| COST U LESS INC Item 1A Risk Factors You should carefully consider the following factors that may affect future results and other information included in this annual report |
| The risks and uncertainties described below are not the only ones we face |
| Additional risks and uncertainties not presently known to us or that are currently deemed immaterial also may impair our business operations or could cause actual results to differ from historical results or those anticipated |
| If any of the following risks actually occur, our business, financial condition and operating results could be materially adversely affected |
| Because we have a small store base, adverse store performance or increased expenses will have a more significant adverse impact on our operating and financial results than if we had a larger store base |
| We opened our first store in 1989 and opened a total of 21 stores through December 2005 and presently operate eleven stores |
| Our closure of the ten other stores prior to March 2001 adversely affected our operating results |
| Should any existing store experience a significant decline in profitability or any new store be unprofitable, the negative effect on our business would be more significant than would be the case if we had a larger store base, and could have a material adverse effect on our business, financial condition and results of operations |
| In addition, if our general and administrative expenses increase, the negative effect on our business and results of operations would be more significant than if we had a larger store base |
| Although we intend to carefully plan for the implementation of additional stores, there can be no assurance that such plans can be executed as envisioned or that the implementation of those plans will not have a material adverse effect on our business, financial condition and results of operations |
| In addition, our ability to acquire products at a lower cost than competitors or obtain volume-based pricing can be adversely affected because of our small store base |
| Our ability to operate profitably in existing markets and to expand into new markets may be adversely affected by competing warehouse clubs or discount retailers |
| The warehouse club and discount retail businesses are highly competitive |
| If we fail to successfully respond to competitive pressures in this industry, or to effectively implement our strategies to respond to these pressures, our operating results may be negatively affected |
| Many of our competitors have substantially greater resources, buying power and name recognition than we have |
| The cost of doing business in island markets is typically higher than on the US mainland because of ocean freight and duty costs and higher facility costs |
| In addition, our gross margin and operating income are generally lower for stores in markets where traditional warehouse clubs and discount retailers also operate stores, due to increased price competition and reduced market share |
| We may be required to implement price reductions and other actions in order to remain competitive in our markets |
| For example, there is an indication that Costco may open a new store in Kauai in 2006, which would likely cause our gross margin and operating income for our Kauai store to be lower in fiscal 2006 due to the increased competition and reduced market share and the actions we may be required to take to remain competitive in Kauai |
| Furthermore, our ability to expand into and operate profitably in new markets may be adversely affected by the existence or entry of competing warehouse clubs or discount retailers |
| These factors could result in reduced sales and margins or loss of market share, any of which could negatively affect our results of operations |
| One or more of our stores may be damaged or destroyed by volatile weather conditions or natural disasters, which would severely harm our business and financial results |
| Our stores are primarily located on islands subject to volatile weather conditions and natural disasters, such as tsunamis, hurricanes, floods, typhoons and earthquakes |
| 10 _________________________________________________________________ If the islands on which any of our stores is located experienced any of these or other severe weather conditions or natural disasters, one or more of our stores could be damaged significantly or destroyed |
| For example, on December 8, 2002, our two stores on the island of Guam suffered damage from Supertyphoon Pongsona, resulting in the immediate closure of both stores |
| Our Tamuning store lost its generator in the storm and our Dededo store had to be closed for reconstruction |
| Additionally, we have four stores in the Caribbean, which has experienced increased activity from hurricanes and tropical storms in the past few years |
| The damage or destruction of one or more of our stores would materially harm our business, operating results and financial condition |
| We could also experience business interruptions, delays in shipping, delays in construction or loss of life as a result of severe weather conditions, any of which could materially affect our business |
| If we were to experience a catastrophic loss as a result of severe weather conditions or otherwise, we may exceed our insurance policy limits and we may have difficulty obtaining similar insurance coverage in the future |
| We maintain property, casualty and business interruption insurance coverage in amounts we consider customary in our industry for these types of events |
| However, insurance payments generally do not fully reimburse us for all of the damages and lost profits caused by adverse weather events |
