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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For fiscal period ended January 29, 2000 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period to__________
Commission File number 0-16309
FACTORY 2-U STORES, INC.
(Exact Name of Registrant as Specified in its Charter)
Delaware 51-0299573
-------- ----------
(State or Other Jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
4000 Ruffin Road
San Diego, California 92123
--------------------- -----
(Address of Principal Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (858) 627-1800
--------------
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
- ------------------- ------------------------------------------
Common Stock, $0.01 par value None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value
-----------------------------
(Title of Class)
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 fore 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 ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained,
to be best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [ ]
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a
plan confirmed by a court.
YES X NO ___
At April 12, 2000 the aggregate market value of the voting stock of the
Registrant held by non-affiliates was approximately $235,345,514.
At April 12, 2000 the Registrant had outstanding 12,429,742 shares of
Common Stock, $0.01 par value per share.
FORM 10-K INDEX
PART I
Item 1. Business 3
Item 2. Properties 7
Item 3. Legal Proceedings 8
Item 4. Submission of Matters to a Vote of Security Holders 8
PART II
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters 8
Item 6. Selected Financial Data 10
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 11
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 17
Item 8. Financial Statements and Supplementary Data 18
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 18
PART III
Item 10. Directors and Executive Officers of the Registrant 18
Item 11. Executive Compensation 19
Item 12. Security Ownership of Certain Beneficial Owners and Management 19
Item 13. Certain Relationships and Related Transactions 19
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. 19
2
PART I
Item 1. Business
THE COMPANY
We operate a chain of off-price retail apparel and housewares stores in Arizona,
California, Nevada, New Mexico, Oregon, Texas and Washington. We sell branded
casual apparel for the family, as well as selected domestics and household
merchandise at prices which generally are significantly lower than other
discount stores. At January 29, 2000, we operated substantially all of our 187
stores under the name Factory 2-U.
Prior to July 31, 1998, we operated through our wholly-owned subsidiaries,
General Textiles and Factory 2-U, Inc. We acquired General Textiles (which was
our principal operating subsidiary) in 1993. At that time, General Textiles was
operating only the Family Bargain Center chain. In November 1995, we acquired
Factory 2-U, Inc. and began to coordinate the purchasing, warehousing and
delivery operations for the Family Bargain Center and Factory 2-U chains.
In July 1998, we merged General Textiles and Factory 2-U, Inc. into a new
corporation, General Textiles, Inc. In November 1998, we merged General
Textiles, Inc. into ourselves, converted our previous three classes of stock
into a single class of Common Stock and changed our name from Family Bargain
Corporation to Factory 2-U Stores, Inc.
Our 187 stores average 14,300 total square feet and are located mostly in strip
centers. Our products include a broad range of family apparel, domestic goods
and housewares. Our typical customers are families with average household income
of approximately $35,000, who generally are profiled as discount store shoppers.
Our merchandising strategy is to offer first quality recognizable national and
discount store brands at a substantial discount, generally 20% to 50% below that
offered by the national discount chains. Our stores are well-lit and present the
merchandise primarily on hanging fixtures. We also use strategically placed
in-store signage to emphasize the savings and create increased customer
awareness.
OPERATIONS
Operating Strategy
We seek to be the leading off-price apparel, domestic goods and housewares
retailer to families with more than average number of children and whose
household incomes approximate $35,000 in the markets we serve. The major
elements of our operating strategy include:
Provide Value to Customers on National and Discount Brand Merchandise: We
emphasize providing value to our customers by selling merchandise found in
national discount chains at savings of 20% to 50% below prices offered by the
national discount chains. We buy excess inventory of recognized brands at
bargain prices and pass along the savings to our customers.
Target Under-Served Market Segments: Our stores target customers who are
under-served in their markets. Typical customers are young, large families with
a household income of approximately $35,000.
Maximize Inventory Turns: We emphasize rapid inventory turn in our merchandise
and marketing strategies because we believe it leads to increased profits and
efficient use of capital. Merchandise presentation, an everyday low price
strategy, frequent store deliveries and advertising programs all target rapid
inventory turn.
3
Expansion Plans
Opening of New Stores: We plan to open 60 to 65 stores in the fiscal year ending
February 3, 2001 (fiscal 2000). The new stores are planned for states in which
we currently operate. During the fiscal year ended January 29, 2000 (fiscal
1999), we opened 38 new stores and closed 19 stores. During the period from
January 29, 2000 through April 12, 2000, we opened 18 new stores and closed 7
stores. The number of stores that we opened and closed each quarter during
fiscal 1999, 1998 and 1997 were as follows:
Quarter
-------------------------------------------------------------------
First Second Third Fourth
Fiscal Year Beginning Open Close Open Close Open Close Open Close Ending
- ----------- --------- -------- ------- -------- -------- -------- -------- ------- -------- ------
1997 150 10 (2) 11 (4) 9 (6) 1 (3) 166
1998 166 - (4) 3 (3) 6 - - - 168
1999 168 9 (8) 10 (1) 15 (6) 4 (4) 187
Our average store opening costs for equipment, fixtures, leasehold improvements
and preopening expenses currently approximate $285,000. Our average initial
inventory for a new store currently approximates $160,000, net of trade credit.
Generally, during the two to three month grand opening period, our new stores
achieve sales in excess of sales of an average comparable mature store due to a
higher level of advertising and, within six months, generate sales consistent
with comparable mature store levels.
Renovation Program: We plan to continue the renovation of older stores. Our
store renovations generally include installing new fixtures, redesigning layouts
and refurbishing floors and walls. Our average cost to renovate a store
currently approximates $50,000. During fiscal 1999, we renovated 74 stores. In
many cases, our store renovations included a name change from Family Bargain
Center to Factory 2-U. In fiscal 1999, we converted 80 stores to our Factory 2-U
name. During fiscal 2000, we plan to renovate 12 to 14 stores and complete the
conversion to the Factory 2-U name.
Warehouses: In September 1999, we opened a new 150,000 square-foot warehouse and
distribution center in San Diego, California. We now have two distribution
centers in the San Diego area. The new facility was opened to accommodate
centralized ticketing of our merchandise, which had previously been done at our
stores, and to meet the increased demand resulting from the opening of our new
stores and growth at our existing stores. Generally, manufacturers ship goods
directly to our distribution centers or, in the case of certain east coast
vendors, to freight consolidators who then ship to our distribution centers. We
generally ship merchandise from our distribution centers to our stores within
two to three days of receipt utilizing the services of independent trucking
companies. We do not typically store merchandise at our distribution centers
from season to season. We plan to open a new distribution center by the fourth
quarter of fiscal 2000. This new distribution center will service the existing
Texas and New Mexico stores and our new stores that will be opened in those
states.
Buying and Distribution
We purchase merchandise from domestic manufacturers, jobbers, importers and
other vendors. Our payment terms are typically net 30 days. We continually add
new vendors and do not maintain long-term or exclusive purchase commitments or
agreements with any vendor. We believe that there are a substantial number of
additional sources of supply of first quality, national and discount brand
merchandise that will meet our increased inventory needs as we grow.
In-Season Goods: Unlike traditional department stores and discount retailers,
which primarily purchase merchandise in advance of the selling season (for
example, back-to-school clothing is purchased by March),
4
we purchase approximately 80% of our merchandise in-season (i.e., during the
selling season). In-season purchases generally represent closeouts of vendors'
excess inventories remaining after the traditional wholesale selling season and
are often created by other retailers' order cancellations. Sometimes vendors
manufacture to meet anticipated demand rather than known demand, anticipating
that we are a potential buyer of the excess inventory, typically at prices below
wholesale. We believe that in-season buying practices are well suited to our
customers, who tend to make purchases on an as-needed basis later into a season.
