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99 Cents Only Stores (NYSE:NDN)

F1Q09 (Qtr End 06/28/08) Earnings Call Transcript

August 7, 2008 4:30 pm ET

Executives

Eric Schiffer – CEO

Robert Kautz – EVP and CFO

Jeff Gold – President and COO

Analysts

Mike Baker – Deutsche Bank Securities

William Keller – FTN Midwest Securities Corp.

John Zolidis – Buckingham Research

David Mann – Johnson Rice & Company

Patrick McKeever – MKM Partners

Victor Hawley – RCB Investment Management

Mailey Clarke [ph] – MFS Investment Management

Meredith Adler – Lehman Brothers

Joan Storms – Wedbush Morgan Securities

Karen Short – Friedman, Billings, Ramsey & Co.

Operator

Good afternoon, ladies and gentlemen. Welcome to 99 Cents Only Stores first quarter fiscal 2009 conference call. During today’s presentation all parties will be in listen-only mode. Afterwards, we will conduct a question-and-answer session. (Operator instructions) As a reminder, this call will be up to one hour in duration and due to the number of participants during the question-and-answer part of the call, we ask that callers please limit your question to one, with one related follow-up question.

On the call today from the Company are Eric Schiffer, CEO; Robert Kautz, CFO; and Jeff Gold, President and COO. By now everyone should have access to the news release which went out today at approximately 1:00 PM Pacific Time. If you have not received the release, it is available on the Investor Relations portion of 99 Cents Only Stores website at www.99only.com.

Before we begin today, we should like to remind everyone of the Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. The following prepared remarks contain forward-looking statements, and management may make additional forward-looking statements in response to your questions. The words, expect, estimate, anticipate, predict, believe, intend, and similar expressions and variations thereof are intended to identify forward-looking statements. Such statements include comments regarding intent, belief, or current expectations of the Company with respect to, among other things, trends affecting the financial conditions or results of operations of the Company, the business and growth strategies of the Company, the results of our initiatives to address shrinkage, the results of operations in the remainder of fiscal 2009, and the results of the Company’s operational and other improvements, including the results of the Company’s profit improvement plan. These statements do not guarantee future performance and therefore undue reliance should not be placed upon them. For a more detailed discussion of the factors that can cause actual results to differ materially from those projected in any forward-looking statements, we refer you to 99 Cents Only Stores’ most recent 10-Q and 10-K filed with the SEC.

I would now like to turn the conference over to Mr. Schiffer. Please go ahead, sir.

Eric Schiffer

Thank you very much. Thank you operator. Good afternoon everyone and thank you for joining us today. On today’s call I will begin by briefly discussing our first quarter results, including an update on shrinkage and then provide an update on our profit improvement plan. I will then turn the call over to our CFO Rob Kautz to review our financial results in more detail. And then I will make some closing remarks regarding our outlook before we open up the call to take questions.

For the first quarter of fiscal 2009 we reported a loss of $0.02 per diluted share. While we recognize our financial results for the first quarter of fiscal 2009 were not satisfactory we believe the first quarter was a step forward in accomplishing many of the goals set forth in our previously outlined profit improvement plan.

Despite the negative sales impact of the entire Easter sales shift, continued challenges in the consumer environment, and lack of extra dollars for discretionary purchases, our same-store sales for the first quarter decreased only 0.5% year-over-year. If you factor out the first two weeks of the quarter which were negatively impacted by the Easter selling season shifting into the fourth quarter of 2008 versus the first quarter of 2008 last year, our same-store sales for the remaining period were a positive 1.7%. With transactions up slightly year-over-year we believe our stores are continuing to attract new customers who are looking for ways to save in these difficult times, and we believe that once we attract new customers, those new customers become long-term customers.

As we mentioned in our fourth quarter sales release, we have been generating a great deal of publicity from local and national news regarding our amazingly low prices on basic household merchandize, including food. In this inflationary environment, we believe we are one of the leading retailers where you can find an expansive quality product assortment including many non-discretionary food and produce items for under a dollar. This is attributable to our experienced buying team and longstanding relationships with our vendors and highlights what we believe is our unique position in the market.

As we anticipated, our overall financial performance continues to be impacted by the high shrinkage that we discussed last quarter. Our shrinkage expense increased 80 basis points year-over-year, more than offsetting improvements we made in other areas of cost of goods sold such as product margins. During the first quarter we implemented a number of key measures to control and reduce our shrinkage and I am pleased to report that we recorded significantly reduced shrinkage expense compared to the fourth quarter or fiscal 2008, although, as mentioned, it was still higher than the first quarter of the prior fiscal year.

As an example of measures we have taken thus far to address our shrinkage issue, we significantly increased the number of our store physical inventories in comparison to our first quarter a year before. Another example is we have begun promptly reporting our inventory levels for all stores on a monthly basis, and for a set of targeted high shrinkage stores on a weekly basis. This has enabled us to identify suspicious build-ups in inventory levels and has empowered our operations to hold field managers accountable.

I would like to stress as has always been our Company’s practice, we will pursue prosecution of any criminal behavior. Rob Kautz will go into more detail on these and other key shrinkage control and reduction measures, shortly. However, I would like to note that we brought in outside resources to assist us in our shrinkage investigation. To-date, we have terminated a number of filed management personnel who were involved in large scale unauthorized removal of pallets of saleable merchandise from our stores. And we are continuing our investigations. We remain committed to reducing shrinkage for fiscal 2009.

In the first quarter we made progress with our profit improvement plan and made a number of key improvements to our operational efficiencies. However, rising food, commodity, and fuel prices offset the full positive impact of these improvements to financial performance. I would like to provide a brief update on each of our five key profit improvement initiatives and highlight specific areas of improvement in the quarter as well as the areas for which we believe we can continue to make improvements.