| If any insurance reimbursement we receive does not fully cover the losses and business interruption caused by severe weather events or natural disasters, or if our insurance coverage is not adequate to cover such losses or we exceed our insurance policy limits, we may be required to pay substantial amounts and our financial condition and liquidity would suffer |
| Additionally, we utilize a combination of insurance policies and self-insurance mechanisms to provide for the potential liabilities for property insurance, general liability, director and officers’ liability, workers’ compensation and employee health care insurance |
| The costs related to obtaining our current insurance coverage have been increasing |
| If the costs of maintaining this insurance coverage continue to increase significantly, we would experience an associated increase in our store and administrative expenses that may negatively impact our results of operations |
| In addition, there is no assurance as to how casualty insurance carriers may react to increasing weather related damages in areas where are stores are located |
| If we are unable to maintain our current or similar insurance coverage, or if an event were to occur that was not covered by our current insurance policy coverage levels (including acts of terrorism, war and actions such as government nationalizations), our business and results of operations could suffer |
| If energy costs and fuel surcharges continue to rise, the profitability of our stores may decline and our business and financial condition could suffer |
| We have experienced increasing energy and fuel surcharge costs over the last few years and have largely been able to pass these additional costs on to our customers with higher prices |
| For example, in fiscal 2005 our energy (utility) expenses were 17prca higher than the same period in fiscal 2004 |
| If these costs continue to rise, we may not be able to continue the practice of passing on these additional costs to our customers |
| Our inability to effectively pass on these costs to our customer could have a significant adverse effect on our business, results of operations and financial condition |
| If we fail to effectively manage the logistical and local operating challenges we face because our business primarily consists of island and international operations, our business and results of operations would suffer |
| Our net sales from island operations represented approximately 94dtta5prca of our total net sales for fiscal 2005 |
| We expect that our island and international operations together will continue to account for nearly all of our total net sales |
| The distance, as well as the time-zone differences, involved with island locations impose significant challenges to our ability to manage our operations |
| Logistical challenges are presented by operating individual store units in remote locations, whether in terms of information flow or transportation of goods |
| In addition, island operations involve uncertainties arising from items such as: • Changes in local labor markets, including unionization and inadequate labor pools; • Local business practices, language and cultural considerations, including the capacity or willingness of local business and government officials to provide necessary services; • Ability to acquire, install and maintain modern capabilities such as dependable and affordable electricity, telephone, computer, Internet and satellite connections often in undeveloped regions; • Political, military and trade tensions; • Currency exchange rate fluctuations and repatriation restrictions; • Local economic conditions; • Difficulty enforcing agreements or protecting intellectual property; • Collection of debts and other obligations in foreign countries; and 11 _________________________________________________________________ • Volatile island operating expenses, including utilities |
| Our inability to effectively manage these logistical challenges and local uncertainties inherent in our island and international operations could have a significant adverse effect on our business, results of operations and financial condition |
| We do not have operating experience in many of the markets in which we may consider opening new stores |
| If we are unable to adapt our operations to support any future expansion plans or if any new stores we open are not profitable, our business and financial condition could suffer |
| We have not opened stores in foreign island markets at a rapid pace |
| Although we have no plans to open stores in new markets during 2006, we continue to explore expansion opportunities in selected markets and additional relocation opportunities for stores in existing markets |
| Croix store into a newly constructed building on a parcel of land located closer to the main trade area in the center of the island than our former store and in July 2005 the Cayman Islands Trade and Business Licensing Board granted approval for us to operate a retail and wholesale business in the Cayman Islands through a controlled subsidiary |
| New markets such as the Cayman Islands and others we may enter may present operational, competitive, regulatory and merchandising challenges that are different from those we currently encounter |
| We do not have operating experience in many of the markets in which we may consider opening new stores |
| In fact, in June 2000, we closed the two stores that we had opened in New Zealand in 1999, as they had performed below expectations, due in part to competitive and merchandising challenges that are different from our other stores |
| Additionally, in February 2001, we closed one of our two Fiji stores, due primarily to the impact that political turmoil and the resulting economic downturn in Fiji were having on the tourist industry |
