "Accounting for
Asset Retirement Obligations", and 144 "Accounting for Impairment or Disposal of
Long-lived Assets and for Long-Lived Assets to be Disposed of". During 2002, the
FASB issued SFAS No.145, "Revision of FASB Statements No. 4, 44, 64, Amendment
of FASB No. 13, and Technical Corrections" and SFAS No. 146, "Accounting for
Costs Associated with Exit and Disposal Activities."
The adoption of SFAS Nos. 141, 142, 144 and 145 did not have a material
impact on the Company's consolidated financial statements. The Company believes
the adoption of SFAS Nos. 143 and 146 will not have a material impact on the
Company's consolidated financial statements.
8
COST-U-LESS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
2. Earnings Per Share
Basic earnings per share is computed using the weighted average number of
common shares outstanding during the period and excludes any dilutive effects of
stock options and warrants. Diluted earnings per share are computed using the
weighted average number of common shares and potentially dilutive shares
outstanding during the period. Potentially dilutive shares are excluded from the
computation if their effect is anti-dilutive.
The following table sets forth the computation of basic and diluted
earnings per common share (in thousands, except share and per share data):
13 Weeks Ended 39 Weeks Ended
-------------- --------------
September 29, September 30, September 29, September 30,
2002 2001 2002 2001
---- ---- ---- ----
(Restated) (Restated)
Numerator:
Net income ............................................. $ 207 $ 150 $ 89 $ 254
========== ========== ========== ==========
Denominator:
Denominator for basic earnings per share--weighted
average shares ...................................... 3,606,376 3,606,376 3,606,376 3,606,376
Effect of dilutive common equivalent shares:
Stock options and warrants ............................. 23,965 8,610 4,753 6,463
---------- ---------- ---------- ----------
Denominator for diluted earnings per share--adjusted
weighted average shares and assumed conversion of
stock options and warrants .......................... 3,630,341 3,614,986 3,611,129 3,612,839
========== ========== ========== ==========
Basic earnings per common share .............................. $ 0.06 $ 0.04 $ 0.02 $ 0.07
Diluted earnings per common share ............................ $ 0.06 $ 0.04 $ 0.02 $ 0.07
3. Line of Credit
On October 1, 2002, the Company amended the terms of its line of credit
with a financial institution (1) to extend the term of the line of credit to
April 1, 2003; (2) to reduce the amount of the line from $8.0 million to $6.75
million; and (3) to change the interest rate on the line of credit to the Prime
Rate plus (a) 0% through and including January 1, 2003, (b) 1% from January 2,
2003 through and including February 2, 2003, (c) 2% from February 3, 2003
through and including March 2, 2003, and (d) 3% from March 3, 2003 and
thereafter. No fixed rate loans are available under the amended line of credit,
except that the $2.0 million of fixed rate loans existing on October 1, 2002,
will continue until the end of the their respective interest rate periods and
thereafter bear interest with reference to the Prime Rate. The Prime Rate was at
4.75% at September 29, 2002.
At September 29, 2002, the line of credit had $0.3 million utilized for
standby letters of credit, leaving $6.45 million available for operations. At
September 29, 2002, there were $3.3 million in borrowings outstanding on the
line of credit. Collateral for the line of credit consists of inventories and
equipment. The line of credit contains certain covenants, including the
requirement that the Company maintains minimum tangible net worth and minimum
ratios of current assets to current liabilities, and debt to tangible net worth.
The Company must also obtain the consent of the lender to (i) pay dividends,
(ii) purchase or sell assets or incur indebtedness, other than in the ordinary
course of business, (iii) make loans to, or investments in, any other person,
(iv) enter into a merger or other business combination, or (v) make capital
expenditures in excess of a specified limit as of and for the year ended
December 30, 2001. At September 29, 2002, the Company was in compliance with all
such covenants.
9
COST-U-LESS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
4. Commitments and Contingencies
Legal Proceedings
The Company is involved from time to time in claims, proceedings and
litigation arising from its business and property ownership. The Company does
not believe that any such claim, proceeding or litigation, either alone or in
the aggregate, will have a material adverse effect on the Company's business,
financial condition or results of operation.
Line of Credit
The Company's existing line of credit will expire on April 1, 2003. The
bank has indicated that it will not renew this line of credit. The Company has
identified possible alternative lenders to provide a line of credit for
operations beyond April 1, 2003, but has not entered into any formal agreement
as of the date of this filing. There can be no assurance that a line of credit,
on reasonable terms or at all, will be available beyond April 1, 2003. If the
Company is unable to negotiate a new line of credit beyond April 1, 2003 on
terms favorable to the Company, there would be a material adverse effect on our
business, financial condition and results of operation.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain Factors That May Affect Future Results of Operations
This discussion and analysis should be read in conjunction with our
unaudited condensed consolidated financial statements and the related notes
thereto appearing in Item 1 of this report. In addition to historical
information, this Form 10-Q contains and may incorporate by reference
statements, which may constitute forward-looking statements which involve known
and unknown risks, uncertainties and other factors that could cause actual
results to differ materially from those expressed or implied by such
forward-looking statements. Forward-looking statements may be identified by the
use of forward-looking terminology such as "may," "will," "expect," "estimate,"
"anticipate," "continue," or similar terms, variations of such terms or the
negative of those terms, but the absence of such terms does not mean that a
statement is not forward-looking. Factors that could affect our actual results
include, but are not limited to: (i) competition; (ii) macro-economic trends and
consumer buying levels; (iii) ability to maintain existing credit and obtain
additional credit; (iv) risks associated with a small store base; (v) tourism
activity and the level of air travel to non-U.S. destinations; (vi) isolation of
store operations from corporate management; (vii) transportation difficulties;
(viii) dependence on, and uncertainties associated with, expansion outside the
U.S.; (ix) weather and other risks associated with island operations; (x)
dependence on key personnel and local managers; (xi) reliance on information and
communication systems provided by third-party vendors; (xii) ability to utilize
tax benefits; and (xiii) risks associated with significant growth. The recent
terrorist attacks on the United States, possible responses by the U.S.
