FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
(Mark One)
(X) Quarterly report pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 1999
( ) Transition report pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
Commission File Number: 0-25464
DOLLAR TREE STORES, INC.
(Exact name of registrant as specified in its charter)
Virginia 54-1387365
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
500 Volvo Parkway
Chesapeake, Virginia 23320
(Address of principal executive offices)
Telephone Number (757) 321-5000
(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:
Yes (X) No ( )
As of November 11, 1999, there were 62,024,613 shares of the Registrant's Common
Stock outstanding.
DOLLAR TREE STORES, INC.
and subsidiaries
INDEX
PART I. FINANCIAL INFORMATION
Page
----
Item 1. Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets
September 30, 1999 and December 31, 1998............................ 3
Condensed Consolidated Income Statements
Three months and nine months ended September 30, 1999 and 1998...... 4
Condensed Consolidated Statements of Cash Flows
Nine months ended September 30, 1999 and 1998....................... 5
Notes to Condensed Consolidated Financial Statements................. 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................................. 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk...... 15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................... 16
Item 6. Exhibits and Reports on Form 8-K................................ 16
Signatures...................................................... 17
2
DOLLAR TREE STORES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)
September 30, December 31,
1999 1998
------------- ------------
ASSETS
Current assets:
Cash and cash equivalents ....................... $ 19,173 $ 74,644
Merchandise inventories ......................... 252,472 142,706
Deferred tax asset .............................. 3,667 6,709
Prepaid expenses and other current assets ....... 8,627 7,451
------- -------
Total current assets ........................ 283,939 231,510
------- -------
Property and equipment, net .......................... 139,933 122,503
Deferred tax asset ................................... 1,433 2,194
Goodwill, net ........................................ 41,106 42,551
Other assets, net (note 5) ........................... 15,947 6,429
------- -------
TOTAL ASSETS ................................ $482,358 $405,187
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................ $ 71,950 $ 53,030
Income taxes payable ............................ 1,206 21,353
Other current liabilities ....................... 19,668 25,988
Current portion of long-term debt (note 4) ...... 25,280 16,500
Current installments of obligations
under capital leases (note 5) ................ 3,114 457
------- -------
Total current liabilities ................... 121,218 117,328
------- -------
Long-term debt, excluding current portion ............ 25,120 30,000
Obligations under capital leases,
excluding current installments (note 5) ........... 29,197 2,469
Other liabilities .................................... 5,607 6,574
------- -------
Total liabilities ........................... 181,142 156,371
------- -------
Shareholders' equity (note 3):
Common stock, par value $0.01. Authorized
300,000,000 shares, 61,997,170 shares
issued and outstanding at September 30, 1999
and authorized 100,000,000 shares,
61,380,418 shares issued and outstanding at
December 31, 1998.............................. 620 614
Additional paid-in capital....................... 69,370 53,030
Retained earnings................................ 231,226 195,172
------- -------
Total shareholders' equity................... 301,216 248,816
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY... $482,358 $405,187
======= =======
See accompanying Notes to Condensed Consolidated Financial Statements
3
DOLLAR TREE STORES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED INCOME STATEMENTS
(In thousands, except per share data)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
1999 1998 1999 1998
---- ---- ---- ----
Net sales........................................ $265,372 $210,008 $745,631 $595,816
Cost of sales.................................... 167,325 132,014 473,028 379,754
Merger related costs (note 3).................... -- -- 443 --
------- ------- ------- -------
Gross profit............................ 98,047 77,994 272,160 216,062
------- ------- ------- -------
Selling, general, and administrative expenses:
Operating expenses.......................... 64,016 51,312 181,851 146,772
Merger related expenses (note 3)............ -- -- 607 --
Depreciation and amortization............... 7,062 5,174 20,163 14,477
------- ------- ------- -------
Total selling, general
and administrative expenses............ 71,078 56,486 202,621 161,249
------- ------- ------- -------
Operating income................................. 26,969 21,508 69,539 54,813
Interest expense................................. 787 1,531 1,939 3,290
------- ------- ------- -------
Income before income taxes....................... 26,182 19,977 67,600 51,523
Provision for income taxes....................... 10,080 7,555 25,667 19,315
------- ------- ------- -------
Net income.............................. $ 16,102 $ 12,422 $ 41,933 $ 32,208
======= ======= ======= =======
Net income per share (note 2):
Basic net income per share.................. $ 0.26 $ 0.20 $ 0.68 $ 0.53
======= ======= ======= =======
Diluted net income per share................ $ 0.24 $ 0.18 $ 0.62 $ 0.48
======= ======= ======= =======
Pro forma income data (note 3):