Our in-season buying practice is facilitated by our ability to process and ship
merchandise through our distribution centers to our stores, usually within two
or three days of receipt from the vendor, and to process a large number of
relatively small purchase orders. We believe that we are a desirable customer
for vendors seeking to liquidate inventory because we can take immediate
delivery of large quantities of in-season goods. Furthermore, because we rarely
request markdown concessions, advertising allowances or special shipping and
packing procedures, insisting instead on the lowest possible price, we are able
to pass these low prices on to our customers.
Merchandising and Marketing
Our merchandise selection, pricing strategies and store formats are designed to
reinforce the concept of value and maximize customer enjoyment of the shopping
experience. Our stores offer customers a diverse selection of first quality,
in-season merchandise at prices which generally are lower than those of
competing discount and off-price stores in their local markets. Nearly all of
our stores carry brand name labels, including nationally recognized brands.
We deliver new merchandise to our stores at least weekly to encourage frequent
shopping trips by our customers and to maximize the rate of inventory turn. As a
result of our purchasing practices, store inventory may not always include a
full range of colors, sizes and styles in a particular item. We believe,
however, that price, quality and product mix are more important to our customers
than the availability of a specific item at a given time.
We emphasize inventory turn in our merchandising and marketing strategy. Our
merchandise presentation, pricing below discounters, frequent store deliveries,
staggered vendor shipments, promotional advertising, store-tailored distribution
and prompt price reductions on slow moving items are all designed to promote
rapid inventory turn. We believe that the pace of our inventory turn leads to
increased profits, reduced inventory markdowns, efficient use of capital and
customer urgency to make purchase decisions.
At our administrative headquarters we receive daily store sales and inventory
information from point-of-sale computers located at each of our stores. This
data is reported by stock keeping unit (the "SKU"), permitting us to tailor
purchasing and distribution decisions. Our chain-wide computer network also
facilitates communications between our administrative headquarters and our
stores, enabling corporate management to provide store management with immediate
pricing and distribution information.
Our stores are characterized by easily accessible merchandise displayed on
hanging fixtures and open shelves in well-lighted areas. Our prices are clearly
marked, usually in whole dollars, with the comparative retail-selling price
often noted on price tags. Our major advertising vehicle is the use of a
full-color print tab showing actual photos of our merchandise. Our print media
is principally delivered to consumers through marriage-mail drops and to a
lesser extent, newspaper inserts. Some of our other advertising programs include
radio and outdoor billboard promotional activities.
Our stores emphasize customer satisfaction to develop customer loyalty and
generate repeat sales. If a customer is not completely satisfied with any
purchase, we will make a full refund or exchange. Most of our sales are for
cash, although we accept checks, debit and credit cards. We do not issue credit
cards, but do offer a layaway program. Our layaway program is important to our
customers, many of whom do not possess credit cards, because it permits them to
pay for purchases over time.
5
Approximately 60% of our sales occur in our third and fourth quarters, during
the back-to-school (August and September) and Holiday (November and December)
seasons. See "Management's Discussion and Analysis of Financial Conditions and
Results of Operations -- Seasonality and Quarterly Fluctuations."
Our Stores
As of April 12, 2000, we operated 198 stores located in seven western states.
Our stores are primarily located in rural and lower income suburban communities
and, to a lesser extent, in metropolitan areas. Most of our stores are located
in strip shopping centers, where occupancy costs are more favorable. As of
January 29, 2000, our stores were located as follows:
Strip
State Center Metropolitan Other Total
----- ------ ------------ ----- -----
California 81 11 12 104
Arizona 26 4 0 30
Washington 13 2 1 16
New Mexico 9 0 1 10
Nevada 7 0 0 7
Oregon 7 0 3 10
Texas 8 1 1 10
--- --- --- ---
151 18 18 187
=== === === ===
Our stores typically range in size from 6,000 square feet to 34,800 square feet,
averaging 14,300 square feet.
We generally lease previously occupied store sites on terms that we believe are
more favorable than those available for newly constructed facilities. After we
sign a store lease, one of our store opening teams prepares the store for
opening by installing fixtures, signs, racks, dressing rooms, checkout counters,
cash register systems and other items. Our district manager and store manager
arrange the merchandise according to the standard store layout and train new
personnel before and after the store is opened. We select store sites based on
demographic analysis of the market area, sales potential, local competition,
occupancy expense, operational fit and proximity to existing store locations.
Once we take possession of a store site, it takes approximately eight weeks to
open a new store.
Our stores typically employ one store manager, two assistant store managers and
seven to ten sales associates, most of whom are part-time employees. We train
new store managers in all aspects of store operations through our
management-training program. Our other store personnel are trained on site. We
often promote experienced assistant store managers to fill open manager
positions.
Our store management team participates in a bonus plan in which they are awarded
bonuses upon achieving plan objectives. We believe that the bonus program is an
important incentive for our key employees, helps reduce employee turnover and
results in lower costs.
We continually review store performance and from time to time close stores that
do not meet performance criteria. The costs associated with closing stores,
which consist primarily of the recognition of remaining lease obligations,
provisions to write down assets to net realizable value and inventory
liquidation costs are charged to operations during the fiscal year in which the
commitment is made to close a store.
We maintain customary commercial liability, fire, theft, business interruption
and other insurance policies.
6
Competition
We operate in a highly competitive marketplace. We compete with large discount
retail chains, such as Wal-Mart, K-Mart, Target and Mervyn's, and with regional
off-price chains, such as MacFrugal's, some of which have substantially greater
resources than ours. We also compete with independent and small chain retailers
and flea markets (also known as "swap meets") which serve the same low and
low-middle income market. We believe that we are well positioned to compete on
the basis of the principal competitive factors in our markets, which are price,
quality and site location.
Employees
As of April 12, 2000, we had 4,212 employees (2,253 of whom were part-time
employees). Of that total, 3,820 were store employees and store field
management, 252 were executives and administrative employees and 140 were
warehouse employees. None of our employees is subject to collective bargaining
agreements and we consider relations with our employees to be good.
Trademarks
Except for the trade names "Family Bargain Center" and "Factory 2-U", which are
federally registered trademarks, we do not have any material trademarks.
Government Regulation
Our operations are subject to various federal, state and local laws, regulations
and administrative practices affecting our business, including those relating to
equal employment and minimum wages. We believe we are in substantial compliance
with all federal, state and local laws and regulations governing operations and
we have obtained all material licenses and permits required for the operation of
our business. We believe that the compliance burdens and risks relating to these
laws and regulations do not have a material adverse effect on our business.
Item 2. Properties
As of April 12, 2000, we operated 198 retail stores located in Arizona,
California, Nevada, New Mexico, Oregon, Texas and Washington, under various
operating leases with third parties. Our store locations include malls, shopping
centers, strip centers, downtown business districts, and stand-alone sites. Our
store leases are separately negotiated. The typical lease for our stores is for
five years with renewal options in five year increments. Approximately 98% of
our leases are "triple net leases" under which we are required to reimburse
landlords for insurance, real estate taxes and common area maintenance costs;
however for many of those leases, we have negotiated reimbursement limitations
on common area costs. Some of our leases require us to pay a minimum monthly
rent and a percentage of sales in excess of a specified gross sales level. Our
annual rent expense for the 187 stores open at January 29, 2000 was
approximately $22.0 million.
Our headquarters are located in a 269,000 square-foot multi-use facility at 4000
Ruffin Road, San Diego, California. This facility consists of 37,000 square feet
of office space, an 8,000 square-foot retail store and a 224,000 square-foot
warehouse and distribution center. We currently sublease 60,000 square feet of
this facility to a third party. Our lease on this facility expires in September
2005. The lease provides for annual base rent at an average of approximately
$1.4 million over the lease term.
In September 1999, we leased a second warehouse facility at 7130 Miramar Road,
San Diego, California. This property consists of a 150,000 square-foot warehouse
and distribution center. Our lease expires in April 2002. The lease provides for
annual base rent at an average of approximately $783,000 over the lease term.