government, the effects on consumer demand, the financial markets, product
supply and distribution and other conditions increase the uncertainty inherent
in forward-looking statements. Forward looking statements reflect the
expectations of our management at the time that they are made and do not
represent an opinion about what may happen in the future. More information about
factors that could affect our financial results is included in the "Risk Factors
that May Affect Future Results" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" sections of our Form 10-K for the
year ended December 30, 2001, which was filed on April 1, 2002 with the
Securities Exchange Commission.
The following management's discussion and analysis of financial condition
and results of operations should be read in conjunction with management's
discussion and analysis of financial condition and results of operations
included in our Form 10-K for the year ended December 30, 2001.
As used in this quarterly report on Form 10-Q, unless the context
otherwise requires, the terms "we," "us," "our," "the Company," and
"Cost-U-Less" refer to Cost-U-Less, Inc., a Washington corporation, and its
subsidiaries.
Overview
During the 39 weeks ended September 29, 2002, we operated eleven retail
stores located in Guam (2), American Samoa (1), Hawaiian Islands (2); U.S.
Virgin Islands (2); Fiji (1); Netherlands Antilles (2) and California (1). In
February 2001, we closed our Nadi, Fiji store, due primarily to the impact that
the political turmoil in Fiji was having on the tourist industry. Our remaining
store in Fiji is located in the city of Suva, which is the capital and the
primary population center of Fiji.
Our stores are patterned after the warehouse club concept, although the
stores (i) are smaller (averaging approximately 30,000 square feet vs. large
format warehouse clubs of approximately 115,000 square feet), (ii) generally
target niche markets, mainly foreign island countries (and U.S. Territories and
U.S. island states), where demographics do not support large format warehouse
clubs, (iii) carry a wide assortment of local and ethnic food items and (iv) do
not charge a membership fee. Although we do not have large seasonal fluctuations
in sales, the fourth quarter is typically the highest sales quarter due to
additional holiday sales.
We are continuing our focus on our core island store operations by
reviewing our merchandising strategies, both those that apply to all stores and
those specific to each store in light of the different conditions in each
market. Currently, we have no plans to open new stores during 2002, but we are
in the process of analyzing opportunities for future expansion. While we believe
these actions can improve profitability, there can be no assurance that these
actions will be successful.
We also continue to explore ways to maximize long-term value for our
shareholders, including focusing on efforts to increase earnings, responding to
competition, and improving same store sales and gross margins. We believe the
number of new island markets with the attributes for our existing growth
strategy is limited and is decreasing as a result of, among other things,
changing market conditions. We are currently evaluating alternative methods of
implementing future expansion.
11
In March 2002, we announced that we had re-evaluated whether our New
Zealand operations were "substantially liquidated" in connection with the store
closures in New Zealand in June 2000. Based on our re-evaluation, we now believe
that "substantial liquidation," as defined in Statement of Financial Accounting
Standards No. 52 (SFAS 52), occurred in June 2000, and therefore our accounting
for New Zealand foreign currency translation required adjustment retroactive to
June 2000 and for each subsequent quarter through the third quarter of fiscal
2001. The restatement was a result of our re-evaluation of the accounting
interpretation and application of SFAS 52, and not the result of any improper
conduct by our personnel or lack of internal controls.
As a result, the New Zealand foreign currency translation adjustments,
which were previously recorded within Other Comprehensive Income (Loss), have
been written off at June 25, 2000, and are included in Store Closure Expense in
fiscal 2000.
Concurrent with this reassessment, other related foreign currency
translation adjustments have also been restated to reclassify that portion of
intercompany transactions that represent transactions and balances that are not
considered to be part of the net investment in the foreign entity, and
accordingly, related transaction gains and losses are recorded for that portion
representing non-permanent investments. The restatement resulted in additional
foreign currency transaction gains of $14,000 and losses of $88,000 for the 13
weeks and 39 weeks ended September 30, 2001, respectively, to be included in
Other Income (Expense). Refer to our Form 10-K/A for the year ended December 31,
2000, filed with the Securities and Exchange Commission on April 1, 2002, for
further discussion of the impact of the restatement.
The management's discussion and analysis of financial condition and
results of operations presented below reflects the restatement of our condensed
consolidated financial statements for the 13 and 39 weeks ended September 30,
2001, as discussed above and in Note 1 to the condensed consolidated financial
statements.
Results of Operations
We reported net income of $207,000 for the 13 weeks ending September 29,
2002, compared to net income of $150,000 for the same period in fiscal 2001. The
improvement in net income was primarily due to increased sales, an improvement
in margin and lower interest expense, which more than offset higher store
expenses and foreign currency translation expenses.
Comparison of the 13 Weeks and 39 weeks Ended September 29, 2002 to the 13 Weeks
and 39 weeks Ended September 30, 2001
Net Sales: Net sales of $43.2 million for the 13 weeks ended September 29,
2002 increased 0.9%, or $0.4 million, compared with net sales of $42.8 million
in the same period in the prior year. Comparable-store sales (stores open for a
full 13 months) increased 3.7% for the 13 weeks ended September 29, 2002, as
strong sales in the Caribbean, led by high comparable sales in St. Thomas,
offset the impact of decreased sales in Guam caused by the opening of a
membership warehouse club store by a competitor in March 2002.