Net income.................................. $ 16,102 $ 12,422 $ 41,933 $ 32,208
Pro forma adjustment for
C-corporation income taxes................ -- 111 505 506
------- ------- ------- -------
Pro forma net income........................ $ 16,102 $ 12,311 $ 41,428 $ 31,702
======= ======= ======= =======
Pro forma basic net income per share........ $ 0.26 $ 0.20 $ 0.67 $ 0.52
======= ======= ======= =======
Pro forma diluted net income per share...... $ 0.24 $ 0.18 $ 0.61 $ 0.47
======= ======= ======= =======
Weighted average number of common
shares outstanding............................. 61,959 61,296 61,772 61,132
======= ======= ======= =======
Weighted average number of common
shares and dilutive potential
common shares outstanding...................... 68,221 67,750 68,055 67,571
======= ======= ======= =======
See accompanying Notes to Condensed Consolidated Financial Statements
4
DOLLAR TREE STORES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended
September 30,
-------------
1999 1998
---- ----
Cash flows from operating activities:
Net income................................................ $ 41,933 $ 32,208
------- -------
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization.......................... 20,163 14,477
Loss on disposal of property and equipment............. 167 521
Provision for deferred income taxes.................... 3,803 (1,585)
Changes in assets and liabilities increasing
(decreasing) cash and cash equivalents:
Merchandise inventories............................. (109,766) (99,927)
Prepaid expenses and other current assets........... (476) (2,486)
Other assets........................................ 397 (16)
Accounts payable.................................... 18,537 9,175
Income taxes payable................................ (14,854) (15,433)
Other current liabilities........................... (6,320) (2,921)
Other liabilities................................... (925) 375
------- -------
Total adjustments.................................. (89,274) (97,820)
------- -------
Net cash used in operating activities.............. (47,341) (65,612)
------- -------
Cash flows from investing activities:
Capital expenditures...................................... (36,362) (38,825)
Proceeds from sale of property and equipment.............. 99 137
------- -------
Net cash used in investing activities.............. (36,263) (38,688)
------- -------
Cash flows from financing activities:
Distributions paid (note 3)............................... (1,410) (1,375)
Proceeds from long-term debt.............................. 19,400 162,900
Repayment of long-term debt and facility fees............. (17,700) (103,130)
Net change in notes payable to bank....................... -- 3,937
Proceeds from sale-leaseback transaction (note 5)......... 21,605 --
Principal payments under capital lease obligations........ (346) (300)
Proceeds from stock issued pursuant to stock-based
compensation plans....................................... 6,584 3,985
------- -------
Net cash provided by financing activities.......... 28,133 66,017
------- -------
Net decrease in cash and cash equivalents.................. (55,471) (38,283)
Cash and cash equivalents at beginning of period........... 74,644 47,638
------- -------
Cash and cash equivalents at end of period................. $ 19,173 $ 9,355
======= =======
See accompanying Notes to Condensed Consolidated Financial Statements
5
DOLLAR TREE STORES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
Dollar Tree Stores, Inc. merged with Step Ahead Investments, Inc. (Step
Ahead) on December 10, 1998 and Tehan's Merchandising, Inc. (Only $One)on June
30, 1999. Each merger was accounted for as a pooling of interests. As a result,
the condensed consolidated financial statements of Dollar Tree Stores, Inc. and
subsidiaries (the Company) have been restated to retroactively combine the
financial statements of Step Ahead and Only $One as if the mergers had occurred
at the beginning of the earliest period presented. The Company's condensed
consolidated financial statements at September 30, 1999, and for the three- and
nine-month periods then ended, are unaudited and reflect all adjustments
(consisting only of normal recurring adjustments) which are, in the opinion of
management, necessary for a fair presentation of the financial position and
operating results for the interim periods. The condensed consolidated income
statements for the periods ended September 30, 1998 reflect the results of
operations for Dollar Tree Stores, Inc. and Only $One for the three- and
nine-month periods then ended combined with the Step Ahead three- and nine-month
periods ended October 25, 1998. The condensed consolidated statement of cash
flows for the period ended September 30, 1998 reflects cash flows for Dollar
Tree Stores, Inc. and Only $One for the nine-month period then ended combined
with the Step Ahead nine-month period ended October 25, 1998. The condensed
consolidated balance sheet as of September 30, 1998 reflects the financial
position of Dollar Tree Stores, Inc. and Only $One on that date combined with
the financial position of Step Ahead as of October 25, 1998. The condensed
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto, together with management's
discussion and analysis of financial condition and results of operations for the
year ended December 31, 1998, contained in the Company's Annual Report on Form
10-K. The results of operations for the three- and nine-month periods ended
September 30, 1999 are not necessarily indicative of the results to be expected
for the entire year ending December 31, 1999.