7
Item 3. Legal Proceedings
We are at all times subject to pending and threatened legal actions that arise
in the normal course of business. In our opinion, based in part on the advice of
legal counsel, the ultimate disposition of current legal matters will not have a
material adverse effect on our financial position or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of our security holders during the fourth
quarter of the fiscal year ended January 29, 2000.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
As part of our recapitalization in November 1998, our previous three classes of
capital stock outstanding were converted into a single class of Common Stock. We
converted each share of common stock outstanding prior to the recapitalization
into .30133 shares of post-recapitalization Common Stock, each share of Series A
9-1/2% Cumulative Convertible Preferred Stock outstanding into one share of
post-recapitalization Common Stock and each share of Series B Junior
Convertible, Exchangeable Preferred Stock outstanding into 173.33 shares of
Post-Recapitalization Common Stock. Immediately following the recapitalization,
we had 11,306,000 shares of Common Stock outstanding.
Prior to our recapitalization, our Common Stock and Series A Preferred Stock
were quoted on the NASDAQ SmallCap Market. Our Common Stock is now traded on the
NASDAQ National Market under the symbol "FTUS." The following table sets forth
the high and low closing prices of our Common Stock, as reported on the NASDAQ
National Market since November 23, 1998, and the high and low bid prices of our
Common Stock prior thereto, all as adjusted to reflect the recapitalization.
COMMON STOCK
High Low
Fiscal 1998
First Quarter $10.58 $4.25
Second Quarter $11.10 $7.47
Third Quarter $9.54 $5.39
Fourth Quarter (to November 23, 1998) $7.16 $5.60
Fourth Quarter (after November 23, 1998) $12.63 $6.81
Fiscal 1999
First Quarter $18.75 $11.00
Second Quarter $27.25 $16.25
Third Quarter $34.13 $20.63
Fourth Quarter $30.00 $17.88
Fiscal Year Ending February 3, 2001
First Quarter (through April 12, 2000) $30.75 $21.75
8
As of January 29, 2000, we had approximately 350 stockholders of record and
approximately 2,300 beneficial stockholders.
Until our recapitalization, we paid quarterly dividends of $0.2375 per share on
our Series A Preferred Stock (aggregating $2,593,000 for fiscal 1998). We have
never paid cash dividends on our Common Stock and do not anticipate paying cash
dividends in the foreseeable future. The declaration and payment of any cash
dividends on our Common Stock in the future will be determined by the Board of
Directors in light of conditions then existing, including our earnings,
financial condition, cash requirements and contractual, legal and regulatory
restrictions relating to the payments of dividends and any other factors that
our Board of Directors deems relevant. We are contractually prohibited from
paying cash dividends on our Common Stock under the terms of our existing
revolving credit facility without the consent of the lender. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources - Revolving Credit Facility."
We recorded non-cash dividends on our Series B Preferred Stock using the
effective interest method to recognize the dividend ratably over the estimated
period in which the Series B Preferred Stock was to be outstanding. For fiscal
1998, the accreted dividends totaled approximately $2.2 million. See Note 9 of
Notes to Financial Statements.
9
Item 6. Selected Financial Data
The selected financial data set forth below, except for Operating Data, is
derived from our audited financial information and should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our Financial Statements, including the Notes, and Supplementary
Data included in this Annual Report on Form 10-K.
Fiscal Year Ended
----------------------------------------------------------------
January 29, January 30, January 31, February 1, January 27
2000 1999 1998 1997(1) 1996
------------ ----------- ----------- --------- ---------
(in thousands, except per share and operating data)
Statement of Operations Data
Net sales $ 421,391 $ 338,223 $300,592 $ 252,165 $ 179,820
Operating income (loss) 22,753 10,464 5,097 (27,939) 5,153
Income (loss) from continuing 20,481 5,019 (129) (36,564) 1,478
operations
Net income (loss) 12,442 2,269 (129) (37,390) 978
Dividends on Series A Preferred Stock - 2,593 3,456 3,509 3,040
Dividends on Series B Preferred Stock - 2,210 2,661 - -
Inducement to convert preferred stock
to common stock - 2,804 - - -
Net income (loss) applicable to common 12,442 (5,338) (6,246) (40,899) (2,062)
stock
Weighted average shares outstanding
Basic 12,214 3,381 1,477 1,358 1,207
Diluted 12,864 3,381 1,477 1,358 1,207
Income (loss) before extraordinary item
and discontinued operations applicable
to common stock
Basic 1.02 (0.77) (4.23) (29.50) (1.29)
Diluted 0.97 (0.77) (4.23) (29.50) (1.29)
Net income (loss) per common share(2)
Basic 1.02 (1.58) (4.23) (30.12) (1.71)
Diluted 0.97 (1.58) (4.23) (30.12) (1.71)
Operating Data
Number of stores 187 168 166 150 131
Total selling square footage 2,169,000 1,804,000 1,788,000 1,567,000 1,367,000
Sales per average selling square foot $ 209 $ 192 $ 180 $ 172 $ 161
Comparable store sales growth 10.3% 10.9% 3.4% 5.3% 2.8%
Balance Sheet Data
Working capital (deficit) $ 1,241 $(9,179) $ (2,749) $ 248 $ 4,314
Total assets 108,466 90,167 84,817 80,669 87,152
Long-term debt and revolving credit
notes, including current portion 11,067 13,773 29,076 37,894 30,120
Stockholders' equity 46,430 27,765 17,218 11,208 27,717
- ----------------------------------------------------------------------------------------------------------------------------------
(1) 53-week fiscal year.
(2) In December 1997, we adopted SFAS No. 128, "Earnings Per Share." The
statement specifies the computation, presentation, and disclosure requirements
for basic earnings per share and diluted earnings per share. The statement
requires retroactive adoption for all prior periods presented. Additionally, all
prior periods presented have been restated giving effect to the reverse stock
split that was effected during the fourth quarter of fiscal 1998.
10
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
The following discussion and analysis should be read in conjunction with the
information set forth under "Selected Financial Data" and "Financial Statements
and Supplementary Data."
General
During the past three fiscal years, a number of events occurred which have had a
significant impact on our financial condition and that of our subsidiaries.
In January 1997, an investment group advised by Three Cities Research, Inc.
("TCR"), purchased a controlling equity interest in us by acquiring all of the
Common and Series A Preferred Stock held by our former chairman, vice chairman
and chief executive officer and purchasing from us shares of newly authorized
Series B Preferred Stock. Subsequent to the close of fiscal 1996, we sold
additional shares of the Series B Preferred Stock to these investors, our
directors and management.
In connection with the change in control, three former directors resigned from
the Board of Directors and three managing directors of TCR were appointed to
serve on the Board. In March 1998, we appointed Michael M. Searles as new
President and Chief Executive Officer of our operating subsidiaries. Mr. Searles
was elected a member of the Board of Directors in March 1998 and Chairman of the
Board in November 1998.
In July 1998, our two operating subsidiaries, General Textiles and Factory 2-U,
Inc., were merged to form General Textiles, Inc. In November 1998, we merged
General Textiles, Inc. into ourselves, converted our previous three classes of
stock into a single class of Common Stock and changed our name from Family
Bargain Corporation to Factory 2-U Stores, Inc. At that time, we had 11,306,000
shares of Common Stock outstanding. We undertook a rights offering and issued to
our stockholders transferable rights to purchase an additional 800,000 shares of
Common Stock for $13.00 per share. The TCR investors purchased approximately
798,000 shares.
During fiscal 1999 and 1998, our operational focus was on improving the
operating performance of existing stores and opening new stores. In fiscal 1999,
we opened 38 new stores, closed 19 stores and renovated 74 stores.