Our first key profit improvement initiative is our variable pricing and remerchandising plan. In the first quarter we improved our product margins by 30 basis points despite significant increases in food and commodity cost that resulted in price increases by some of our key vendors. This improvement underscores the success to-date of our variable pricing initiative. It is worth noting that selling certain items at $0.59 versus two for $0.99 has not had a negative impact on our overall sales.

Additionally, we have been and will continue working with our key vendors to improve our product assortment and packaging in order to enhance our margins. We also successfully tested several new merchandising initiatives and are rolling them out Company wide this summer.

Second, is store labor reduction. We focused on tighter management of store over time and overall store labor productivity and by doing so we improved our store labor costs year-over-year despite increases in minimum wage in January 2008 in California and Arizona, which were on top of increases in January of 2007. We are constantly evaluating additional ways to decrease store labor without compromising our customer experience. We are currently in the process of testing less labor-intensive merchandising, fixtures, and packaging, and will roll them out in the second and third quarters. As we begin implementing these Company wide we expect to see further store labor productivity improvements, which have offset minimum wage increases.

We have made progress on our initiatives to evaluate and update our store operating process and we continue to identify and plan the implementation of opportunities as they are identified.

Our third key initiative is improving our distribution and transportation costs. This is an area for which I am proud of our accomplishments in the first quarter. Through more effective delivery scheduling, trailer cube utilization, and reduced backhauls from stores, we managed to hold our distribution and transportation costs flat year-over-year in the face of rapidly rising fuel prices and freight costs.

This was also in spite of the costs and inefficiencies associated with racking our main distribution center. We have now substantially completed the racking of our main distribution center, which we believe will help further improve our distribution efficiencies going forward.

Our fourth key profit improvement initiative is a controlled new store expansion plan. We are maintaining a disciplined store growth plan and are selecting only Grade ‘A’ location in markets within our existing distribution network. Year-to-date, we have opened 10 stores and expect to open nine additional stores for a total of 19 store openings for fiscal 2009.

Our next two stores, by the way, will open on August 21st, one in Redondo Beach, Southern California and one in Las Vegas, Nevada. Going forward, we expect to close a number of poor performing stores whose leases are coming due.

Our fifth key initiative is to increase profitability in our new markets. We are in the final stages of completing our strategic analysis of our Texas market. Over the past several months, members of our management team and Board of Directors have conducted an extensive evaluation of our operations in Texas and explored various courses of action. We will be finalizing our direction and expect to announce our future plans in Texas shortly before the date of our annual shareholder meeting September 23rd, 2008.

As a reminder, in June we announced the authorization of our share repurchase program, which allows to repurchase up to $30 million of our stock on the open market.

We remain intensely focused on improving our profitability and are continuingly exploring new ways to do so.

With that, I would like to now turn the call over to Rob Kautz to review our first quarter financial results. Rob?

Robert Kautz

Thank you, Eric. As Eric mentioned, for the quarter ended June 28th, 2008, we generated a loss per share of $0.02 on a net loss of $1.5 million. This compares to earnings of $0.04 per share on net earnings of $3 million in the prior year. Please note that last year’s Q1 earnings included a one-time discrete tax benefit that contributed about $1.4 million, or $0.02 per share to earnings. And that quarter also included a significant benefit from higher margin Easter sales.

So, starting from the top, total sales for the first quarter were $304.9 million, representing an increase of 4.1% year-over-year with retail sales up 4.2% at $294.7 million. As Eric also mentioned, the Easter shift had a negative impact on our sales results as was expected. Last year Easter fell eight days into the first quarter whereas now Easter sales were included this year. Our same-store sales for the fourth quarter increased 0.5% versus the prior year basically in line with our expectation for a flat comp. Same-store sales growth strengthened through the first quarter and continues to strengthen at this time.

Despite the combined effect of strong headwinds from rising prices, the gross margin impact of the full Easter shift, and shrinkage and scrap increasing by 80 basis points, our gross margin only declined by 30 basis points to 38.3%. This was primarily due to the success of variable pricing, which Eric discussed, and a great job by our buying team.

As Eric mentioned, I will give an update on the main points of our shrinkage reduction plan, which I specifically outlined during our last conference call. First point, we have been promptly reporting our inventory levels at each store to identify suspicious buildups in inventory levels. This has empowered our operations team to hold field managers accountable and helped to us focus our investigative efforts.

Two, we continue to refine our use of the loss prevention exception reporting software system to reduce theft at the store cash registers.

Three, we had established criteria for centralizing decisions regarding excess and obsolete inventory in the stores, which was previously managed at a local district level. Over time, we expect to improve discipline in this area.

Four, we are increasing the number of store physical counts and will count all of our warehouses again at the end of the second quarter.

And number five, lastly, we have substantially completed the racking of our distribution center and are implementing exception reporting and data integrity improvements. These will lay the foundation for fully remediating our inventory control systems and moving to a perpetual inventory in our Commerce distribution center in the future.

So, I would like to emphasize that although our buyers were faced with rising cost and the negative Easter shift, we still improved overall merchandise margin by 30 basis points, which Eric discussed in more detail.

Our SG&A expense as a percentage of sales increased overall by 30 basis points to 39.0%. Store operating costs increased about 30 basis points due to store non-labor expenses. About half of these were one-time lease cost adjustments, half in utilities, and also in controllable expenses. The good news, as mentioned by Eric, is that labor productivity improvements more than offset increases in minimum wages.