| We have encountered, and may continue to encounter, substantial delays, increased expenses or loss of potential store sites due to the complexities, cultural differences, and local political issues associated with the regulatory and permitting processes in the island markets in which we may locate our stores |
| There can be no assurance that we will be able to adapt our operations to support our future expansion plans or that any new stores will be profitable |
| Any failure on our part to manage our growth could have a material adverse effect on our business, financial condition and results of operations |
| A decline in the general economic condition in the United States or in island markets in which we operate could have a significant impact on our financial performance |
| The success of our operations depends to a significant extent on a number of factors relating to discretionary consumer spending, including employment rates, business conditions, interest rates, inflation, population and gross domestic product levels in each of our island markets, taxation, consumer spending patterns and customer preferences |
| We cannot fully foresee the changes in business and economic conditions that may result from domestic or foreign factors |
| There can be no assurance that consumer spending in our markets will not be adversely affected by these factors, thereby affecting our growth, net sales and profitability |
| A downturn in tourism or a decline in the national or regional economies of the United States and the US Territories or any foreign countries in which we currently or will operate, could have a material adverse effect on our business, financial condition and results of operations |
| A prolonged decrease in tourism and air travel could have an indirect but significant impact on our financial performance, operations and liquidity |
| Because our operations are primarily located in US Territories and foreign island countries throughout the Pacific and Caribbean, the success of our operations depends to a significant extent on tourism and the travel industry |
| Prolonged adverse occurrences affecting tourism or air travel, particularly to non-US destinations, including political instability, armed hostilities, terrorism, weather conditions, or other activity that involves or affects air travel or the tourism industry generally, could have an indirect but adverse and significant impact on our financial performance, operations, liquidity or capital resources |
| The loss of key personnel or our inability to successfully hire skilled store managers could harm our business and results of operations |
| Our success depends in large part on the abilities and continued service of our executive officers and other key employees |
| Additionally, we rely significantly on the skill and expertise of our on-site store managers, particularly in island markets where language, education and cultural factors may impose additional challenges |
| We do not carry key-man life insurance on any of our personnel |
| There can be no assurance that we will be able to hire, train and retain skilled managers and personnel to support our existing business and any growth, or that we will be able to retain the services of our executive officers and other key employees, the loss of any of whom could have a material adverse effect on our business, financial condition and results of operations |
| If our information systems are disrupted or outgrown, our business and results of operations could suffer |
| Our business is highly dependent on communications and information systems, primarily systems provided by third- 12 _________________________________________________________________ party vendors |
| Any failure or interruption of our systems or systems provided by third-party vendors could cause delays or other problems in our operations, which could have a material adverse effect on our business, financial condition and results of operations |
| In addition, our point of sale information and transaction processing system may not be adequate for our business if we experience rapid expansion in the number of our stores |
| If our point of sale system is outgrown, we would need to develop and install a new point of sale system in our stores, which could be expensive and time consuming and could cause our results of operations to suffer |
| If our store employees decided to become unionized, we may experience increased operating costs or other operation problems |
| None of our employees are currently covered by a collective bargaining agreement |
| However, several of our hourly employees in our St |
| Maarten store have joined the local union |
| Unionization of any of our stores could result in higher employee compensation and restrictive working condition demands that could increase our operating costs and have a material adverse effect on our business, financial condition and results of operations |
| We are subject to various governmental regulations and licensing requirements, which may have an adverse effect on our business |
| Governmental regulations and licensing requirements in foreign countries where we plan to expand our operations might prevent or delay entry into the market or prevent or delay the introduction, or require modification, of certain of our operations |
| For example, in July 2005 the Cayman Islands Trade and Business Licensing Board granted approval for us to operate a retail and wholesale business in the Cayman Islands through a controlled subsidiary |
| However, this is the first in a series of steps that we must take before we can open a store operating under the Cost-U-Less name in the Cayman Islands and we expect that it could take at least twelve to eighteen months once the permitting, governmental approval and lease process is complete |