For the 39 weeks ended September 29, 2002, net sales of $130.9 million
were slightly lower than the $131.2 million of sales for the same period in the
prior year. The slight decline in net sales was primarily due to lower
business-to-business sales in the current year as compared to particularly
strong sales in the prior year, and due to the impact of the new competition in
Guam. We expect the current level of business-to-business activity to continue
throughout the remainder of fiscal 2002. Conversely, comparable-store sales
increased 1.8% for the 39 weeks ended September 29, 2002, as decreased sales in
Guam were more than offset by sales increases in a majority of our other stores.
Additionally, although we are experiencing a decline in sales in Guam as a
result of a new competitor, we expect our sales in Guam to rebound to
pre-competition levels as they did when the same competitor entered our St.
Thomas market in fiscal 2001.
Gross Profit: Gross profit improved to $7.4 million, or 17.2% of sales for
the 13 weeks ended September 29, 2002, compared to $7.2 million, or 16.7% of
sales in the same period in the prior year. Gross profit also improved slightly
for the 39 weeks ended September 29, 2002 to 16.4% of sales, or $21.4 million,
as compared to 16.2% of sales, or $21.3 million, for the 39 weeks ended
September 30, 2001. The increase in gross profit as a percent of sales resulted
primarily from improvements in merchandising and a stronger mix of retail store
sales, with typically higher margins, as compared to business-to-business sales,
which generally provide a lower gross margin but are executed at minimal direct
expense.
12
Store expenses: Store expenses increased to $5.5 million for the 13 weeks
and $16.6 million for the 39 weeks ended September 29, 2002 as compared to $5.3
million and $15.8 million for the same periods in the prior year. As a
percentage of sales, store expenses increased to 12.8% of net sales for the 13
weeks and 12.7% of net sales for the 39 weeks ended September 29, 2002 as
compared to 12.4% and 12.0% for the comparable periods in the prior year. The
increase in store expenses was primarily due to higher payroll and related costs
associated with an upgrade in store management, higher sales volume and a higher
level of customer service, as well as increases in self-insured medical claims
and repairs and maintenance expense.
General and administrative expenses: General and administrative expenses
remained relatively flat at $1.4 million and $4.4 million for the 13 weeks and
39 weeks ended September 29, 2002, respectively, as compared to $1.4 million and
$4.3 million for the 13 and 39 week periods in the prior year. General and
administrative expenses were 3.2% of sales for the 13 weeks and 3.4% of sales
for the 39 weeks ended September 29, 2002, as compared to 3.2% of sales for both
periods in the prior year.
Store opening expenses: Store opening expenses were $2,000 and $14,000 for
the 13 weeks and 39 weeks ended September 29, 2002, respectively, as compared to
$10,000 and $44,000 for the 13 and 39 week periods in the prior year. Store
opening expenses in both years relate to costs associated with the evaluation of
potential new store locations.
Interest expense, net: Interest expense, net decreased to $84,000 and
$287,000 for the 13 weeks and 39 weeks ended September 29, 2002, respectively,
as compared to $134,000 and $474,000 for the 13 and 39 week periods in the prior
year, due primarily to a reduction in interest rates.
Other income (expense): Other income (expense) of ($103,000) and $91,000
for the 13 weeks and 39 weeks ended September 29, 2002, respectively, as
compared to other income (expense) of $3,000 and ($120,000) for the 13 and 39
week periods in the prior year was primarily attributable to gains and losses on
foreign currency transactions, including translation of intercompany amounts
that represent transactions and balances that exceed the permanent investments
in those countries. The income and (expense) in both fiscal years is primarily
attributable to appreciation and (depreciation) in the Fijian dollar as compared
to the U.S. dollar.
Income tax provision: The tax provisions and benefits for the 13 and 39
week periods ended September 29, 2002 and September 30, 2001, represent taxes
and tax benefits associated with income or losses generated in the U.S. and U.S.
Territories. Our effective tax rate is higher than the expected federal
statutory rate because no tax benefits were provided on foreign losses, as we
have no assurance that we will be able to generate an adequate amount of taxable
income in the future to utilize such benefits.
Net income: Our net income increased to $207,000, or $0.06 per share, for
the 13 weeks ended September 29, 2002, compared to net income of $150,000, or
$0.04 per share in the same period in the prior year. Our net income of $89,000,
or $0.02 per share, decreased as compared to net income of $254,000, or $0.07
per share in the same period in the prior year.
Liquidity and Capital Resources
Net cash used by operations was $1.6 million for the 39 weeks ended
September 29, 2002 as compared to $31,000 provided by operations in the same
period in the prior year. The increase in cash used by operations was primarily
due to a reduction in accrued expenses and the lack of cash provided by
receivables as was experienced in the 39 weeks ended September 30, 2001.
Net cash used in investing activities was $0.4 million for the 39 weeks
ended September 29, 2002 and $0.5 million for the 39 weeks ended September 30,
2001. We currently have no plans to open new stores during fiscal 2002, but we
are in the process of analyzing opportunities for new stores in the future.
Net cash provided by financing activities increased to $0.9 million for
the 39 weeks ended September 29, 2002 as compared to $0.6 million in the same
period in the prior year. This increase was due to additional borrowings that
were used primarily to pay down our accounts payable to 75% of inventory at
September 29, 2002 compared to 82% of inventory at December 30, 2001. Our
current ratio has improved to 1.16 at September 29, 2002 compared to 1.11 at
December 30, 2001.