11
Results of Operations
We define our fiscal year by the calendar year in which most of the activity
occurs (the year ended January 29, 2000 is referred to as fiscal 1999). The
following table sets forth selected statement of operations data expressed as a
percentage of net sales for the periods indicated:
Fiscal year 1999 1998 1997
-------------------------------------------------------------------------------------------------------
Net sales 100.0 100.0 100.0
Cost of sales 64.3 65.7 67.7
-------------------------------------
Gross profit 35.7
34.3 32.3
Selling and administrative expenses 28.4
28.7 28.4
Pre-opening expenses 0.8 0.8 0.9
Amortization of intangibles 0.6 0.7 0.7
Stock based compensation expense 0.5 - -
Special charges - 0.7 0.6
Merger costs - 0.3 -
-------------------------------------
Operating income 5.4 1.7
3.1
Interest expense 0.5
1.2 1.7
------------------------------------
Income (loss) before income taxes and extraordinary
item 4.9 1.9 -
Income taxes 1.9 0.4 -
Extraordinary item, net of income tax benefit - 0.8 -
-------------------------------------
Net income (loss) 3.0 0.7 -
Inducement to convert preferred stock to common - 0.9 -
stock - 1.4 2.1
Preferred stock dividends
Net income (loss) applicable to common stock 3.0 (1.6) (2.1)
---------------------------------------------------------------------------
Fiscal 1999 Compared to Fiscal 1998
As of January 29, 2000, we operated 187 stores compared to 168 as of January 30,
1999. In fiscal 1999, we opened 38 new stores and closed 19 stores.
Net sales were $421.4 million for fiscal 1999 compared to $338.2 million for
fiscal 1998, an increase of $83.2 million or 24.6%. Comparable store sales
increased 10.3% in fiscal 1999 over the prior year. The increase in net sales
was related to new store growth and an increase in comparable store sales which
was due to an increased number of transactions and average purchase.
Gross profit was $150.4 million for fiscal 1999 compared to $115.9 million for
fiscal 1998, an increase of $34.5 million or 29.8%. As a percentage of net
sales, gross profit was 35.7% in fiscal 1999 compared to 34.3% in fiscal 1998.
The increase in gross profit as a percentage of net sales was primarily
attributable to a higher initial markup on purchases and lower inventory
shrinkage.
12
Selling and administrative expenses were $119.8 million for fiscal 1999 compared
to $97.1 million for fiscal 1998, an increase of $22.6 million or 23.3%. As a
percentage of net sales, selling and administrative expenses were 28.4% for
fiscal 1999 compared to 28.7% for fiscal 1998. Approximately $18.5 million of
the increase was sales volume related. The increase in selling and
administrative expenses was also attributable to increased corporate employee
and field supervisor expenses and information systems expenses. Selling and
administrative expenses as a percentage of net sales decreased due to sales
volume growth.
We recorded non-cash stock based compensation expense during fiscal 1999 in the
amount of $2.3 million when certain stock options with a market price hurdle
became exercisable and approximately $170,000 related to the grant of stock and
stock options.
We recorded a special charge of $2.4 million in fiscal 1998 in connection with
hiring the current President and CEO.
Merger costs of $1.0 million recorded in fiscal 1998 represented the expenses
associated with the recapitalization, including the merger of Factory 2-U, Inc.
and General Textiles into General Textiles, Inc. and the merger of General
Textiles, Inc. into ourselves.
Interest expense was $2.3 million in fiscal 1999 compared to $4.2 million in
fiscal 1998, a decrease of $1.9 million. The decrease was attributable to lower
average borrowings under our revolving credit facility and the exchange of the
subordinated and junior subordinated notes for new notes which resulted in a
lower debt discount amortization. See "Liquidity and Capital Resources -
Subordinated Notes."
Federal and state income taxes were $8.0 million in fiscal 1999 compared to $1.3
million in fiscal 1998, an increase of $6.8 million. Income taxes increased as a
result of higher taxable income versus the same period a year ago.
We incurred an extraordinary charge of $2.8 million in fiscal 1998 because notes
payable associated with the General Textiles bankruptcy were extinguished early
and new subordinated notes were issued with more favorable terms. See "Liquidity
and Capital Resources - Subordinated Notes."
Net income was $12.4 million in fiscal 1999 compared to net income before
preferred stock dividends of $2.3 million in fiscal 1998. No dividends were paid
or accreted in fiscal 1999 as a result of the recapitalization discussed above.
See Management's Discussion and Analysis of Financial Condition and Results of
Operations - General. Net income applicable to common stock was $12.4 million in
fiscal 1999 compared to a net loss applicable to common stock of $5.3 million in
fiscal 1998. Total preferred stock dividends in fiscal 1998 were $4.8 million,
which included non-cash dividends on the Series B Preferred Stock of $2.2
million. The increase in net income was a result of the operating and other
factors cited above.
Fiscal 1998 Compared to Fiscal 1997
As of January 30, 1999, we operated 168 stores compared to 166 as of January 31,
1998. We opened 9 new stores and closed 7 in fiscal 1998.
Net sales were $338.2 million for fiscal 1998 compared to $300.6 million for
fiscal 1997, an increase of $37.6 million or 12.5%. Comparable store sales
increased 10.9% in fiscal 1998 over the same period of the prior year. The
increase in net sales was related to new store growth and an increase in
comparable store sales which was due to an increased number of transactions and
average purchase.
Gross profit was $115.9 million for fiscal 1998 compared to $97.1 million for
fiscal 1997, an increase of $18.8 million. As a percentage of net sales, gross
profit was 34.3% in fiscal 1998 compared to 32.3% in fiscal 1997. The increase
in gross profit as a percentage of net sales was primarily attributable to
13
higher initial markups and lower inventory shrinkage, partially offset by higher
markdowns in fiscal 1998 compared to fiscal 1997.
Selling and administrative expenses were $97.1 million for fiscal 1998 compared
to $85.3 million for fiscal 1997, an increase of $11.9 million. As a percentage
of net sales, selling and administrative expenses were 28.7% for fiscal 1998
compared to 28.4% for fiscal 1997. The increase in selling and administrative
expenses as a percentage of net sales was primarily a result of higher store
wage rates, due in part to an increase in the minimum wage, and increased
administrative support expenses.
Amortization of intangibles was $2.4 million for fiscal 1998 compared to $2.2
million for fiscal 1997, an increase of $120,000. The increase was attributable
to a non-compete agreement with our former president and CEO in fiscal 1998. The
non-compete agreement is being amortized over 41 months. In January 1997, our
principal executive officers, who were our largest stockholders, sold their
stock interest, resigned from their positions as officers and directors and,
among other things, entered into an agreement not to compete with us until June
2000 in return for $1.8 million in secured promissory notes, which were paid in
January 1998. In August 1997, the former President and CEO entered into an
agreement not to compete with us until January 2001 in return for payments
totaling $970,000.
We recorded a special charge of $2.4 million in fiscal 1998 in connection with
hiring the current President and CEO. In fiscal 1997, a charge of $1.8 million
was incurred when the former president and CEO resigned. At the end of fiscal
1998, future payments totaling $1.2 million related to these special charges
were included in accrued liabilities.
Merger costs of $1.0 million in fiscal 1998 represented the expenses associated
with the recapitalization, including the merger of Factory 2-U, Inc. and General
Textiles into General Textiles, Inc. and the merger of General Textiles, Inc.
into ourselves.
Interest expense was $4.2 million in fiscal 1998 compared to $5.2 million in
fiscal 1997, a decrease of $1.0 million. The decrease was attributable to
decreases in the amortization of debt discount related to the exchange of the
subordinated and junior subordinated notes for new notes. See "Liquidity and
Capital Resources - Subordinated Notes."
Federal and state income taxes were $1.3 million in fiscal 1998, an increase of
$1.3 million over prior year. Income taxes increased as a result of higher
taxable income versus the same period a year ago.
We incurred an extraordinary charge of $2.8 million in fiscal 1998 because notes
payable associated with the General Textiles bankruptcy were extinguished early
and new notes were issued with more favorable terms. See "Liquidity and Capital
Resources - Subordinated Notes."