2. NET INCOME PER SHARE
The following table sets forth the calculation of basic and diluted net
income per share:
Three months ended Nine months ended
September 30, September 30,
------------- -------------
1999 1998 1999 1998
---- ---- ---- ----
(In thousands, except per share data)
Basic net income per share:
Net income............................... $16,102 $12,422 $41,933 $32,208
------ ------ ------ ------
Weighted average number of
common shares outstanding.............. 61,959 61,296 61,772 61,132
------ ------ ------ ------
Basic net income per share....... $ 0.26 $ 0.20 $ 0.68 $ 0.53
====== ====== ====== ======
6
Three months ended Nine months ended
September 30, September 30,
------------- -------------
1999 1998 1999 1998
---- ---- ---- ----
(In thousands, except per share data)
Diluted net income per share:
Net income........................................ $16,102 $12,422 $41,933 $32,208
------ ------ ------ ------
Weighted average number of
common shares outstanding....................... 61,959 61,296 61,772 61,132
Dilutive effect of stock options and
warrants (as determined by applying
the treasury stock method)...................... 6,262 6,454 6,283 6,439
------ ------ ------ ------
Weighted average number of
common shares and dilutive potential
common shares outstanding....................... 68,221 67,750 68,055 67,571
------ ------ ------ ------
Diluted net income per share............... $ 0.24 $ 0.18 $ 0.62 $ 0.48
====== ====== ====== ======
3. ACQUISITION
On June 30, 1999, the Company completed a merger with privately-held, New
York-based Tehan's Merchandising, Inc. which operated 24 stores under the name
"Only $One". These stores offer variety merchandise at a fixed price of $1.00
and are located in New York state. The merger qualified as a tax-free exchange
of stock and was accounted for as a pooling of interests. The Company issued
501,600 shares of Common Stock for all of the Only $One outstanding common
stock. In connection with the merger, the Company incurred approximately $1.1
million ($0.8 million after taxes or $0.01 diluted net income per share) of
merger related costs and expenses, consisting primarily of writedowns of
inventory and professional fees, which were charged to operations during the
quarter ended June 30, 1999.
Prior to June 30, 1999, Only $One was treated as an S-corporation for
Federal and state income tax purposes. As such, income of Only $One for periods
prior to June 30, 1999 was taxable to the Only $One shareholders, rather than to
Only $One. Effective with the Company's merger with Only $One, Only $One became
a C-corporation. The pro forma provisions for income taxes presented in the
condensed consolidated income statements represent an estimate of the taxes that
would have been recorded had Only $One been a C-corporation prior to the merger
on June 30, 1999. Distributions paid presented in the condensed consolidated
statements of cash flows represent distributions paid to the Only $One
shareholders for payment of their pass-through tax liabilities.
4. INTEREST RATE SWAP AGREEMENT
On April 1, 1999, the Company entered into an interest rate swap agreement
(swap) related to the $19.0 million Loan Agreement with the Mississippi Business
Finance Corporation (Loan Agreement). This swap converts the variable rate to a
fixed rate and reduces the Company's exposure to interest rate fluctuations.
Under this agreement, the Company pays interest to the bank which provided the
swap at a fixed rate of 5.53%. In exchange, the bank pays the Company at a
variable interest rate, which approximates the rate on the Loan Agreement, which
was 5.45% at September 30, 1999. The variable interest rate is adjusted monthly.