On October 1, 2002, we amended the terms of our line of credit with a
financial institution (1) to extend the term of the line of credit to April 1,
2003; (2) to reduce the amount of the line from $8.0 million to $6.75 million;
and (3) to change the interest rate on the line of credit to the Prime Rate plus
(a) 0% through and including January 1, 2003, (b) 1% from January 2, 2003
through and including February 2, 2003, (c) 2% from February 3, 2003 through and
including March 2, 2003, and (d) 3% from March 3, 2003 and thereafter. No fixed
rate loans are available under the amended line of credit, except that the $2.0
million of fixed rate loans existing on the date of the amendment will continue
until the end of the their respective interest rate periods and thereafter bear
interest with reference to the Prime Rate. The Prime Rate was at 4.75% at
September 29, 2002.
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The line of credit currently has $0.3 million utilized for standby letters
of credit, leaving $6.45 million available for operations. At September 29,
2002, we had $3.3 million in borrowings outstanding on our line of credit.
Collateral for the line of credit consists of inventories and equipment. The
line of credit contains certain covenants, including the requirement that we
maintain minimum tangible net worth and minimum ratios of current assets to
current liabilities, and debt to tangible net worth. We must obtain the consent
of the lender to (i) pay dividends, (ii) purchase or sell assets or incur
indebtedness, other than in the ordinary course of business, (iii) make loans
to, or investments in, any other person, (iv) enter into a merger or other
business combination, or (v) make capital expenditures in excess of a specified
limit as of and for the year ended December 30, 2001. We are currently in
compliance with all such covenants.
Our current line of credit will expire on April 1, 2003. The bank has
indicated that it will not renew this line of credit. We have taken steps to
identify alternative lenders to provide a line of credit for operations beyond
April 1, 2003, but we have not entered into any formal agreement as of the date
of this filing. We believe that any such facility would continue to be
collateralized by inventories and equipment and may result in higher interest
rates than those that exist under our current facility. There can be no
assurance that a line of credit, on reasonable terms or at all, will be
available to us beyond April 1, 2003. If we are unable to negotiate a new line
of credit beyond April 1, 2003 on terms favorable to us, there would be a
material adverse effect on our business, financial condition and results of
operation.
A significant portion of our cash flow is generated by our operations. If
our operating results deteriorate, as a result of a decrease in customer demand
or severe pricing pressures from our customers or our competitors, our ability
to generate positive cash flow from operations may be jeopardized. We believe
that amounts available under our various credit facilities, existing cash
available for working capital purposes, and cash flow from operations will most
likely be sufficient to fund our operations through the next 12 months. There
can be no assurance that we will be able to obtain additional financing when
needed, or that any available financing will be on terms acceptable to us.
On October 17, 2002, we announced that our Board of Directors has adopted
a program to repurchase from time to time at management's discretion shares of
our common stock in the open market or in privately negotiated transactions
until December 31, 2002 at prevailing market prices. As of October 17, 2002, the
Company had 3,606,376 shares of common stock outstanding.
Critical Accounting Policies
We have chosen accounting policies that we believe are appropriate to
report accurately and fairly our operating results and financial position, and
we apply those accounting policies in a consistent manner. The significant
accounting policies are summarized in Note 1 to the consolidated financial
statements included in our Annual Report on Form 10-K for the year ended
December 30, 2001.
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States requires us to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
the 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. We base our estimates on historical experience and other
factors believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results
could differ from those estimates.
We believe that the following accounting policy is the most critical in
the preparation of our financial statements because it involves the most
difficult, subjective or complex judgments about the effect of matters that are
inherently uncertain.
Income Taxes
Income tax expense includes U.S. and foreign income taxes. We account for
income taxes under the liability method. Under the liability method, deferred
tax assets and liabilities are determined based on differences between financial
reporting and tax basis of assets and liabilities, and are measured using the
enacted tax rates and laws that will be in effect when the differences are
expected to reverse. We apply judgment in determining whether it is more likely
than not that the deferred tax assets will be realized, and valuation allowances
are established when necessary. Our effective tax rate is currently higher than
the expected federal statutory rate because valuation allowances have been
established regarding the tax benefits of foreign losses, as we have no
assurance that we will be able to generate an adequate amount of taxable income
in the future to utilize such benefits. We are developing and implementing
certain tax planning strategies, which may affect our ability to recognize some
of the deferred tax assets that are currently allowed for and may ultimately
change our estimate of the valuation allowance.
14
Recent Accounting Pronouncements
During 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) Nos.141, "Business
Combinations", 142 "Goodwill and Other Intangible Assets", 143 "Accounting for
Asset Retirement Obligations", and 144 "Accounting for Impairment or Disposal of
Long-lived Assets and for Long-Lived Assets to be Disposed of". During 2002, the
FASB issued SFAS No.145, "Revision of FASB Statements No. 4, 44, 64, Amendment
of FASB No. 13, and Technical Corrections" and SFAS No. 146, "Accounting for
Costs Associated with Exit and Disposal Activities."
The adoption of SFAS Nos. 141, 142, 144 and 145 did not have a material
impact on the Company's consolidated financial statements. The Company believes
the adoption of SFAS Nos. 143 and 146 will not have a material impact on the
Company's consolidated financial statements.
Risk Factors that May Affect Future Results
You should carefully consider the following factors that may affect future
results and other information included in this quarterly report on Form 10-Q and
in our annual report on Form 10-K for the fiscal year ended December 30, 2001.
The risks and uncertainties described below are not the only ones we face.
Additional risks and uncertainties not presently known to us or that are
currently deemed immaterial also may impair our business operations or could
cause actual results to differ from historical results or those anticipated. If
any of the following risks actually occur, our business, financial condition and
operating results could be materially adversely affected.