Net income before preferred stock dividends was $2.3 million in fiscal 1998
compared to a net loss before preferred stock dividends of $129,000 in fiscal
1997. Total preferred stock dividends were $4.8 million in fiscal 1998 and $6.1
million in fiscal 1997. Preferred stock dividends in fiscal 1998 included
non-cash dividends on the Series B Preferred Stock of $2.2 million compared to
$2.7 million in fiscal 1997. Additionally, in fiscal 1998, we recognized an
inducement charge of $2.8 million in connection with conversion of Series A
Preferred Stock to post-recapitalization common stock. The lower preferred stock
dividends in fiscal 1998 were due to the recapitalization discussed above. The
net loss applicable to common stock was $5.3 million in fiscal 1998 compared to
a net loss applicable to common stock of $6.2 million in fiscal 1997. The
improvement in the net loss applicable to common stock was due to the operating
and other factors cited above.
14
Liquidity and Capital Resources
General
As of January 29, 2000, we had outstanding indebtedness in the principal amount
of $11.1 million.
We finance our operations through credit provided by vendors and other
suppliers, amounts borrowed under our $50.0 million revolving credit facility
and internally generated cash flow. Credit terms provided by vendors and other
suppliers are usually net 30 days. Amounts which may be borrowed under the
revolving credit facility are based on a percentage of eligible inventories and
receivables, as defined, outstanding from time to time, as more fully described
below.
Revolving Credit Facility
At January 29, 2000, we had a revolving credit facility under which we could
borrow up to $50.0 million at the prime rate plus 0.75%, subject to limitations
based on inventory levels. At that time, we had no outstanding balance and
approximately $28.5 million of availability. We were not in compliance with the
current ratio covenant as of January 29, 2000.
Subsequent to year end, we entered into a new $50.0 million revolving credit
facility with another financial institution and terminated the prior revolving
credit facility. Under our new revolving credit facility we may borrow up to 70%
of our eligible inventory and 85% of our eligible receivables, as defined, not
to exceed $50.0 million. The new credit facility also provides a $5.0 million
subfacility for letters of credit. Interest on the credit facility is at the
prime rate, or at our election, LIBOR plus 2.0%. Under the terms of the new
credit facility, the interest rate may increase or decrease subject to earnings,
as defined, on a rolling four fiscal quarter basis. Accordingly, prime rate
borrowings could range from prime to prime plus 0.50 and LIBOR borrowing from
LIBOR plus 1.50 to LIBOR plus 2.50. At March 3, 2000, the prime interest rate
was 8.75%. The new credit facility expires on March 3, 2003, subject to
automatic one-year renewal periods, unless terminated earlier by either party.
We are obligated to pay fees equal to 0.125% per annum on the unused amount of
the new credit facility. The new credit facility is secured by a first lien on
accounts receivable and inventory and requires us to maintain specified levels
of tangible net worth in the event that our borrowing availability is less than
a specified amount.
Subordinated Notes
In fiscal 1998, we exchanged existing Subordinated Reorganization Notes and
Junior Subordinated Reorganization Notes for New Subordinated Notes and New
Junior Subordinated Notes that eliminated an estimated excess cash flow
calculation previously used to determine the timing and amount of payments and
provided a fixed debt payment schedule. In accordance with Emerging Issues Task
Force 96-19, we accounted for the exchange of the old notes as an extinguishment
of debt, and, in connection therewith, recorded an extraordinary loss, net of
tax benefit, of $2.8 million. This loss represented increases in the present
value of the principal amount of the old notes and fees paid to the lenders. The
fees included the issuance of 22,600 shares of pre-recapitalization common stock
and warrants to purchase 82,690 shares of pre-recapitalization common stock,
both stated at fair market value when they were issued. The New Subordinated
Notes totaled $3.3 million and were fully paid on December 8, 1998.
The New Junior Subordinated Notes are non-interest bearing and are reflected on
our balance sheets at the present value using a discount rate of 10%. As of
January 29, 2000, the New Junior Subordinated Notes had a face value of $16.3
million and a related unamortized discount of $5.3 million, resulting in a net
carrying value of $11.1 million. The discount is amortized to interest expense
as a non-cash charge until the notes are
15
paid in full. We made a principal payment on the New Junior Subordinated Notes
of $1.0 million during fiscal 1999. Additional principal payments are scheduled
on December 31, 2000 ($1.0 million), on December 31, 2001 and December 31, 2002
($2.0 million), on December 31, 2003 and December 31, 2004 ($3.0 million) and a
final payment on May 28, 2005 ($5.3 million).
We believe that our sources of cash, including the new credit facility, will be
adequate to finance our operations, capital requirements and debt obligations as
they become due for at least the next twelve months.
Capital Expenditures
We anticipate capital expenditures of approximately $21.0 million in fiscal 2000
which includes costs to open new stores, to renovate and relocate existing
stores, to construct a new distribution center, to upgrade information systems
and to renovate and expand our administrative offices. We believe that future
capital expenditures will be financed from internal cash flow and borrowings
under our new credit facility.
Inflation
In general, we believe that inflation has had no recent material impact on our
operations and none is anticipated in the next fiscal year.
Minimum Wage Increases
We employ, both in our stores and in our corporate headquarters, a substantial
number of employees who earn hourly wages near or at the minimum wage. Actions
by both the federal and certain state governments have increased and may
continue to increase the hourly wages that we must pay to such employees.
Historically, we have mitigated such increases through policies to manage our
ratio of wages to sales. However, we can make no assurances that these measures
and other steps taken will be adequate to control the impact of any hourly wage
increases in the future and may have a negative impact on profitability in the
future.
Seasonality and Quarterly Fluctuations
We have historically realized our highest levels of sales and income during the
third and fourth quarters of our fiscal year (the quarters ending in October and
January) as a result of the "Back to School" (August and September) and Holiday
(November and December) seasons. The seasonally lower sales in our first two
quarters (February through July), can result in losses during those quarters,
even in years in which we will have full year profits.
Year 2000 Issue
The Year 2000 issue is the result of computer systems and software products
coded to accept only 2 digit entries in the date code field. This could have
resulted in system failure or the generation of erroneous data in systems that
do not properly recognize such information.
We diligently addressed the potential Year 2000 issue by utilizing both internal
and external resources as applicable, to identify, correct or reprogram our
internal systems for Year 2000 compliance. In fiscal 1999, we implemented a new
integrated software package to support future growth and to address the issues
associated with the year 2000 at a cost of approximately $2.8 million.
16
To date, we have not experienced any significant business disruptions or system
failures as a result of the Year 2000 issue. None of our major vendors, service
providers and customers have reported substantial Year 2000 related problems.
Although the Year 2000 event has occurred, and while there can be no assurance
that there will be no problems related to the Year 2000 issue after January 1,
2000, we believe we will not be adversely impacted by the Year 2000 issue.
New Accounting Pronouncements
In December 1999, the Securities and Exchange Commission (the "SEC") issued
Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements." This SAB summarizes the SEC's view in applying generally accepted
accounting principles to revenue recognition in financial statements. This SAB
was amended by SAB No. 101A, which defers the effective date for all registrants
with fiscal years that begin between December 16, 1999 and March 15, 2000, to
allow for the adoption of implementing during the second quarter of fiscal 2000.
We have reviewed the impact of SAB No. 101 on our financial statements, and do
not believe that its adoption will have a material impact on our financial
statements.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities:, which
establishes accounting and reporting standards for derivative instruments and
hedging activities. SFAS No. 133 requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. This Statement was amended
by SFAS No. 137 which defers the effective date to all fiscal quarters of fiscal
years beginning after June 15, 2000. SFAS No. 133 is effective for our first
quarter in the fiscal year beginning February 4, 2001 and is not expected to
have a material effect on our financial position or results of operations.