| Additionally, our ability to compete may be adversely affected by foreign governmental regulations and licensing requirements that encourage or mandate the employment of citizens of, or purchase of supplies from vendors, in a particular jurisdiction |
| We may also be subject to taxation in these foreign jurisdictions, and the final determination of our tax liabilities may involve the interpretation of the statutes and requirements of the various domestic and foreign taxing authorities |
| We may also be subject to currency repatriation restrictions |
| If governmental regulations or licensing requirements prevent or delay our entry into market, require modification of our existing operations, or subject us to taxation or currency repatriation issues, our business, financial condition and results of operations could suffer |
| If we are unable to overcome challenges resulting from the isolation of store operations from our corporate management and our increased dependence on local managers, we may experience decreased productivity or other operational problems |
| Our headquarters and administrative offices are located in Washington State; however, ten of our eleven stores and a majority of our employees are located on islands |
| Although we invest resources to hire and train our on-site managers, the inability of our executives to be physically present at our current and planned store sites on a regular basis may result in the following: • Isolation of store operations from corporate management and an increased dependence on store managers; • Diminished ability to oversee employees, which may lead to decreased productivity or other operational problems; • Construction delays or difficulties caused by inadequate supervision of the construction process; and • Communication challenges |
| We may need to invest significant resources to update and expand our communications systems and information networks and to devote a substantial amount of time, effort and expense to national and international travel in order to overcome these challenges; failure to do so could have a material adverse effect on our business, financial condition and results of operations |
| We may encounter disruption in the transportation of our products, which would significantly harm our business |
| Our island locales require the transportation of products over great distances on water, which results in the following: • Substantial lags between the procurement and delivery of product, thus complicating merchandising and inventory control methods; • Possible loss of product due to potential damage to, or destruction of, ships or containers delivering our goods; • Tariff, customs and shipping regulation issues; • Substantial ocean freight and duty costs; 13 _________________________________________________________________ • Port and container security issues; and • Interruption in the delivery of product due to labor disruption or weather related issues |
| Moreover, only a limited number of transportation companies service our regions, none of which has entered into a long-term contract with us |
| The inability or failure of one or more key transportation companies to provide transportation services to us, changes in the regulations that govern shipping tariffs or any other disruption in our ability to transport our merchandise could have a material adverse effect on our business, financial condition and results of operations |
| Our failure to adequately address barriers and challenges associated with expansion outside of the United States or its territories could cause our business to suffer |
| Three of our stores are located outside the United States or its territories |
| Our future expansion plans may involve entry into additional foreign countries, which may involve additional or heightened barriers and challenges that are different from those we currently encounter, including risks associated with being further removed from the political and economic systems in the United States and anti-American sentiment as a result of political or military action |
| We do not currently engage in currency hedging activities |
| The failure to adequately address the additional challenges involved with international operations could have a material adverse effect on our business, financial condition and results of operations |
| Certain provisions in our charter documents and elsewhere may discourage third parties from attempting to acquire control of our Company, which may have an adverse effect on the price of our stock |
| Our board of directors has the authority, without obtaining shareholder approval, to issue up to 2cmam000cmam000 shares of preferred stock and to fix the rights, preferences, privileges and restrictions of such shares without any further vote or action by our shareholders |
| Our articles of incorporation and bylaws also provide for a classified board and special advance notice provisions for proposed business at annual meetings |
| In addition, Washington law contains certain provisions that may have the effect of delaying, deferring or preventing a hostile takeover of our company |
| Further, we have a shareholder rights plan that is designed to cause substantial dilution to a person or group that attempts to acquire our company without approval of our board of directors, and thereby make a hostile takeover attempt prohibitively expensive for a potential acquirer |
| These provisions, among others, may have the effect of making it more difficult for a third party to acquire, or discouraging a third party from attempting to acquire, control of our company, even if shareholders may consider such a change in control to be in their best interests, which may cause the price of our common stock to suffer |