I would also like to add to Eric’s comments regarding our distribution and transportation costs remaining flat at 6% year-over-year. This was primarily achieved by increasing our revenue per pallet due to the variable pricing and through more efficient distribution methods.

In corporate G&A, we had a 50 basis point increase to 4.6% of sales, primarily increases in information technology staffing and related expenses relative to first quarter last year. Other SG&A cost increased stock based compensation were offset this year by the consolidation of a gain on the sale of a perspective property. This gain is partially by our partner’s minority interest in the gain represented separately on our income statement with no material net effect on our EPS.

So, in conclusion, our Company ended the quarter with approximately $130 million in cash and marketable securities and virtually no debt.

I would like to now turn the call back over to you Eric.

Eric Schiffer

Thanks, Rob. Before we open up the call to take questions, I would like to discuss our outlook. We are certainly operating in a very challenging economy although we are pleased to see that we are attracting new customers in these difficult times. I would like to briefly highlight several significant accomplishments.

As Rob noted, we have seen continued strengthening of our same-store sales for the current quarter. Despite significant pressure from vendor price increases and comparing against the period last year, which included the benefit of higher margin Easter sales, our buying team improved product cost margins by 30 basis points, which underscores the success of our variable pricing initiative.

Our store operating team offset minimum wage increases through store labor productivity improvements. Our Distribution and transportation team held their cost flat as a percentage of sales in the face of significantly higher fuel prices, a minimum increase, and the disruption caused by the racking of our main Commerce distribution center.

We remain committed to reducing shrinkage for fiscal 2009. Our team is increasingly focused on execution accountability and improving our operating efficiencies across the board. We continue to believe that we can achieve our previously quantified long-term profit improvement plan initiatives to increase earnings before taxes, and we are continuing our current strategic planning process and will aggressively look for and implement additional ways to improve our short-term and long-term profitability, and ultimately maximize shareholder value.

Thank you for calling in and thank you for listening. Now, let’s turn to the Q&A. operator?

Question-and-Answer Session

Operator

Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session. (Operator instructions) Our first question comes from the line of Mike Baker - Deutsche Bank. Please go ahead.

Mike Baker – Deutsche Bank Securities

Thanks guys. So I am interested – you said that your multi-price point had no impact on your sales. You mean it had no negative impact on your units or was it just zero impact on sales at all units times price and so the benefit is really just on the margins and or the other initiatives that you talked about are really similar to the multi-price point initiative. Then my followup would be wondering why (inaudible) preclude you guys from buying back stock now. I know you have announced that you can do it. I don’t think you bought back any this quarter. So just want to get some color there. Thanks.

Eric Schiffer

Thanks, thanks Michael, it’s Eric. We were referring to the overall effect on sales for the items where we have taken the prices and instituted the variable pricing. Certain items – certain specific items may have had a drop in the sales but gross margin dollars improved on all of them and so we are very happy and satisfied with the program and one thing which we decided to ramp up towards the end of the first quarter was to get more aggressive on the variable pricing. It’s been a Company wide test so to speak on a number of items – on a lot of items, but we felt we can get more aggressive. And secondly, given the rise in food prices across the board, across all retailers as well as suppliers, the initial pricing on some of the items that we had taken there was more flexibility to go even higher on that than we initially had done. May be we were a little tentative. So we got more aggressive.

As far as other merchandising initiatives, prefer not to give them out before they are rolled out but they have to do with the front section of our store, putting higher margin items up there, higher margin, better impulse item versus what we traditionally did which was low margin six packs of soda and beverages and people will still buy those in our stores. This way they will walk into the store and perhaps pick up some other items as they go through the store. Merchandising has to do with our check stands as well as some other programs that we again we believe lead to higher sales of higher margin items that will help our average ticket and help our margins.

As far the – addressing the question about the stock buyback, the Company was in a closed window. We have a window that closes at the end of every month – a month before the end of every quarter. And the window opens up for our Company two business days afterwards. So the window would open at the beginning of next week.

Mike Baker – Deutsche Bank Securities

Okay, thank you.

Eric Schiffer

Sure. Thank you.

Operator

Thank you, sir. Our next question comes from the line of William Keller with FTN Midwest. Please go ahead.

William Keller – FTN Midwest Securities Corp.

Hi, good afternoon. Thank you. Just to make sure I understand the one-time gain on that sale is up in SG&A somewhere and then it’s offset almost entirely by the minority interest?

Robert Kautz

Yeah, that’s correct. Well we were – what I was trying to point out is you see the minority interest is a negative 1.4 million so that gain, that was a consolidated perspective so that is reflected and we put that in the other – other operating expenses and SG&A. so that’s a gain from the – for the sale of the single unit.

William Keller – FTN Midwest Securities Corp.

Okay, got you. Thank you.

Robert Kautz

There is no net effect here. It was a small gain that we reflected but no material effect.

William Keller – FTN Midwest Securities Corp.

Material. Okay, and then as far as your shrinking it’s good to see that improve sequentially. Is that 3.4% based on accruals and estimates or is that based more on some of the enhanced count in inventory management that you are using them?

Robert Kautz

Well, to be specific, we counted 73 stores since this issue arose and we are – we have done some extensive analysis to interpret that result and of course we are looking at the trends in our inventory balances for each store now, et cetera. So it’s a combined result of all the above.

William Keller – FTN Midwest Securities Corp.

Great. Thank you very much.

Eric Schiffer

Thank you.

Operator

Thank you, sir. Our next question comes from the line of John Zolidis with Buckingham Research. Please go ahead, sir.

John Zolidis – Buckingham Research

Hi good afternoon.

Eric Schiffer

Hi John.