The swap, effective through April 1, 2009, is for the entire amount outstanding
under the Loan Agreement. The bank which provided the swap has the option to
cancel it on April 1, 2006. The Company
7
amended the swap on November 1, 1999 (see Note 7). The Loan Agreement is
callable, therefore, the amount is included in the current portion of long-term
debt.
5. LEASES
On September 30, 1999, the Company sold certain retail store leasehold
improvements to an unrelated third party and leased them back for a period of
seven years. The Company has an option to purchase the leasehold improvements at
the end of the fifth and seventh years at amounts approximating their fair
market values at the time the option is exercised. This transaction is being
accounted for as a financing arrangement. At September 30, 1999, the Company
recorded a capital lease obligation of $29.0 million, of which $2.7 million is
classified as current. The lease obligation accrues interest at an average rate
of 9.28% over the lease term. The lease requires monthly payments of $438,000 in
years one through five and $638,000 in years six and seven. The lease agreement
includes financial covenants that are not more restrictive than those of
existing loan agreements. As part of the transaction, the Company received net
proceeds of $20.9 million and an $8.1 million 11% note receivable which matures
in September 2006 and is included in other assets, net.
During June 1999, the Company entered into an $18.0 million operating lease
agreement for the purpose of financing construction costs to build a new
distribution center in Stockton, California, which will replace the existing
leased facilities located in the Sacramento, California area. Under this
agreement, the lessor purchases the property, pays for the construction costs
and subsequently leases the facility to the Company. The initial lease term is
five years. The lease provides for a residual value guarantee and includes a
purchase option based on the outstanding cost of the property. When the assets
are placed into service, the Company will estimate its liability, if any, under
the residual value guarantee and record additional rent expense on a
straight-line basis over the remaining lease term.
During April 1999, the Company entered into an agreement to sublease the
Memphis distribution facility through March 2000 with an option for the
sublessee to renew the lease through March 2001.
6. STORE OPENING COSTS
In accordance with Statement of Position (SOP) 98-5, Reporting on the Costs
of Start-up Activities, effective January 1, 1999, the Company expenses store
opening costs as incurred. The impact of the implementation of this SOP was not
material to the Company's financial results.
7. SUBSEQUENT EVENT
On November 1, 1999, the Company entered into an agreement to amend the
terms of its existing interest rate swap such that the Company pays interest to
the bank at a fixed interest rate of 4.99%, reduced from 5.53%. The bank
continues to pay the Company at a variable interest rate, which approximates the
rate on the Loan Agreement. A maximum variable interest rate was set, such that
no payments are made by either party under the swap for monthly periods with an
established interest rate greater than 8.28%. Also, the bank no longer
8
has the option to cancel the swap.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
A WARNING ABOUT FORWARD-LOOKING STATEMENTS: We have made "forward-looking
statements" in this document as that term is used in the Private Securities
Litigation Reform Act of 1995. Such statements are based on the beliefs and
assumptions of our management, and on information currently available to our
management. Our assumptions, beliefs and current information could be mistaken.
Forward-looking statements include any statements preceded by, followed by or
including words such as "believe," "anticipate," "expect," "intend," "plan,"
"view" or "estimate." Forward-looking statements also include, and are subject
to risks relating to, our future operations, performance, or financial condition
such as:
- comparable store net sales trends,
- expansion plans and store openings,
- dependence on imports and vulnerability to foreign economic and
political conditions as well as import restrictions, duties and
tariffs,
- increases in shipping costs, the minimum wage, and other costs,
- our ability to sublease the Memphis facility beyond March 2000 or our
ability to sublease the Sacramento facility, and
- Year 2000 compliance.
Any statements concerning our future operations, performance, or financial
condition could be inaccurate or incorrect. For additional discussion of the
factors that could affect our actual results, performance or actions, please see
the "Risk Factors" published in our latest prospectus filed with the Securities
and Exchange Commission and also the discussion and analysis below.
Results of Operations and General Comments
The Three Months Ended September 30, 1999 Compared to the Three Months Ended
September 30, 1998
Net Sales. Net sales increased $55.4 million, or 26.4%, to $265.4 million
for the three months ended September 30, 1999, from $210.0 million for the three
months ended September 30, 1998. We attribute this increase to sales at new
stores opened in 1999 and 1998 which are not included in our comparable store
net sales calculation and a 5.6% increase in comparable store net sales in the
third quarter of 1999.