Competition. The warehouse club and discount retail businesses are highly
competitive. We have historically faced significant competition from warehouse
clubs and discount retailers, such as Wal-Mart, and Costco in Hawaii, and from
Kmart in the U.S. Virgin Islands and Guam. Our competition also consists of
discount retailers and other national and international grocery store chains.
Some of our competitors have substantially greater resources, buying power and
name recognition than we have. The cost of doing business in island markets is
typically higher than on the U.S. mainland because of ocean freight and duty
costs and higher facility costs. While we expect that the size of many of the
markets in which we operate or expect to enter will delay or deter entry by many
of our larger competitors, there can be no assurance that our larger competitors
will not decide to enter these markets or that other competitors will not
compete effectively against us. Our gross margin and operating income are
generally lower for those stores in markets where traditional warehouse clubs
and discount retailers also operate stores, due to increased price competition
and reduced market share. We may be required to implement price reductions and
other actions in order to remain competitive in our markets. PriceSmart opened a
store in May 2001 on St. Thomas, where we have an established market share. To
remain competitive in St. Thomas, among other things, we implemented a customer
rewards program, which presents customers with merchandise certificates based on
the achievement of specified levels of customer purchases. Additionally,
PriceSmart opened a store in Guam in March of 2002. In response, we remodeled
our Dededo store and have increased our price competitiveness and marketing
activities in Guam. We are currently experiencing a decline in sales in Guam as
a result of the new competitor. There is no assurance that the steps taken in
Guam will cause initial sales losses to rebound to pre-competition levels as
they did when similar competition entered our St. Thomas market. Moreover, our
ability to expand into and operate profitably in new markets, particularly small
markets, may be adversely affected by the existence or entry of competing
warehouse clubs or discount retailers.
Impact of General Economic Conditions. The success of our operations
depends to a significant extent on a number of factors relating to discretionary
consumer spending, including employment rates, business conditions, interest
rates, inflation, population and Gross Domestic Product levels in each of its
island markets, taxation, consumer spending patterns and customer preferences.
There can be no assurance that consumer spending in our markets will not be
adversely affected by these factors, thereby affecting our growth, net sales and
profitability. A decline in the national or regional economies of the United
States and the U.S. Territories where we currently operate or any foreign
countries in which we currently or will operate could have a material adverse
effect on our business, financial condition and operating results.
Ability to Maintain Existing Credit and Obtain Additional Credit. A
significant portion of our cash flow is generated by our operations. If our
operating results deteriorate, as a result of a decrease in customer demand or
severe pricing pressures from our customers or our competitors, our ability to
generate positive cash flow from operations may be jeopardized. We believe that
amounts available under our various credit facilities, existing cash available
for working capital purposes, and cash flow from operations will most likely be
sufficient to fund our operations through the next 12 months. Our current line
of credit will expire on April 1, 2003. The bank has indicated that it will not
renew this line of credit. We have taken steps to identify alternative lenders
to provide a line of credit for operations beyond April 1, 2003, but we have not
entered into any formal agreement as of the date of this filing. There can be no
assurance that a line of credit, on reasonable terms or at all, will be
available to us beyond April 1, 2003. Additionally, there can be no assurance
that we will be able to obtain additional financing when needed, or that any
available financing will be on terms acceptable to us. If we are not able to
extend the term of
15
our existing credit line beyond April 1, 2003, or obtain additional financing on
terms favorable to us, there would be a material adverse effect on our business,
financial condition and results of operation.
Small Store Base. We opened our first store in 1989 and opened a total of
21 stores through December 2001, and presently operate eleven stores. Our
closure of ten stores has adversely affected our operating results. Should (i)
any new store be unprofitable, (ii) any existing store experience a decline in
profitability, or (iii) our general and administrative expenses increase, the
effect on our operating results would be more significant than would be the case
if we had a larger store base, and could have a material adverse effect on our
business, financial condition and operating results. Although we intend to
carefully plan for the implementation of additional stores, there can be no
assurance that such plans can be executed as envisioned or that the
implementation of those plans will not have a material adverse effect on our
business, financial condition and operating results. In addition, our ability to
acquire products at a lower cost than competitors or obtain volume-based pricing
can be adversely affected because of our small store base.
If we cannot obtain sufficient funds to grow our business, our operations
and business may suffer. We expect to have substantial future capital
requirements to expand our business. Currently, we do not have sufficient funds
to pursue a growth strategy. Our ability to expand our business and pursue a
growth strategy will depend on our ability to obtain significant external
financing. Our ability to obtain additional financing depends on a number of
factors, such as market conditions and our operating performance. There can be
no assurance that we will be able to obtain additional financing in a timely
manner and upon acceptable terms, if at all. If we fail to obtain necessary
funds upon acceptable terms, we may be forced to delay expansion of our business
or otherwise curtail our operations and our operations and business may suffer.
A prolonged decrease in tourism and air travel could have an indirect but
significant impact on our financial performance, operations and liquidity.
Because our operations are primarily located in the U.S. Territories and foreign
island countries throughout the Pacific and Caribbean, the success of our
operations depends to a significant extent on tourism and the travel industry.
Prolonged adverse occurrences affecting tourism or air travel, particularly to
non-U.S. destinations, including political instability, armed hostilities,
terrorism, or other activity that involves or affects air travel or the tourism
industry generally, could have an indirect but adverse and significant impact on
our financial performance, operations liquidity or capital resources.