John Zolidis – Buckingham Research

I have two separate questions. One, can you talk about what you think might be driving the acceleration in same-store sales into I guess July from the June quarter? That seems to be pretty much the opposite of what is being experienced by a number of the other discount retailers. And then my second question is one stores. You mentioned that you may be closing underperforming stores as their leases come up for renewal. I was curious how many stores, if any, do you have that are actually unprofitable at this time? Thank you.

Eric Schiffer

Now, this is Eric, I will address the first part in terms of the question that – the statement which we made in the release and I reiterated on the call about the strengthening of our comps into this current second quarter. We have received a tremendous amount of – I know we always talk about publicity our Company gets, but it’s just been phenomenal over the last two months towards – ramping up towards the end of June, just tremendous publicity on a national news network basis and local and in many of our markets we are in on TV and paper. And I don’t know what’s captured it. I mean obviously it’s the economy. There is also the fact that someone wrote a cook book about items for our stores called ‘The 99¢ Only Stores Cookbook,’ which that person has gotten tremendous national coverage on TV shows and I think with today’s economic times – I am speculating here – it’s just driving people to try our stores for the first time and we all know that may be some of us a little more insulated from it, the average consumer is just being squeezed so much and it’s just terrible out there. And they are looking for solutions on getting by. And I think when they are looking for solutions, I can't think of a store that provides a better solution than ours. And our traditional customer knows that and our toughest thing has always been to get people to come in. Historically, in many ways people – certain people didn’t have that concern and so they didn’t look for that solution. So may be that’s why they hadn’t gone into our store. But in today’s economy, I think people of all income levels are feeling very uncertain and they are looking for solutions. And I believe our store provides that. I think we are trying to readjust our marketing, our PR, and advertising strategies to take advantage of what could be a huge potential for our Company to grow our sales and grow them in a profitable way so that we are not just being cherry picked but having the right items that are merchandised out there. And – for example, we have a big push right now to bring people in for back-to-school and which never historically was a huge selling season for us. But I saw in USA Today they mentioned that 83% of consumers say they are going to spend less this back-to-school and many of them they are going to be going to the Dollar Stores to buy their back-to-school supplies. I never heard that before and was glad to hear it and we are – we have a big marketing push with direct mailers to customers as well as in our advertising and – as well as PR campaigns to take advantage of that. So, it’s not just taking advantage of items that have to do with food, a lot of basic household items. So that was the first question.

Your second question was on our stores. We have a number of – when I said as leases come due by the way, most of these leases, they have option extension periods. So we can choose whether or not to exercise the option, as you know. So, if we have a store that’s underperforming and I think that’s the term I used, and we decide to make sense to close it because we can pick the business up at a nearby store, or it’s just so underperforming it doesn’t make sense to keep open because as you know over the past couple of years, few years, we have opened up some stores that are pretty large, larger than we need. And in our new format going forward we are targeting 14 to 20 – 14,000 to 20,000 square feet and over the last several years as you know we opened up stores that were 25,000 to 35,000 square feet. So, that’s how we are looking at it. I hope that addresses it somewhat.

John Zolidis – Buckingham Research

Okay. Just a quick followup maybe to just get a clarification. If you don’t want to talk about the number of stores that might be losing money, how many stores are you considering closing in the current year?

Eric Schiffer

Well, I don’t know the exact amount off the top of my head and I think Rob and Jeff have a better idea, but it’s not a great deal. We have 275 stores and obviously it’s going to be well under a small percentage of that. But at this point we are not allowed to give guidance on those type of things but when you say – but for leases that are coming due, we will look at each one and give it a really fair analysis whether it makes sense or not, but there is a number, there is a number out there and the number with leases coming due that we will consider be poor performing is well under 10% for stores which have leases coming due that we would consider to be poor performing and it’s probably under 5%, I would say. And Jeff’s nodding his head.

John Zolidis – Buckingham Research

Okay. Well that’s great. I am glad to hear you guys are evaluating those closely and obviously that frees up working capital for other uses like share repurchase.

Eric Schiffer

Okay.

John Zolidis – Buckingham Research

Throw that idea in there. So thanks a lot.

Eric Schiffer

Thanks. Thank you.

Operator

Thank you sir. Our next question comes from the line of David Mann with Johnson Rice. Please go ahead.

David Mann – Johnson Rice & Company

Yes, thank you, good afternoon.

Eric Schiffer

Good afternoon.

David Mann – Johnson Rice & Company

My question was on produce. Given that in pretty much all of the store visits that I am able to do the employees and customers seem to really speak highly about the produce offering and the traction of it. So I guess after last year’s strong sales you had high spoilage rate. How are you positioning yourselves going into the seasonally strong produce periods versus what you did last year? And may be you can specifically talk about where you are in terms of cooler rollout, the procedures, and what kind of in-stock issues you are having given the produce inflation.

Eric Schiffer

Yeah, that’s – thank you, thank you. Yes, we have – we carry, as you know, a – our biggest selection of produce that we carry are in the summer months and that was true for last year and is true for this year. For example, we are selling a pound and a half of peaches for $0.99, a pound and a half of nectarines, a pound and a half of plums, and lots of great items. Varies – many of these items are very sensitive and that resulted last year in a very large scrap of produce items as we aggressively bought into it. The changes that have occurred that we believe will benefit us versus what happened last year in terms of the scrapping of produce as a percentage of our sales – of our produce sales that is, are several significant changes. First of all, our buying team is much more careful than last year. We have learned a lot by looking at the rate of sales and the rate of scrapping of items that are more sensitive than others. And they are also closely, more closely working with our allocation and store operations team. If they see an issue – they are buying produce everyday. So they can quickly change how they buy and quickly can back off.