Cautionary Statement for Purposes of "Safe Harbor Provisions" of the Private
Securities Litigation Reform Act of 1995
In December 1995, Congress enacted the Private Securities Litigation Reform Act
of 1995. The Act contains amendments to the Securities Act of 1933 and the
Securities Exchange Act of 1934 which provide protection from liability in
private lawsuits for "forward-looking" statements made by specified persons. We
desire to take advantage of the "safe harbor" provisions of the Act.
Certain statements in this Annual Report on Form 10-K, or in documents
incorporated by reference into this Annual Report on Form 10-K, are
forward-looking statements. Those forward-looking statements are subject to
uncertainties that may cause the actual results to differ from the results
anticipated by the forward-looking statements. Factors which may cause actual
results to differ from those anticipated by forward-looking statements include,
among others, general economic and business conditions (both nationally and in
the regions in which we operate); government regulations (including regulations
regarding temporary immigration of agricultural works and minimum wages of
agricultural and other workers); claims asserted against us; competition;
changes in our business strategy or development plans; difficulties attracting
and retaining qualified personnel; the inability to obtain adequate quantities
of merchandise at favorable prices; and the other factors described in this
Annual Report on Form 10-K and in our other filings with the Securities and
Exchange Commission.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to interest rate risk on our fixed rate debt obligations. At
January 29, 2000, fixed rate debt obligations totaled approximately $16.3
million. The fixed rate debt obligations are non-interest bearing and are
discounted at a rate of 10%, resulting in a net carrying value of $11.1 million.
17
Maturities are $1.0 million, $2.0 million, $2.0 million, $3.0 million, $3.0
million and $5.3 million in fiscal year 2000, 2001, 2002, 2003, 2004 and 2005,
respectively. While generally an increase in market interest rates will decrease
the value of this debt, and decreases in rates will have the opposite effect, we
are unable to estimate the impact that interest rate changes will have on the
value of this debt as there is no active public market for the debt and we are
unable to determine the market interest rate at which alternate financing would
have been available at January 29, 2000.
Item 8. Financial Statements and Supplementary Data
INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page
FACTORY 2-U STORES, INC.
Report of Independent Public Accountants F-1
Factory 2-U Stores, Inc. Balance Sheets as of January 29, 2000 and January 30, 1999 F-2
Factory 2-U Stores, Inc. Statements of Operations for fiscal years
ended January 29, 2000, January 30, 1999 and January 31, 1998 F-4
Factory 2-U Stores, Inc. Statements of Stockholders' Equity for fiscal years
ended January 29, 2000, January 30, 1999 and January 31, 1998 F-5
Factory 2-U Stores, Inc. Statements of Cash Flows for fiscal years
ended January 29, 2000, January 30, 1999 and January 31, 1998 F-6
Factory 2-U Stores, Inc. Notes to Financial Statements F-8
All other schedules are omitted because of the absence of conditions under which
they are required or because the required information is set forth in the
financial statements and notes thereto.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required by this item is incorporated herein by reference to the
Registrant's Definitive Proxy Statement pursuant to Regulation 14A in connection
with the 2000 Annual Meeting of Stockholders under the headings "Proposal 1 -
"Election of Directors" and "Executive Officers", which will be filed with the
SEC no later than 120 days after the close of the fiscal year ended January 29,
2000.
18
Item 11. Executive Compensation
The information required by this item is incorporated herein by reference to the
Registrant's Definitive Proxy Statement under the heading "Executive
Compensation", which will be filed with the SEC no later than 120 days after the
close of the fiscal year ended January 29, 2000.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this item is incorporated by reference to the
Registrant's Definitive Proxy Statement under the heading "Security Ownership of
Certain Beneficial Owners and Management", which will be filed with the SEC no
later than 120 days after the close of the fiscal year ended January 29, 2000.
Item 13. Certain Relationships and Related Transactions
The information required by this item is incorporated by reference to the
Registrant's Definitive Proxy Statement under the heading "Certain Relationships
and Related Transactions", which will be filed with the SEC no later than 120
days after the close of the fiscal year ended January 29, 2000.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) 1. Financial Statements. See Index to Financial Statements and
Supplementary Data contained in Item 8.
2. Financial Statement Schedules. See Index to Financial Statements and
Supplementary Data contained in Item 8.
3. Exhibits. See Item 14(c).
(b) Reports on Form 8-K. For the last quarter of the fiscal year ended
January 29, 2000, we filed the following reports on Form 8-K:
None.
(c) Exhibits. Reference is made to the Index to Exhibits immediately preceding
the exhibits thereto.
(d) Financial Statement Schedules. The required financial statement schedules
are entered on the Index to Financial Statements and Supplementary
Data contained in Item 8.
19
Index to Exhibits
Exhibit
Number Document
- --------------------------------------------------------------------------------
2.1 Plan and Agreement of Merger dated June 18, 1998 between Family Bargain
Corporation and General
Textiles, Inc. (1)
3.1 (i) Certificate of Incorporation
(ii) Bylaws (2)
4.1 Junior Subordinated Note Agreement dated April 30, 1998 among General
Textiles, American Endeavour Fund Limited and London Pacific Life &
Annuity Company (1)
4.2 Form of Warrant dated April 30, 1998 (1)
10.1 Factory 2-U Stores, Inc. Employee Stock Purchase Plan (3)
10.2 Financing Agreement between The CIT Group/Business Credit, Inc.
(as Agent and a Lender) and Factory 2-U Stores, Inc. (as Borrower),
dated as of March 3, 2000
10.3 Amended Employment Agreement between Factory 2-U Stores, Inc. and
Michael M. Searles
11.1 Computation of per share earnings
23.1 Consent of Arthur Andersen LLP, Independent Public Accountants
27 Financial Data Schedule
- -----------------------------
(1) Incorporated by reference to Registration Statement on Form S-2,
No. 333-58797 filed with the SEC on October 14, 1998.
(2) Incorporated by reference to Registration Statement on Form S-1,
No. 33-77488, filed with the SEC on April 7, 1994.
(3) Incorporated by reference to Registration Statement on Form S-8,
No. 333-94123 filed with the SEC on January 5, 2000.
20
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed
on its behalf by the undersigned, hereunto duly authorized.
FACTORY 2-U STORES, INC.
By: /s/ Michael M. Searles
---------------------------
Michael M. Searles
Chairman of the Board
Dated: April 21, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of
this Company and in the capacities and on the date indicated.
Signature Title Date
/s/ Michael M. Searles President, Chief Executive Officer
- ----------------------- and Director
Michael M. Searles (Principal Executive Officer) April 21, 2000
/s/ Douglas C. Felderman Executive Vice President, April 21, 2000
- ------------------------- Chief Financial Officer
Douglas C. Felderman (Principal Financial
and Accounting Officer)
/s/ Peter V. Handal Director April 20, 2000
- -------------------------
Peter V. Handal
/s/ Ira Neimark Director April 21, 2000
- -------------------------
Ira Neimark
/s/ Ronald Rashkow Director April 19, 2000
- -------------------------
Ronald Rashkow
/s/ H. Whitney Wagner Director April 18, 2000
- -------------------------
H. Whitney Wagner
/s/ Wm Robert Wright II Director April 20, 2000
- -------------------------
Wm. Robert Wright II
21
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Factory 2-U Stores, Inc.:
We have audited the accompanying balance sheets of Factory 2-U Stores,
Inc. (a Delaware corporation) as of January 29, 2000 and January 30,
1999, and the related statements of operations, stockholders' equity
and cash flows for each of the three years in the period ended January
29, 2000. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for
our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Factory 2-U
Stores, Inc. as of January 29, 2000 and January 30, 1999, and the
results of its operations and its cash flows for each of the three
years in the period ended January 29, 2000 in conformity with
accounting principles generally accepted in the United States.
/s/ ARTHUR ANDERSEN LLP
San Diego, California
February 25, 2000
F-1
FACTORY 2-U STORES, INC.