During the third quarter of 1999, we added 54 new stores and closed one
store, compared to 77 new stores opened and one store closed in the third
quarter of 1998. Four of the new stores were obtained from a small dollar store
operator. In 1999, we began opening larger stores in the 6,000 to 10,000 square
foot range, which means that we can continue to increase our gross square
footage while adding a fewer number of units. During the third quarter
9
1999, we added 5.6% to our gross square footage, compared to increasing gross
square footage by 8.6% for the same period last year. For the calendar year of
1999, we expect to increase our gross square footage by more than 24%. Our
management anticipates that future net sales growth will come mostly from square
footage growth related to new store openings and expansion of existing stores.
The comparable store net sales calculation includes sales at the 98 Cent
Clearance Center stores, acquired in December 1998, and sales at the Only $One
stores, acquired in June 1999. Both acquisitions were accounted for as poolings
of interest. The increase in comparable store sales was driven in part by a
higher in-stock position of domestic consumable basics.
Gross Profit. Gross profit increased $20.1 million, or 25.7%. Our gross
profit margin (gross profit expressed as a percentage of net sales) decreased to
36.9% in the third quarter of 1999 from 37.1% in the same period in 1998. This
decrease occurred mainly because merchandise costs, which include freight costs,
were higher, as a percentage of sales, this year compared to last as our
merchandise mix included more domestic merchandise than during the third quarter
of 1998. Domestics generally carry a higher cost than imported goods. We
attribute the change in the our mix year over year to the receipt of a higher
quantity of imports than usual in 1998 as we sought to avoid last summer's
shipping container shortage.
The above increase was partially offset by leverage of distribution costs
due to the increase in comparable store net sales in third quarter 1999 compared
to 1998. Distribution costs were lower because of efficiencies at our two newest
distribution centers. The Chesapeake, VA facility, which has been in operation
since early 1998, is more mature than a year ago, and the Olive Branch, MS
facility, opened in early 1999, was able to service more stores than forecasted.
A recent increase in our transpacific shipping rates did not have a
significant impact on our results for the quarter because of the change in the
merchandise mix discussed above. We anticipate that increased foreign freight
costs may have a negative impact on gross margin in the fourth quarter when the
foreign merchandise received in the third quarter is sold. Our management
believes that the impact of these higher rates may be partially offset by
leveraging other costs.
SGA Expenses. Selling, general and administrative (SGA) expenses, excluding
depreciation and amortization, increased $12.7 million, or 24.8%. SGA expenses
excluding depreciation and amortization decreased to 24.1% as a percentage of
net sales for the three months ended September 30, 1999 compared to 24.4% as a
percentage of net sales for the three months ended September 30, 1998. This
decrease happened primarily because our comparable store net sales allowed us to
leverage our fixed costs. Depreciation and amortization increased $1.9 million,
to 2.7% as a percentage of net sales in 1999 from 2.5% in 1998. This percentage
increase is mainly the result of depreciation related to the new distribution
facility in Olive Branch, MS.
Increases in expenses can have a negative impact on our operating results,
especially since we cannot pass on increased expenses to our customers by
increasing our merchandise prices. Consequently, our future
10
success will depend in large part on our ability to control costs.
On November 9, 1999, the US Senate approved a proposal increasing the
federal minimum wage by $1.00 an hour in three installments through March 2002.
Our management believes that an increase in the minimum wage, if eventually
passed into law, could have a significant impact on our payroll costs.
Operating Income. Our operating income increased $5.5 million or 25.4%. As
a percentage of net sales, operating income of 10.2% is consistent with the same
period in 1998.
Interest Expense. Interest expense decreased to $0.8 million in the third
quarter of 1999 from $1.5 million in the third quarter of 1998. This decrease
was primarily a result of lower levels of debt in 1999 compared to 1998,
resulting from a higher cash position throughout the three months ended
September 30, 1999.