Isolation of Store Operations From Corporate Management; Increased
Dependence on Local Managers. Our headquarters and administrative offices are
located in Preston, Washington; however, ten of our eleven stores and a majority
of our employees are located on islands. Although we invest resources to hire
and train our on-site managers, the inability of our executives to be physically
present at our current and planned store sites on a regular basis may result in
the following:
o Isolation of store operations from corporate management and an
increased dependence on store managers;
o Diminished ability to oversee employees, which may lead to decreased
productivity or other operational problems;
o Construction delays or difficulties caused by inadequate supervision
of the construction process; and
o Communication challenges
We may need to invest significant resources to update and expand our
communications systems and information networks and to devote a substantial
amount of time, effort and expense to national and international travel in order
to overcome these challenges; failure to do so could have a material adverse
effect on our business, financial condition and operating results.
Risks Associated With Island and International Operations. Our net sales
from island operations represented approximately 89% of our total net sales for
the 39 weeks ended September 29, 2002. We expect that our island and
international operations together will continue to account for nearly all of our
total net sales. The distance, as well as the time-zone differences, involved
with island locations impose significant challenges to our ability to manage our
operations. Logistical challenges are presented by operating individual store
units in remote locations, whether in terms of information flow or
transportation of goods.
Difficult Transportation Environment. Our island locales require the
transportation of products over great distances on water, which results in the
following:
o Substantial lags between the procurement and delivery of product,
thus complicating merchandising and inventory control methods;
o Possible loss of product due to potential damage to, or destruction
of, ships or containers delivering our goods;
o Tariff, customs and shipping regulation issues;
o Substantial ocean freight and duty costs; and
o Interruption in the delivery of product due to labor disruption.
16
Moreover, only a limited number of transportation companies service our
regions, none of which has entered into a long-term contract with us. The
inability or failure of one or more key transportation companies to provide
transportation services to us, changes in the regulations that govern shipping
tariffs or any other disruption in our ability to transport our merchandise
could have a material adverse effect on our business, financial condition and
operating results.
Uncertainties Associated With Expansion Outside U.S. Territories.
Currently, eight of our stores are located in the U.S. Territories and foreign
island countries throughout the Pacific and Caribbean. Our remaining three
stores are in Hawaii and California. Our future expansion plans may involve
entry into additional foreign countries, which may involve additional or
heightened risks and challenges that are different from those we currently
encounter, including risks associated with being further removed from the
political and economic systems in the United States. We do not currently engage
in currency hedging activities. On February 15, 2001, we closed one of the two
stores we operated in Fiji due primarily to the impact that the political
turmoil in Fiji was having on the tourist industry, with the resulting economic
downturn severely impacting our store in Nadi. Our remaining store in Fiji is
located in the city of Suva, which is the capital of Fiji and the primary
population center. There can be no assurance that further political and economic
changes in Fiji, or political and economic changes in other markets, will not
have a material adverse effect on our business, financial condition and
operating results. The failure to adequately address the additional challenges
involved with international operations, and specifically those associated with
our store in Fiji, could have a material adverse effect on our business,
financial condition and operating results.
Weather and Other Risks Associated With Island Operations. Our operations
are primarily located on islands subject to volatile weather conditions and
natural disasters, which could result in delays in construction or result in
significant damage to, or destruction of, our stores. In addition, island
operations involve uncertainties arising from such as:
o Local business practices, language and cultural considerations,
including the capacity or willingness of local business and
government officials to provide necessary services;
o Ability to acquire, install and maintain modern capabilities such as
dependable and affordable electricity, telephone, computer, Internet
and satellite connections often in undeveloped regions;
o Political, military and trade tensions;
o Currency exchange rate fluctuations and repatriation restrictions;
o Local economic conditions;
o Longer payment cycles;
o Difficulty enforcing agreements or protecting intellectual property;
and
o Collection of debts and other obligations in foreign countries
There can be no assurance that we will be able to devote the resources
necessary to meet the challenges posed by island operations, or that losses from
business interruption will be adequately compensated by insurance; any failure
to do so would have a material adverse effect on our business, financial
condition and operating results.
Ability to Execute Growth Strategy. The success of our future growth
strategy will depend to a significant degree on our ability to do the following:
o Operate our stores on a profitable basis;
o Expand our operations through the opening of new stores;
o Properly identify and enter new markets;
o Locate suitable store sites;
o Negotiate acceptable lease terms;
o Locate local developers to construct facilities to lease;
o Construct or refurbish sites; and
o Obtain necessary funds on satisfactory terms
We have not opened stores in foreign island markets at a rapid pace and
currently have no store openings planned for 2002. We do not have operating
experience in many of the markets in which we may open new stores. In fact, in
June 2000, we closed the two stores that we had opened in New Zealand in 1999,
as they had performed below expectations, due in part to competitive and
merchandising challenges that are different from our other stores. Additionally,
in February 2001 we closed one of our two Fiji stores, due primarily to the
impact that the political turmoil and resulting economic downturn in Fiji were
having on the tourist industry. New markets may present operational,
competitive, regulatory and merchandising challenges that are different from
those we currently encounter. There can be no assurance that we will be able to
adapt our operations to support our future expansion plans or that our new
stores will be profitable. Any failure on our part to mange our growth could
have a material adverse effect on our business, financial condition and
operating results.
17
Additionally, we rely significantly on the skill and expertise of our
on-site store managers. We will be required to hire, train and retain skilled
managers and personnel to support any growth, and may experience difficulties
locating store managers and employees who possess the training and experience
necessary to operate our new stores, including our management information and
communications systems, particularly in island markets where language, education
and cultural factors may impose additional challenges. Further, we have
encountered, and may continue to encounter, substantial delays, increased
expenses or loss of potential sites due to the complexities, cultural
differences, and local political issues associated with the regulatory and
permitting processes in the island markets in which we may locate our stores.