Balance Sheets
(in thousands)
January 29, January 30,
2000 1999
----------- -----------
ASSETS
Current assets:
Cash $ 9,473 $ 3,124
Merchandise inventory 35,048 31,353
Prepaid expenses and other assets 2,291 1,137
Deferred income taxes 2,184 1,690
---------- -----------
Total current assets 48,996 37,304
Leasehold improvements and equipment,
net of accumulated depreciation and amortization 27,425 18,187
Deferred income taxes 1,032 1,149
Other assets 1,507 2,419
Excess of cost over net assets acquired,
less accumulated amortization of
$10,139 and $8,537, respectively 29,506 31,108
---------- -----------
Total assets $ 108,466 $ 90,167
========== ===========
(continued)
The accompanying notes are an integral part of these financial statements.
F-2
FACTORY 2-U STORES, INC.
Balance Sheets
(in thousands, except share data)
January 29, January 30,
2000 1999
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt
and capital leases $ 1,251 $ 2,418
Accounts payable 19,994 21,258
Income taxes payable 4,235 2,656
Accrued expenses 22,275 20,151
--------- ----------
Total current liabilities 47,755 46,483
Revolving credit facility - 1,843
Long-term debt 10,067 9,930
Capital lease and other long-term obligations 1,658 2,257
Deferred rent 2,556 1,889
--------- ----------
Total liabilities 62,036 62,402
--------- ----------
Commitments and contingencies
Stockholders' equity:
Series A 9-1/2% cumulative convertible preferred stock,
$0.01 par value; 4,500,000 shares authorized, 0 shares
issued and outstanding - -
Series B junior convertible, exchangeable preferred stock,
$0.01 par value; 40,000 shares authorized,
0 shares issued and outstanding - -
Common stock, $0.01 par value, 35,000,000 shares and
80,000,000 shares authorized, respectively; and
12,390,817 shares and 12,106,175 shares issued and
outstanding, respectively 124 121
Stock subscription notes receivable (2,710) (4,087)
Additional paid-in capital 108,091 103,248
Accumulated deficit (59,075) (71,517)
---------- -----------
Total stockholders' equity 46,430 27,765
---------- -----------
Total liabilities and stockholders' equity $ 108,466 $ 90,167
========== ===========
The accompanying notes are an integral part of these financial statements.
F-3
FACTORY 2-U STORES, INC.
Statements of Operations
(in thousands, except per share data)
Fiscal Year Ended
---------------------------------------------------
January 29, January 30, January 31,
2000 1999 1998
----------- ----------- -----------
Net sales $ 421,391 $ 338,223 $ 300,592
Cost of sales 270,962 222,332 203,528
----------- ----------- -----------
Gross profit 150,429 115,891 97,064
Selling and administrative expenses
(exclusive of non-cash stock-based compensation
expense shown below) 119,781 97,140 85,276
Pre-opening expenses 3,273 2,579 2,703
Amortization of intangibles 2,358 2,358 2,238
Stock-based compensation expense 2,264 - -
Special charges - 2,350 1,750
Merger costs - 1,000 -
----------- ----------- -----------
Operating income 22,753 10,464 5,097
Interest expense, net 2,272 4,189 5,226
----------- ----------- ------------
Income (loss) before income taxes and
extraordinary item 20,481 6,275 (129)
Income taxes 8,039 1,256 -
----------- ----------- ------------
Income (loss) before extraordinary item 12,442 5,019 (129)
Extraordinary item - debt extinguishment, net
of income tax benefit - 2,750 -
----------- ----------- ------------
Net income (loss) 12,442 2,269 (129)
Inducement to convert preferred stock to
common stock - 2,804 -
Preferred stock dividends:
Series A - 2,593 3,456
Series B - 2,210 2,661
----------- ----------- -----------
Net income (loss) applicable to common stock $ 12,442 $ (5,338) $ (6,246)
=========== =========== ===========
Income (loss) per share:
Basic
Income (loss) before extraordinary item $ 1.02 $ (0.77) $ (4.23)
Net income (loss) $ 1.02 $ (1.58) $ (4.23)
Diluted
Income (loss) before extraordinary item $ 0.97 $ (0.77) $ (4.23)
Net income (loss) $ 0.97 $ (1.58) $ (4.23)
Weighted average common shares outstanding
Basic 12,214 3,381 1,477
Diluted 12,864 3,381 1,477
The accompanying notes are an integral part of these financial statements.
F-4
FACTORY 2-U STORES, INC.
Statements of Stockholders' Equity
(in thousands, except share data)
Preferred Stock
--------------------------------------------
Series A Series B Common Stock
------------------------ -------------------------- ------------------------------
Shares Amount Shares Amount Shares Amount
Balance at February 1, 1997 3,727,415 $ 37 $ 22,000 $ - 1,414,242 $ 14
Series A preferred
stock dividends - - - - - -
Series B preferred
stock dividend accretion - - - - - -
Conversion of preferred
stock to common stock (88,725) (1) - - 71,049 1
Issuance of preferred
stock in a private placement - - 9,599 - - -
Issuance of preferred
stock to management for notes - - 2,115 - - -
Common stock rights redemption - - - - - -
Net loss - - - - - -
--------- -------- --------- ----- ---------- -------
Balance at January 31 1998 3,638,690 $ 36 33,714 $ - 1,485,291 $ 15
--------- -------- --------- ----- ---------- -------
Series A preferred
stock dividends - - - - - -
Series B preferred
stock dividend accretion - - - - - -
Issuance of preferred
stock to management for notes - - 1,824 - - -
Issuance of common
stock in debt restructuring - - - - 22,600 -
Issuance of common
stock in rights offering - - - - 800,000 8
Conversion of preferred
stock to common stock (3,638,690) (36) (35,538) - 9,798,468 98
Correction for unsplit units - - - - (184) -
Inducement to convert
preferred stock to common stock - - - - - -
Compensation expense - - - - - -
Net income - - - - - -
---------- -------- ---------- ------ ---------- --------
Balance at January 30, 1999 - $ - - $ - 12,106,175 $ 121
--------- -------- --------- ------ ---------- --------
for exercise of stock options
and warrants - - - - 294,798 3
Compensation expense related
to grant of stock options - - - - - -
Compensation expense related
to stock option performance - - - - - -
Tax effect related to
non-qualified stock options - - - - - -
Issuance of common
stock to Board members as
compensation - - - - 4,750 -
Correction of prior year conversion - - - - 173 -
Repurchase of warrants - - - - - -
Payments of notes receivable - - - - - -
Cancellation of stock
subscriptions receivable - - - - (15,079) -
Net income - - - - - -
--------- -------- ---------- ------ --------- --------
Balance at January 29, 2000 - $ - - $ - 12,390,817 $ 124
--------- -------- ---------- ------ ---------- --------
Stock
Subscription Additional
Notes paid-in Accumulated
Receivable capital deficit Total
---------- -------- ---------- ----------
Balance at February 1, 1997 $ - $ 71,090 $ (59,933) 11,208
Series A preferred
stock dividends - - (3,456) (3,456)
Series B preferred
stock dividend accretion - 2,661 (2,661) -
Conversion of preferred
stock to common stock - - - -
Issuance of preferred
stock in a private placement - 9,600 - 9,600
Issuance of preferred
stock to management for notes (2,115) 2,115 - -
Common stock rights redemption - (5) - (5)
Net loss - - (129) (129)
-------- ---------- ---------- -------
Balance at January 31 1998 $ (2,115) $ 85,461 $ (66,179) $17,218
-------- ---------- ---------- -------
Series A preferred
stock dividends - - (2,593) (2,593)
Series B preferred
stock dividend accretion - 2,210 (2,210) -
Issuance of preferred
stock to management for notes (1,972) 1,972 - -
Issuance of common
stock in debt restructuring - 789 - 789
Issuance of common
stock in rights offering - 9,992 - 10,000
Conversion of preferred
stock to common stock - (62) - -
Correction for unsplit units - - - -
Inducement to convert
preferred stock to common stock - 2,804 (2,804) -
Compensation expense - 82 - 82
Net income - - 2,269 2,269
--------- --------- --------- -------
Balance at January 30, 1999 $ (4,087) $ 103,248 $ (71,517) $27,765
--------- --------- ---------- -------
Issuance of common stock
for exercise of stock options
and warrants - 2,186 - 2,189
Compensation expense related
to grant of stock options - 83 - 83
Compensation expense related
to stock option performance - 2,094 - 2,094
Tax effect related to
non-qualified stock options - 972 - 972
Issuance of common
stock to Board members as
compensation - 87 - 87
Correction of prior year conversion - - - -
Repurchase of warrants - (457) - (457)
Payments of notes receivable 1,255 - - 1,255
Cancellation of stock
subscriptions receivable 122 (122) - -
Net income - - 12,442 12,442
---------- --------- -------- -------
Balance at January 29, 2000 $ (2,710) $ 108,091 $(59,075) $46,430
The accompanying notes are an integral part of these financial statements.