Our receiving that gets done here at our distribution centers, when they receive the produce, they are much more aggressive and having given carte blanche to reject any load or any pallet that they determine as being questionable. Our vendors realize this and they understand that and I think that is something that is a 180 degree change from a year ago. And in fact we have had our receiving crew on the back when they reject loads on produce. We want them to be careful. The way the product is handles internally at our distribution centers, which is – which are refrigerated and I don’t think there was that much of an issue last year on that and I think we have gotten even better on that. I think we have improved on the distribution, the transportation, and the handling of it to get it to the stores on refrigerated trucks, and on getting it from the truck inside the box, inside the store quickly, not leaving it outside, or leaving it sitting on the dock, things that can lead to problems. And that’s been through education and training at our store level. So we have improved on the handling at our store level through better training and better raising the profile of how important this issue is including tying the manager’s bonus at store level to – more to shrink and to scrap so that they are much more aware of that.

Finally, in terms of fixtures, we had last year – last year about this time one-third of our stores had what we were referring to as standalone produce fixtures, produce coolers. These are standalone on the sales floor that really helped to reduce not only the spoilage rate, they also helped to promote the sale of the items, to give it a much better appearance. At this point it’s essentially rolled out almost every store except for some stores in our Texas market. But every store outside of Texas, and many of the Texas stores have this. So we have gone from probably about 30% in all the stores to probably about 90%. And that’s a tremendous, tremendous difference.

We also instituted one other additional thing, which is as we are shifting our – the refrigerated items, produce and – as well as deli items so to speak to the stores, we have been tracking the temperature. We have installed sophisticated temperature gauges that can tell us not just what the temperature is when you open the door when it arrives but – one thing that can happen we realized in a six-hour, eight-hour, ten-hour trip, the trucker, to save money on fuel cost, can raise the level of the temperature inside and then an hour outside of the store they can lower it again. So when it arrives there it seems fine, but what that does it reduces the shelf life of the item and it sound insidious and but it does happen. And so we now monitor the temperature of the entire ride and we can tell when there are blips such as the door opening and so on, and that’s been something new that really helps to keep everybody honest.

David Mann – Johnson Rice & Company

Okay.

Eric Schiffer

I think that’s enough for the different measures. But we are feeling that we have done a lot in that particular area and obviously that was an issue that came out on our conference call I think it was November of last year for our September quarter. Thank you.

David Mann – Johnson Rice & Company

And Eric, can you just clarify in terms of the ability to be in stock given product inflation and also is the assortment kind of be basically the same as last year?

Eric Schiffer

On produce, you are referring to, David?

David Mann – Johnson Rice & Company

On – just on produce, yeah.

Eric Schiffer

Yeah, I don’t know if we are going to be carrying as many items as we carried last year. In fact we have encouraged the buyers for items that are sensitive to not carry them. Some berries, for example, are very tricky, and some other items. So, we may have actually less SKUs but I think we will do a better job of keeping in stock the SKUs that we carry because we made – I guess I didn’t mention this, but we made major changes in our allocation procedures. We have an allocation algorithm that we use to decide how to replenish stores and we do it centrally. And there has been a significant number of changes in that and that will allow us to keep items in stock better but not sending too many items.

David Mann – Johnson Rice & Company

Okay, great. If I could follow up with a question about the average ticket in the quarter. I guess that went down a little –

Eric Schiffer

That’s follow-ups.

David Mann – Johnson Rice & Company

Okay. Well those were clarifications. In terms of the ticket going down a little bit in the quarter, is there anything you are doing to address that and has it perhaps picked up a little bit as comps have accelerated?

Eric Schiffer

Well I think as we have seen rising prices, we have lost some items and I think it was mentioned in the last quarter call in that first quarter and may be this – you were trying to get to this, but we – one item has been difficult to keep in stock for the last several months has been bananas where prices have gone through the roof and we sell a bag of bananas, not just – we don’t sell them by the pound, so we sell a whole bag, and we have been unable to get that. And we are in the process of getting that in place and I believe as of next weeks we will be back in stock on a full basis for a large bag of bananas. But that was an item – that is a huge item for us, as people know, and that could have an impact. Also being able to keep eggs as well. The prices for eggs went very high and so we weren’t carrying dozen of eggs, we were selling a six pack of eggs, which was good value, but it wasn’t as impressive and the customers obviously liked buying a dozen better. We have a dozen back in stock now. Those prices have come down a little bit. So, there was some impact from missing some key items that we have back in stock now.

David Mann – Johnson Rice & Company

Thank you.

Operator

Thank you, sir. Our next question comes from the line of Patrick McKeever with MKM Partners. Please go ahead.

Patrick McKeever – MKM Partners

Okay thanks. A question on Texas, Eric, if you could maybe give I don’t know, a little color on Texas, and how the Texas stores performed during the quarter and that sort of thing. Usually, you give some color in the release or on the call. And then secondly, could you just tell us what the options are that you are considering for your Texas operation? Thanks.