There can be no assurance that we will be able to open new stores according to
our business plans, or that we will be able to continue to attract, develop and
retain the personnel necessary to pursue our growth strategy. Failure to do so
could have a material adverse effect on our business, financial condition and
operating results.
We may not be able to fully pursue our future growth strategy by expanding
into new island markets. We believe that there are certain attributes of
appropriate markets into which we may expand our operations through the opening
of new stores, including:
o Acceptance and demand for U.S. goods;
o Familiarity with the warehouse concept;
o Absence of large warehouse club competition;
o Stable political and regulatory environment; and
o Favorable pricing structure to provide adequate return on investment
We believe the number of new island markets with these attributes is
limited in number and is decreasing as a result of, among other things, the
entry by many of our larger competitors into these markets. If we are unable to
expand into new island markets ahead of large warehouse club competitors, our
business, financial condition and results of operations may be adversely
affected.
We also will need to continually evaluate the adequacy of our existing
systems and procedures, including store management, financial and inventory
control and distribution systems. As we grow, we will need to continually
analyze the sufficiency of our distribution depots and inventory distribution
methods and may require additional facilities in order to support its planned
growth. There can be no assurance that we will anticipate all the changing
demands that our expanding operations will impose on such systems. Failure to
adequately update our internal systems or procedures as required could have a
material adverse effect on our business, financial condition and operating
results.
Dependence on Key Personnel. Our success depends in large part on the
abilities and continued service of our executive officers and other key
employees. In addition, we do not currently carry key-man life insurance. There
can be no assurance that we will be able to retain the services of such
executive officers and other key employees, the loss of any of whom could have a
material adverse effect on our business, financial condition and operating
results.
Dependence on Systems. As we expand, we will need to upgrade or
reconfigure our management information systems. While we have taken a number of
precautions against certain events that could disrupt the operation of our
management information systems, we may experience systems failures or
interruptions, which could have a material adverse effect on our business,
financial condition and operating results. Our business is highly dependent on
communications and information systems, primarily systems provided by
third-party vendors. Any failure or interruption of our systems or systems
provided by third-party vendors could cause delays or other problems in our
operations, which could have a material adverse effect on our business,
financial condition and operating results.
Utilization of Tax Benefits. Our ability to utilize various tax benefits
and credits is dependent on our ability to generate adequate taxable income in
the United States and in foreign jurisdictions. As of December 30, 2001, we had
recognized an aggregate foreign tax benefit of $2.4 million on foreign operating
losses and a corresponding valuation allowance of $1.8 million. Approximately
one-half of the Net Operating Losses ("NOL's") will begin expiring in the year
2006. The remaining NOL's were generated in Curacao, St. Maarten and Australia
and are not subject to expiration time limits. Additionally, during fiscal 2001
and fiscal 2000, we recorded foreign tax credits of $0.4 million and $0.3
million, respectively, with corresponding valuation allowances for the entire
amount of the credits. Utilization of the tax benefit and foreign tax credits is
dependent on our generating future taxable income. There can be no assurance
that we will be able to produce adequate future taxable income to utilize this
tax benefit, and failure to generate such income may have a material adverse
effect on our business, financial condition and operating results.
18
Anti-takeover Considerations. Pursuant to our Restated Articles of
Incorporation, our Board of Directors has the authority, without shareholder
approval, to issue up to 2,000,000 shares of Preferred Stock and to fix the
rights, preferences, privileges and restrictions of such shares without any
further vote or action by our shareholders. Our restated articles and bylaws
also provide for a classified board and special advance notice provisions for
proposed business at annual meetings. These provisions, among others, may have
the effect of making it more difficult for a third party to acquire, or
discouraging a third party from attempting to acquire, control of our company,
even if shareholders may consider such a change in control to be in their best
interests. In addition, Washington law contains certain provisions that may have
the effect of delaying, deferring or preventing a hostile takeover of our
company.
On February 23, 1999, our Board of Directors declared a dividend
distribution of preferred share purchase rights (the "Rights") pursuant to a
Shareholder Rights Plan. The Rights initially trade with shares of our common
stock and have no impact upon the way in which shareholders can trade our common
stock. However, if the plan is not waived by our board of directors, ten days
after a person or group acquires 15% or more of our common stock, or such date,
if any, as the Board of Directors may designate after a person or group
commences or publicly announces its intention to commence a tender or exchange
offer which could result in that person or group owning 15% or more of the
common stock (even if no purchases actually occur), the Rights will become
exercisable and separate certificates representing the Rights will be
distributed. The Rights would then begin to trade independently from our shares
at that time. The Rights are designed to cause substantial dilution to a person
or group that attempts to acquire our company without approval of the Board of
Directors, and thereby make a hostile takeover attempt prohibitively expensive
for the potential acquirer. As of September 29, 2002, no rights have become
exercisable.
Governmental Regulations. Governmental regulations in foreign countries
where we plan to expand our operations might prevent or delay entry into the
market or prevent or delay the introduction, or require modification, of certain
of our operations. Additionally, our ability to compete may be adversely
affected by foreign governmental regulations that encourage or mandate the
employment of citizens of, or purchase of supplies from vendors in a particular
jurisdiction. We may also be subject to taxation in these foreign jurisdictions,
and the final determination of our tax liabilities may involve the
interpretation of the statutes and requirements of the various domestic and
foreign taxing authorities. We may also be subject to currency repatriation
restrictions. There can be no assurance that any of these risks will not have a
material adverse effect on our business, financial condition and operating
results.