The Nine Months Ended September 30, 1999 Compared To The Nine Months Ended
September 30, 1998
Net Sales. Net sales increased $149.8 million, or 25.1%, to $745.6 million
for the nine months ended September 30, 1999 from $595.8 million for the nine
months ended September 30, 1998. We attribute this increase to sales at new
stores opened in 1999 and 1998 which are not included in our comparable store
net sales calculation and a 4.3% increase in comparable store net sales in the
first nine months of 1999.
During the first nine months of 1999, we added 169 new stores and closed
four stores, compared to 179 new stores opened and six stores closed in the
first nine months of 1998. We added 19.8% to our gross square footage in the
first nine months of both 1999 and 1998.
Gross Profit. Gross profit increased $56.1 million, or 26.0%. Our gross
profit margin increased to 36.5% in the first nine months of 1999 from 36.3% in
the same period in 1998. If you exclude merger related costs otherwise included
in cost of sales (primarily related to merchandise markdowns), then the gross
profit margin increased to 36.6%. This increase occurred mainly because certain
costs as a percentage of sales declined:
- Our inventory shrinkage decreased, mainly because of lower shrinkage
in our distribution centers and improved inventory controls at our
acquired stores. This decrease may not continue in future periods.
- Our distribution costs were lower due to efficiencies at our two
newest distribution centers as discussed above.
These decreased costs more than offset a slight increase in merchandise
costs, which include freight costs, for the nine months. The year-to-date
increase in the merchandise costs was impacted by the factors discussed above.
SGA Expenses. SGA expenses, excluding depreciation and amortization,
increased $35.7 million, or 24.3%, in the first nine months of 1999. As a
percentage of net sales, SGA expenses decreased to 24.5% for the nine months
11
ended September 30, 1999 compared to 24.6% for the same period of 1998. If you
exclude merger related expenses, SGA expenses decreased to 24.4% for the first
nine months of 1999 from 24.6% during the same period in 1998. This decrease
happened primarily because our year-to-date comparable store net sales allowed
us to leverage our fixed costs. Depreciation and amortization increased $5.7
million, to 2.7% as a percentage of net sales in 1999 from 2.4% in 1998. This
percentage increase is mainly the result of depreciation related to the new
distribution facility in Olive Branch, MS.
Operating Income. Our operating income increased $14.7 million or 26.9%. As
a percentage of net sales, operating income increased to 9.3% in the first nine
months of 1999 from 9.2% in the same period in 1998. If you exclude merger
related costs and expenses, operating income increased to $70.6 million in 1999
from $54.8 million in 1998 and increased as a percentage of net sales to 9.5%
from 9.2%. These increases were attributable to the factors discussed above.
Interest Expense. Interest expense decreased to $1.9 million in the first
nine months of 1999 from $3.3 million in the first nine months of 1998. This
decrease was primarily a result of lower levels of debt in 1999 compared to
1998, resulting from a higher cash position throughout the nine months ended
September 30, 1999.
Liquidity and Capital Resources
Our business requires capital primarily to open new stores and operate
existing stores. Our working capital requirements for existing stores are
seasonal in nature and typically reach their peak in the months of September and
October. Historically, we have met our seasonal working capital requirements for
existing stores and funded our store expansion program from internally generated
funds and borrowings under our credit facilities.
The following table compares certain cash-related information for the nine
months ended September 30, 1999 and 1998:
Nine Months Ended June 30,
1999 1998
---- ----
(in millions)
Net cash provided by (used in):
Operating activities............ $(47.3) $(65.6)
Investing activities............ (36.3) (38.7)
Financing activities............ 28.1 66.0
Cash used in operating activities is generally expended to build inventory
levels.
Cash used in investing activities was used primarily to open new stores.
Cash provided by financing activities was obtained from the following:
- in 1999, $21.6 million from a sale-leaseback transaction,
- in 1998, net borrowings under our bank facility used to fund our
seasonal working capital needs,
12
- the exercise of stock options in both years, and
- in 1999, the issuance of an additional $2.5 million in callable bonds
related to the construction of the Olive Branch distribution facility.
At September 30, 1999, our borrowings under our bank facility, senior notes
and bonds were $49.0 million and we had an additional $135.0 million available
through our bank facility. Of the amount available, approximately $28.0 million
was committed to letters of credit issued for the routine purchase of foreign
merchandise.