Eric Schiffer

Well, you saw in the release that we are going to make an announcement but I won't – I will go into a little bit more detail than we went to in the release but we don’t typically break out our different markets. But you are right. In Texas, because of the high profile we have historically at times broke out sales. For the first quarter, Texas comps were I think basically in line, may have been a little bit better in the first quarter than the overall average for the Company. We did do a promotion in Texas that helped. The people worked very hard on. It was our five-year anniversary in Texas in June’08 and so there was an anniversary sale with some promotion. And we are looking at – I guess how to say on the options and we have a great team down there and they are working very hard to do their best down there. And we fully support them. But obviously it’s no secret that we have struggled in Texas. Obviously it’s no secret at all. And it’s – we have been there five years now. So, as we said in the – as we said a few months ago that we are not ruling out any options, but we are looking and doing our – doing what is a very extensive and rigorous analysis of the whole Texas and our Texas operations. And we are close to finalizing it and as we said – but I would say the options, to give you a little more color, I would say the options range from closing unprofitable stores while focusing on improving the entire operation down there and looking at improving distribution and other key operating parts of the business down there all the way – they run the gamut from that all the way to a complete withdrawal. Those are things that are on the table that we are looking at. So we will make an announcement prior to our shareholder meeting, which is September 23rd. That’s when we expect to be able to do. To make an announcement prior to that obviously we need to send a release out.

Patrick McKeever – MKM Partners

Okay.

Eric Schiffer

Alright.

Patrick McKeever – MKM Partners

Thank you. Thanks.

Eric Schiffer

Sure.

Operator

Thank you, sir. Our next question comes from the line of Victor Hawley with RCB Investment Management. Please go ahead.

Victor Hawley – RCB Investment Management

Hi guys. Since you are no longer truly a 99 Cents Only Store, what thought is there in going above a dollar you know maybe a special section where you don’t find yourself out of bananas or out of a dozen eggs if your customers have come in to know and expect from you over the years that maybe it’s a $1 [ph] maybe it’s a $1.29 but something where you can roll it off and say we need to carry this product to maintain our core customers.

Eric Schiffer

Yeah, I think that that’s a very significant point and a great question. And when you are part of a family that comes up with a concept sometimes you are the last to admit that it needs to be changed. And we have had a lot of talks about it in the senior executives here as well as other people. We have looked at it very long and hard and it’s been the main topic of our – when we had our strategic planning retreat with our Board and the senior executives to look at that, thinking long term. And it is no question with commodity prices and fuel prices and costs and minimum wage, these – certainly minimum wage increases aren’t going to go away and they are going to continue and certainly there is going to be increases on many of these other factors. We have always said that – and if you talk to our customers, our core customers, they say they love our stores. Some people call our stores a blessing for the community and the reason why is not just it is a dollar store because as you know there is a ton of dollar stores out there. You go in any neighborhood, any cities, you have a ton of dollar stores, and believe me they are not blessings for their community, far from it. It’s because everything we sell, we are fanatics to make sure they are good to great value. And so that doesn’t mean, as you noted, you couldn’t still sell a gallon of milk if you have good to great value, but it would have to be over $0.99 or bananas or other things. So to get to what you are going is that that’s definitely on the table, that subject. That’s something we are looking at over the course of the next – in the future for us. We are looking at doing some experiments. I know there is other dollar stores that already have started those experiments and that’s something that we will be looking at. There is different ways to approach it. And so we definitely had a strong feeling initially on certain ways of approaching. Obviously one way you could start selling things $1.05, $1.09, $1.15, in other ways you could have more of a break between your $0.99 price point and the next price point. And so we definitely have a lot of thoughts on it and the way we would go about doing it, when you have a lot of stores you can try things in a store, or a few stores. So, we would do that.

As far as the name, you are right, it does say 99 Cents Only, but there is Motel 6. So they – I don’t know when the last time someone rented a motel room for $6 from them. But it’s got to be a long time from – some time ago. But I think the main thing is that from I guess – from an investor – from wanting to hear is that we are open to it. We are going to be trying things and it’s with a way that the cost structure has – the way the cost structures are for our Company and for just the economy and the environment. There is no question we are going to need to do something. And we will do it and we will maintain that great value so our customers continue to refer to us as a blessing for the community.

Victor Hawley – RCB Investment Management

Good to hear, thanks.

Eric Schiffer

Thank you.

Operator

Thank you, sir. Our next question comes from the line of Mailey Clarke [ph] with MFS Investment Management. Please go ahead.

Mailey Clarke – MFS Investment Management

My question has been answered. Thank you very much.

Eric Schiffer

Okay. My favorite kind of question.

Operator

Thank you, ma’am. Our next question comes from the line of Meredith Adler with Lehman Brothers. Please go ahead.

Meredith Adler – Lehman Brothers

Thanks for taking the question. I was wondering obviously you don’t have tons of data on who your customers are, but could you have any sense I mean we hear anecdotally that a lot of Mexicans have been going back to Mexico. And if that’s true, presumably you would be – maybe – you always had a lot of Mexican customers, every day attracting new customers. And then just a question about whether if you do believe your mix of customers is changing do you need to change your assortment in some way?

Eric Schiffer

Thank you. To the first part, we wouldn’t – I wouldn’t know how to answer that, but it’s – we haven’t seen it. As we said before our – we have seen some continuing strengths in our comp sales as we noted in our release. And we do have a lot of Latino customers although I am not sure from any country I guess south of the border or from Spain, may be, I don’t know. But basically I just heard the other day – actually I heard it yesterday that LA County or LA City is – the minority is now the majority. I think it was on the news yesterday. Driving in they said for the first time minorities are now the majority in LA. And in Orange County minorities are now the majority. And so that’s clear what I am saying, but –

Meredith Adler – Lehman Brothers

Yes.

Eric Schiffer

So, I don’t know. But as far as that. As far as New York goes may be that’s happening out there you guys are – so the second part of your question was – can you remind me?

Meredith Adler – Lehman Brothers

It’s kind of related but maybe I will reword [ph] the question that – at what point do you start to think about assortment being more targeted to individual stores. Is that beyond your technological abilities? I know you talked about allocation getting better, but would you actually make the assortment vastly different between stores and either customers or–?