Decreases in Sales; Fluctuations in Comparable Store Sales. Although
comparable store sales increased 3.7% for the 13 weeks and 1.8% for the 39 weeks
ended September 29, 2002 as compared to the comparable periods in 2001, we
experienced comparable sales declines in both fiscal 2001 and fiscal 2000.
Additionally, total sales declined 4.5% in fiscal 2001 as compared to fiscal
2000. Total sales increased 11.5% in fiscal 2000 over fiscal 1999, increased
24.8% in fiscal 1999 over 1998, and increased 7.2% in 1998 over 1997. Total
sales in fiscal 1997 declined 7.4% compared to fiscal 1996. The decline in
fiscal 2001 was primarily due to the impact of deteriorating economies in Guam,
Samoa and Curacao, Netherlands Antilles, as well as the impact of the opening of
a membership warehouse club in St. Thomas. The decline in 1997 was primarily due
to store closures in the continental United States and to a slight decline in
comparable store (stores open at least 13 months) sales, largely attributable to
the Hawaii market. The fiscal 2000 increase was primarily due to sales from the
St. Maarten store opened in June 2000, an increase in business sales, the
benefit of an additional week of sales in fiscal 2000 as compared to fiscal 1999
and sales from the New Zealand stores that opened in November 1999 and were
closed in June 2000. The increase in fiscal 1999 and fiscal 1998 was primarily
due to additional stores. Comparable store sales decreased 4.7% in fiscal 2001,
2.2% in fiscal 2000 and 0.5% in fiscal 1997. Comparable store sales increased
6.8% in fiscal 1999 and 9.9% in fiscal 1998.
A variety of factors affect our comparable store sales, including, among
others, actions of competitors (including the opening of additional stores in
our markets), the retail sales environment, general economic conditions, weather
conditions and our ability to execute our business strategy effectively. In
addition, our future expansion may result in opening additional stores in
markets where we already do business. Historically, we have experienced a
reduction in sales at an existing store when we open a new store in the same
market. These factors may result in future comparable store sales declines.
Moreover, there can be no assurance that comparable store sales for any
particular period will not decrease in the future.
19
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We operate stores in foreign countries and have market risks associated
with foreign currencies. However, sales are primarily made in U.S. cash or
foreign currencies with minimal trade credit extended and no borrowings exist in
foreign currencies. Cash deposited from sales are remitted back to the U.S. bank
account, routinely. Because of the minimal trade credit, our exposure to foreign
currency market risk is not considered significant and is not concentrated in
any single currency. Although we experienced foreign currency translation losses
in conjunction with the closure of our New Zealand stores in 2000, we do not
believe that we experience any significant market risk from foreign currencies
in our existing markets.
We also assessed our vulnerability to interest rate risk associated with
our financial instruments, including, cash and cash equivalents, lines of credit
and long term debt. Due to the nature of these financial instruments, we believe
that the risk associated with interest rate fluctuations does not pose a
material risk. Our line of credit and long-term debt can be expected to vary in
the future as a result of future business requirements, market conditions and
other factors.
We do not have any derivative financial instruments as of September 29,
2002.
ITEM 4. CONTROLS AND PROCEDURES
(a) Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer,
we conducted an evaluation of our disclosure controls and procedures, as
such term is defined under Rule 13a-14(c) promulgated under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), within 90 days of
the filing date of this report. Based on their evaluation, our principal
executive officer and principal accounting officer concluded that our
disclosure controls and procedures are effective.
(b) There have been no significant changes (including corrective actions with
regard to significant deficiencies or material weaknesses) in our internal
controls or in other factors that could significantly affect these
controls subsequent to the date of the evaluation referenced in paragraph
(a) above.
20
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
No. Description
--- -----------
10.1 Note Modification Agreement dated October 1, 2002 to the
Promissory Note between Bank of America N.A. and the Company,
dated September 15, 2000.
10.2 Amendment No. 2 dated October 1, 2002 to the Business Loan
Agreement between Bank of America, N.A. and the Company, dated
September 15, 2000
10.3 Employment Agreement between Cost-U-Less, Inc. and J. Jeffrey
Meder, dated October 22, 2002
99.1 Certification of Chief Executive Officer
99.2 Certification of Chief Financial Officer
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarterly period ended
September 29, 2002. However, on October 22, 2002, we filed a report on
Form 8-K regarding our October 17, 2002 press release which announced
that our Board of Directors has adopted a program to repurchase from
time to time at management's discretion shares of our common stock in
the open market or in privately negotiated transactions until December
31, 2002, at prevailing market prices. Repurchases will be made using
our own cash resources.
21
SIGNATURES
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 thereunto duly authorized.
COST-U-LESS, INC.
(Registrant)
Date November 12, 2002 /s/ J. Jeffrey Meder
-------------------------- ---------------------------------
J. Jeffrey Meder
President and
Chief Executive Officer
Date November 12, 2002 /s/ Martin P. Moore
-------------------------- ---------------------------------
Martin P. Moore
Chief Financial Officer
22
Form of Sarbanes-Oxley Section 302(a) Certification
I, J. Jeffrey Meder, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Cost-U-Less, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: November 12, 2002
------------------------------
/s/ J. Jeffrey Meder
- ------------------------------------
J. Jeffrey Meder
President and
Chief Executive Officer
23
Form of Sarbanes-Oxley Section 302(a) Certification
I, Martin P. Moore, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Cost-U-Less, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: November 12, 2002
-----------------------------
/s/ Martin P. Moore
- -----------------------------------
Martin P. Moore
Chief Financial Officer
24