During June 1999, we entered into an $18.0 million operating lease
agreement to finance the construction of a new distribution center in Stockton,
California. This facility will replace the leased distribution center located in
the Sacramento, California area. The new facility is scheduled to be operational
in the first quarter of 2000. We are liable for rent and pass-through costs
under the Sacramento lease until June 2008, at a current annual cost of
approximately $512,000. Although we expect to be able to sublease the Sacramento
facility, there is no assurance that an acceptable sublease will be secured.
On September 30, 1999, we sold some of our retail store leasehold
improvements to an unrelated third party and leased them back for seven years.
We have an option to repurchase the leasehold improvements at the end of the
fifth and seventh years at amounts approximating their fair market values at the
time the option is exercised. This transaction is treated as a financing
arrangement. The total amount of the capital lease obligation is $29.0 million.
We are required to make monthly lease payments of $438,000 in years one through
five and $638,000 in years six and seven. As a result of the transaction, we
received net cash of $20.9 million and an $8.1 million 11% note receivable which
matures in September 2006.
Year 2000 Compliance
We use a large number of computer software programs throughout our entire
organization, such as purchasing, distribution, retail store management,
financial business systems and various administrative functions. We developed
some of these programs in-house and bought others from vendors.
We have evaluated and adjusted all known date-sensitive systems and
equipment for Year 2000 compliance. We define Year 2000 compliance to mean that
a given system continues to function appropriately after December 31, 1999, with
no significant business interruption. We divided our Year 2000 project into four
phases:
- inventory and initial assessment,
- remediation and testing,
- implementation and re-testing, and
- contingency planning.
All phases of the Year 2000 project are complete and include both
information technology systems, such as computer equipment and software, as
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well as non-information technology equipment, such as warehouse conveyor
systems. We will continue to monitor and test our systems to ensure ongoing
compliance.
Our plan provided for internal compliance of mission-critical systems by
mid-1999. While no one can offer a realistic guarantee that there won't be any
business disruptions, we believe that all of our internal systems, including all
mission-critical systems, are currently Year 2000 compliant. Some programs and
equipment were replaced beginning in late 1998 by routine upgrades which
provided numerous system enhancements. These replacement programs and equipment
are Year 2000 compliant. The upgrades were previously planned and were not
accelerated due to Year 2000 issues. We have not deferred any information
technology projects to address the Year 2000 issue.
We have relied primarily on internal resources to identify, correct or
reprogram and test systems for Year 2000 compliance. To date, we have spent less
than $150,000 in modifying our systems for the Year 2000; the total costs of
modifying our current systems, as well as the possible implementation of
contingency plans, are not expected to exceed $275,000. These costs are not
expected to have a material adverse effect on our financial condition and
results of operations in future periods.
Additionally, we are continuing to communicate with service providers and
domestic suppliers of merchandise to assess their Year 2000 readiness and the
extent to which we may be vulnerable to any third parties' failure to correct
their own Year 2000 issues. Many of these parties have stated that their ability
to supply us will not be affected by the Year 2000 issue. However, we cannot be
sure of their timely compliance and our operations could suffer due to the
failure of a significant third party to become Year 2000 compliant.
We feel we are unable to adequately assess the potential effect of Year
2000 problems on our international suppliers, particularly in China. Several
recent studies suggest that the preparedness of China and other Asian countries
is considerably less than that of the United States and Europe, particularly in
the fields of manufacturing and utilities. We cannot predict the duration or
severity of any disruptions which may occur in China or the home countries of
our other overseas suppliers. In addition, we have evaluated the preparedness of
third parties who handle our international merchandise shipping for China. We
believe these third parties are substantially Year 2000 compliant. A failure in
our normal merchandise supply chain from China or other overseas suppliers could
have a material adverse effect on our business.
At the end of 1999, we expect to have adequate inventory on-hand, either in
our distribution centers, in our retail stores or on the water, to support our
sales in early 2000. We also believe that our overall merchandise flow is
flexible enough to absorb minor delays given the relatively longer lead times
for imported goods. Therefore, we have not established a formal contingency plan
for acquiring and receiving merchandise in the event Year 2000 issues cause
disruptions in our procurement of merchandise.