Eric Schiffer

I think that is a very good question, Meredith, and I think that especially in these economic times as we are trying to market and gear a PR campaign to try to get those middle income customers that maybe haven’t come and maybe upscale customers that haven’t come to our store before. But now they got a lot of cost concerns about their long-term economic viability and they may be coming for the first time. I think we are actively thinking about how do we merchandise for those areas. First is areas which maybe are close to the border and based upon the three-mile radius they are always going to have a low income group of – low – a strong majority of low income customers at the store. So we are looking at – I don’t so much particular items but we are – but we do have the ability to – we do give the store management the ability to order their items that they can certainly gear. If you are on the border, you can order more Latino products. If you are in a Jewish area you can order more Jewish items that we will carry. But there are merchandising things we are thinking about trying and that could be very exciting. One thing, for example, could be a club section, selling items by the case. And that’s something that if we have stores in a suburban area, people who used to go to – used to go into Costco or shopping in the aisle at the supermarket, they don’t want to buy one four pack of toilet paper. They want to buy a whole case. They want to buy whole cases of paper towels. Given the size of our stores (inaudible) 5000, 6000 square foot boxes, we have the ability to create the section and that would be an example of a merchandising strategy that we would test and try and see if that would work out. I mean and that would be an example of what you are talking about that we could do.

Meredith Adler – Lehman Brothers

Okay. And you – and how much technology – do you have the right technology to do some of these things or is that something you need to add?

Eric Schiffer

Well, we have, again, the ability for the stores to see all the items and to make the decision about what they want or order. As far – and we have the ability to decide to allocate certain items to certain stores and allocate based on scanned sales. Just a question of wanting to develop that. If we think the potential is there to develop certain techniques to do in a more refined way. So, I think we do have the technology to be able to at lease attack it on an initial level. As we get more sophisticated on our planning and allocations and I think that is the department right now, allocation, that reports into Jeff, who is here in the room. As we continue to push on that and develop it I imagine we’ll improve on our abilities there. And I think the IT department, which reports into Rob, who is the other person in the room with me, is making a tremendous number of changes and has done a great job of reorganizing the effort in IT and I think they are making a lot of tremendous progress.

Meredith Adler – Lehman Brothers

Great. Thank you very much.

Eric Schiffer

Okay. I will say that both presidential candidates, I understand, support immigration reform, if that helps you.

Operator

Thank you, ma’am. Our next question comes from the line of Joan Storms with Wedbush Morgan. Please go ahead.

Joan Storms – Wedbush Morgan Securities

Hi, good afternoon guys.

Eric Schiffer

Hi.

Robert Kautz

Hey, Joan.

Joan Storms – Wedbush Morgan Securities

Couple of questions. On the re-racking in the DC, in the LA DC, can you be – just name a couple benefits that you get from that and does that increase your capacity and your less reliance upon some of the outside buildings in the area. And then also are you still working on – related to the DC, are you still working on that network analysis where there may be the potential that you design a sort of smaller, and more efficient DC for some of the outer lying region?

Eric Schiffer

Hey, Joan, thanks, this is Eric. I will now turn it over to Jeff who has distribution and transportation reports through him. Go ahead, Jeff.

Jeff Gold

Sure. Good afternoon. First on the racking on our main Commerce DC, it will provide several benefits. There will be a minor increase in our capacity in our DC particularly in the number of pick slots, in the number of items that we can carry in the DC will be somewhat enhanced. Overall capacity a slight increase, just a few percentage, a few percentage increase in capacity in our main DC. The real benefits that we get are the ability to track inventory better by specific item, by specific location, and to improve the productivity of our picking in our distribution – the order picking in our DC. It will allow great – reduce the congestion in our DC by having traffic aisles that will be single purpose. Our order picking will be in one set of aisles and the replenishment will be in a different set of aisles behind it so that you – so you don’t have the congestion. Additionally, the capacity in the picking locations will be increased. So more items will – more backup stock will be immediately available in each of the picking locations, which will allow the order pickers to be picking a greater portion of the time so that they are not looking for items or walking to bin locations or driving to bin location to have them be out of stock. The bins will be in stock a higher percentage of the time when the order picker gets there the first time. So we should expect to see order picking productivity as a significant improvement.

In terms of the impact of the racking to the overall distribution center and network the little bit of capacity increase will not make a significant impact to the – and allow us necessarily to exit distribution center. What will allow us to exit DCs will be our – and will be the – when we are ready to take – when we finished taking a look at our overall network and we are in the process of doing that. We will finish it later this calendar year and have our – we should have our plan finalized of a specific direction of where we are going, whether it’s to open a full line distribution center in northern California with a combination of some satellite DCS in different – in different states for all or a portion of our product mix so that we can really save the overall transportation aisles that were shipping our products. And we will have more information on that towards the end of this calendar year. We are excited about that as we continue to believe there is substantial potential for long-term, but as we mentioned in the profit improvement plan that we announced a few months ago, we are not prepared at this time to quantify the benefits and definitely not prepared to talk to the investment public about what magnitude of benefits we believe there are. But we believe they are significant and we’ll know more and we’ll keep you posted as we are – as we have those numbers fine tuned a little bit more.

Joan Storms – Wedbush Morgan Securities

Okay, thanks. And then have you – Eric, have you sort of thought a little bit more about as you are evaluating Texas, maybe how many more existing stores you can have in your existing markets at this point in time?

Eric Schiffer

In the – in which existing market, I am sorry.

Joan Storms – Wedbush Morgan Securities

Northern and southern California, Arizona, Vegas.

Eric Schiffer

Oh, well, believe with the smaller format that we have been opening stores it’s a little bit easier to get locations than when you historically we were looking for these 25,000-30,000 square foot boxes. And I will turn it over to Jeff in terms of the potential for our stores in terms of number of stores in the three states that Joan mentioned. This year we do plan on opening total of 19 stores, as we said in the release. And of the 19 stores, I think just California, not counting Nevada and Arizona, California represents about 70$ of those locations and – but Jeff, do you want to just talk, going forward?

Jeff Gold

Yeah, just in real broad terms, we expect to continue to – continue to grow modestly in our existing markets for the next few years without having to be forced to stretch outside of this market. So we are not going to come to you next year and say we can't add any more stores in our core markets. We have room to grow and we are not at our saturation point. We can definitely add strong performing location over the next several years.

Joan Storms – Wedbush Morgan Securities

Okay. Thank you. That was very helpful.

Eric Schiffer

Thank you.

Operator

Thank you, ma’am. And we have one more question from the line of Karen Short from Friedman, Billings, Ramsey. Please go ahead.

Karen Short – Friedman, Billings, Ramsey & Co.

Hi, thanks for taking my question. I had two questions. One, I was wondering if you would be willing to quantify the cost in the quarter for the re-racking in the DC. Do you have a dollar amount associated with that?

Eric Schiffer

Jeff or Rob?

Jeff Gold

I know the number, I –

Eric Schiffer

Jeff will turn it over to Rob.

Robert Kautz

It’s not (inaudible)

Karen Short – Friedman, Billings, Ramsey & Co.

Well you guys –

Eric Schiffer

Well go ahead. Go ahead.

Karen Short – Friedman, Billings, Ramsey & Co.

Well, I have another question. I was just checking it. Seems that switching inventory while you are looking at the number, it looks like inventory (inaudible) was down about 18% this quarter which is an improvement obviously versus – well I think it was down 13% in the fourth quarter. Can you just maybe elaborate on what’s driving that?

Eric Schiffer

Well, this is Eric. You are looking year-over-year, right?

Karen Short – Friedman, Billings, Ramsey & Co.

Yeah.

Eric Schiffer

What – one of the things that happened last year in the summer is our inventory grew and – for a number of reasons I won't get into but the buyers have done a tremendous job this year of controlling inventory while still keeping our items in stock but not keeping them in stock by over-ordering and doing a much better job of getting them here when they need to be. And inventory management I think has been a great accomplishment over the last I would say six months or so, six to nine months that I think the buyers have done tremendous job versus if you want to compare it to the first and second quarter or last year, which is what you are referring to. So even though we have growing the number of stores, we have done a very good job of managing the inventory there without materially affecting our in stock level.

Karen Short – Friedman, Billings, Ramsey & Co.

Okay. And then I just was wondering do you have a sense of what – how many SKUs right now you have with variable pricing and where you can – that can go to? I don’t know if you have said that, I think I may have missed it.

Eric Schiffer

It’s a little tricky because you know if we have candy bars – I look at it more like categories or juices. There could be hundreds of SKUs in the candy bar that is now selling at $0.39 instead of three per $0.99, for example. But we do feel that the – if I look at all the SKUs and categories that have it, there is a material positive impact on our gross margin and gross margin dollars. I think as I said earlier that we kind of realized that we can get much more aggressive on this towards the end of the first quarter in June, late June and so there has been some significant changes since late June which because of the increases in pricing and commodities they provided s a store (inaudible) a significant perceived value to the consumer. So I think this a something probably we feel comfortable talking about the impact of that on our next conference call, and hopefully we have some very good things to say about it.

Karen Short – Friedman, Billings, Ramsey & Co.

Okay, and did you get us some sort of cost for the re-racking in the quarter?

Eric Schiffer

I will let Rob answer that question.

Robert Kautz

Are you talking about the investment in the racking project itself, Karen, you are talking about expenses incurred during the quarter –

Karen Short – Friedman, Billings, Ramsey & Co.

Well I am trying to have expenses incurred during the quarter given that that’s – we are not done with those expenses

Robert Kautz

I think it was a – there is a fair amount of disruption that was offset – we were able to quantify the amount of labor specifically moving the goods around which was – that was really not material. The quantifying the disruption of the whole process and how much of that we would have saved through productivity improvements we really can't. We don’t really have a way to quantify that.

Karen Short – Friedman, Billings, Ramsey & Co.

Okay.

Robert Kautz

Obviously it was there.

Karen Short – Friedman, Billings, Ramsey & Co.

Right. Okay. Thanks a lot.

Eric Schiffer

Sure. Thank you.

Operator

Thank you, ma’am. And I would now like to turn the conference back to Mr. Eric Schiffer for any closing remarks. Please go ahead.

Eric Schiffer

Okay. Thank you very much. I want to thank everyone for calling in today and for your continued interest. As we stated in the release, our annual shareholder meeting will be on Tuesday, September 23rd same spot as usual in the City of Commerce. We look forward to seeing some of you then and speaking with you three. Thank you again and have a good afternoon and thanks for calling in.

Operator

Thank you, sir. Ladies and gentlemen, this concludes the 99 Cents Only Stores first quarter fiscal 2009 earnings conference call. If you would like to listen to a replay of today’s conference please dial 303-590-3030 or 1-800-406-7325 and answer passcode 3904455. Once again, if would like to listen to a replay of today’s conference, please dial 303-590-3030 or 1-800-406-7325 entering passcode 3904455. Thank you for your participation. You may now disconnect. Have a pleasant day.

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Source: 99 Cents Only Stores F1Q09 (Qtr End 06/28/08) Earnings Call Transcript
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