Although we anticipate that minimal business disruption will occur as a
result of Year 2000 issues, possible consequences include, but are not limited
to, loss of communications links with store locations, customs delays, loss of
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electric power, and the inability to process transactions or engage in similar
normal business activities. In addition, the United States and other world
economies could witness unusual purchasing patterns or other disruptions if
large numbers of consumers believe interruptions in power, communications, water
or food supplies are likely, regardless of the actual risks. Any such
disruptions could affect our business operations. With the completion of the
assessment, implementation and testing phases of our plan, we analyzed
reasonably likely worst-case scenarios in order to establish appropriate
contingency plans. We have established contingency plans for all mission
critical systems even though testing indicates that they are compliant.
The cost of the conversions and the completion dates are based on
management's best estimates and may be updated as additional information becomes
available. The above section, even if incorporated into other documents or
disclosures, is a Year 2000 readiness disclosure as defined under the Year 2000
Information and Readiness Disclosure Act of 1998.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board (FASB) issued its
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS No. 133). SFAS No. 133 establishes
standards for derivative instruments and hedging activities and requires that
companies recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. In
June 1999, the FASB issued its Statement of Financial Accounting Standards No.
137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of
the Effective Date of SFAS No. 133, an Amendment of SFAS No. 133", which defers
the effective date of SFAS No. 133 to all fiscal quarters of fiscal years
beginning after June 15, 2000. Management is reviewing the impact of the
implementation of this pronouncement on our financial condition and results of
operations.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
During April 1999, as a result of the favorable interest rate environment,
we entered into an interest rate swap agreement that converts a portion of our
variable rate debt to a fixed rate and reduces our exposure to interest rate
fluctuations. Under this agreement, we pay interest to the bank which provided
the swap at a fixed rate of 5.53%. In exchange, the bank pays us at a variable
interest rate which is similar to the rate under the callable bonds and was
5.45% at September 30, 1999. The variable interest rate is set monthly. The swap
is for the entire amount outstanding under our callable bonds, which was $19.0
million at September 30, 1999, and is effective through April 1, 2009.
On November 1, 1999, we entered into an agreement to amend the terms of the
interest rate swap. As a result, we will pay interest to the bank at a fixed
rate of 4.99%, instead of 5.53%. Also, no payments are made by either party
under the swap for monthly periods in which the variable interest rate is
greater than 8.28%. The agreement entered into in April allowed the bank to
cancel the swap on April 1, 2006; however, the new agreement does not allow the
bank to cancel the swap at any time.
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PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS.
We previously reported in our 1998 Annual Report on Form 10-K a dispute
involving Michael and Pamela Alper and a corporation they control. No litigation
is currently pending against us in this matter.
We recalled 155,000 retractable dog leashes which allegedly caused several
personal injuries, as previously reported in our 1998 Annual Report on Form
10-K. Management does not believe the Company will suffer any uninsured loss in
this matter.
Additionally, the Company is a party to ordinary routine litigation and
proceedings incidental to its business, including certain matters which may
occasionally be asserted by the U.S. Consumer Product Safety Commission, none of
which is individually or in the aggregate material to the Company.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
The following documents are filed herewith:
10.1 Master Lease Agreement between DTS Properties, Inc. and Dollar Tree
Stores, Inc., dated September 30, 1999. (Confidential material omitted
and filed separately with the Securities and Exchange Commission
pursuant to a request for confidential treatment.)
10.2 Purchase and Sale Agreement by and between Dollar Tree Stores, Inc.
and DTS Properties, Inc., dated September 30, 1999.
(b) Reports on Form 8-K.
The following reports on Form 8-K were filed during the third quarter of
1999:
1. Report on Form 8-K, filed July 22, 1999, included a press release
regarding earnings for the quarter ended June 30, 1999. It also
included quarterly financial data for the years 1998 and 1999 which
has been restated on a combined basis to account for the pooling of
interests between Dollar Tree Stores, Inc. and the operator of 24 Only
$One stores.
2. Report on Form 8-K, filed August 18, 1999, included 30 days of
post-merger combined financial results for the month ended July 31,
1999 which reflected the merger between Dollar Tree Stores, Inc. and
Tehan's Merchandising, Inc. on June 30, 1999.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
DATE: November 12, 1999
DOLLAR TREE STORES, INC.
By: /s/ Frederick C. Coble
----------------------
Frederick C. Coble
Senior Vice President,
Chief Financial Officer
(principal financial and accounting
officer)
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