F-5
FACTORY 2-U STORES, INC.
Statements of Cash Flows
(in thousands)
Fiscal Year Ended
---------------------------------------------------
January 29, January 30, January 31,
2000 1999 1998
----------- ----------- -----------
Cash flows from operating activities:
Income (loss) from operating activities $ 12,442 $ 5,019 $ (129)
Adjustments to reconcile income (loss) to net cash
provided by operating activities
Depreciation 6,859 4,484 3,505
Amortization of intangibles 2,358 2,359 2,238
Amortization of debt discount 1,137 1,430 2,168
Loss on disposal of equipment 796 163 181
Deferred rent expense 364 (362) 153
Stock based compensation expense 2,264 - -
Changes in operating assets and liabilities:
Merchandise inventory (3,695) (1,533) (702)
Prepaid expenses and other assets (1,375) (4,117) (1,540)
Accounts payable (1,264) 2,255 1,512
Accrued expenses and other liabilities 4,638 10,120 4,089
---------- ---------- ---------
Net cash provided by operating activities 24,524 19,818 11,475
---------- ---------- ---------
Cash flows used in investing activities:
Purchase of leasehold improvements and equipment (16,893) (6,798) (5,865)
---------- ---------- ---------
Net cash used in investing activities: (16,893) (6,798) (5,865)
---------- ---------- ---------
(continued)
The accompanying notes are an integral part of these financial statements.
F-6
FACTORY 2-U STORES, INC.
Statements of Cash Flows
(in thousands)
Fiscal Year Ended
---------------------------------------------------
January 29, January 30, January 31,
2000 1999 1998
---------- ----------- -----------
Cash flows used in financing activities:
Borrowings on revolving credit facility 454,157 54,816 335,053
Payments on revolving credit facility (456,000) (365,630) (340,283)
Payments of long-term debt and capital lease obligations (2,426) (9,445) (6,218)
Cash payments of preferred stock dividends - (2,593) (3,456)
Proceeds from issuance of common stock, net - 10,000 -
Proceeds from issuance of Series B Preferred Stock - - 9,595
Payments of deferred debt issuance costs - (211) (320)
Repurchase of warrants (457) - (75)
Proceeds from exercise of stock options and warrants 2,189 - -
Payments of stock subscription notes receivable 1,255 - -
----------- ----------- -----------
Net cash used in financing activities (1,282) (13,063) (5,704)
----------- ----------- -----------
Net increase (decrease) in cash 6,349 (43) (94)
Cash at the beginning of the period 3,124 3,167 3,261
----------- ----------- -----------
Cash at the end of the period $ 9,473 $ 3,124 $ 3,167
=========== =========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 1,295 $ 2,679 $ 2,948
Income taxes $ 6,011 $ 111 $ -
Supplemental disclosures of non-cash investing and
financing activities:
Acquisition of equipment financed by capital leases $ - $ 970 $ 2,173
Issuance of Series B preferred stock for notes $ - $ 1,972 $ 2,115
Series B preferred stock dividend accretion $ - $ 2,210 $ 2,661
Conversion of preferred stock to common stock
inducement charge $ - $ 2,804 $ -
Tax effect related to non-qualified stock options $ 972 $ - $ -
The accompanying notes are an integral part of these financial statements.
F-7
FACTORY 2-U STORES, INC.
Notes to Financial Statements
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
Factory 2-U Stores, Inc. (the "Company") operates a chain of off-price
retail apparel and housewares stores in Arizona, California, Nevada,
New Mexico, Oregon, Texas and Washington. The Company sells branded
casual apparel for the family, as well as selected domestics and
household merchandise at prices which generally are significantly lower
than other discount stores. At January 29, 2000, the Company operated
substantially all of its 187 stores under the name Factory 2-U.
Principles of Consolidation
Fiscal year ended January 31, 1998 reflects consolidated financial
statements which include the accounts of Family Bargain Corporation and
its wholly-owned subsidiaries, General Textiles and Factory 2-U, Inc.
All significant intercompany accounts were eliminated in consolidation.
In July 1998, General Textiles and Factory 2-U, Inc. merged to form a
new Delaware corporation named General Textiles, Inc. In November 1998,
General Textiles, Inc. merged into Family Bargain Corporation which
simultaneously changed its name to Factory 2-U Stores, Inc. The
financial statements as of and for the fiscal years ended January 29,
2000 and January 30, 1999, reflect the mergers (Note 3).
Fiscal Year
The Company's fiscal year is based on a 52/53 week year ending on the
Saturday nearest January 31. Fiscal years ended January 29, 2000,
January 30, 1999 and January 31, 1998 included 52 weeks. The Company
defines its fiscal year by the calendar year in which most of the
activity occurs (e.g. the fiscal year ended January 29, 2000 is
referred to as fiscal 1999).
Merchandise Inventory
Merchandise inventory is stated at the lower of cost or market
determined using the retail inventory method on a first-in, first-out
flow assumption. In addition, consistent with industry practice, the
Company capitalizes certain buying, warehousing, storage and
transportation costs. At both January 29, 2000 and January 30, 1999,
such costs included in inventory were $2.4 million.
Leasehold Improvements and Equipment
Leasehold improvements and equipment are stated at cost. Equipment
under capital leases is stated at the present value of minimum lease
payments at the date of acquisition. Depreciation and amortization are
calculated using the straight-line method over the shorter of the
estimated useful lives of the related asset or the lease term,
generally five years.
Excess of Cost Over Net Assets Acquired
Excess of cost over net assets acquired ("goodwill") is amortized on a
straight-line basis over 25 years. The Company assesses the
recoverability of goodwill by determining whether its balance can be
recovered from the future undiscounted operating cash flows. The
impairment, if any, is measured based on the excess of the carrying
value of the asset over the asset's fair value or discounted estimates
of future cash flows.
F-8
Asset Impairment
The Company assesses potential asset impairment in accordance with
Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of." This statement requires that long-lived assets and
certain identifiable intangibles be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Recoverability of an asset to be held
and used is measured by comparing the carrying amount of the asset to
future net cash flows expected to be generated by the asset. If such
asset is considered to be impaired, the impairment to be recognized is
measured by the amount that the carrying value of the asset exceeds the
fair value of the asset.
Fair Value of Financial Instruments
The carrying amounts of all receivables, payables and accrued expenses
approximate fair value due to the short-term nature of such
instruments. The carrying amount of the revolving credit facility
approximates fair value due to the floating rate on such instrument.
The carrying value of long-term debt with fixed payment terms
approximates fair value.
Advertising Costs
Advertising costs are expensed as incurred. Advertising costs for the
fiscal years ended January 29, 2000, January 30, 1999 and January 31,
1998 were approximately $12.3 million, $9.9 million and $9.3 million,
respectively.
Deferred Rent
Rent expense under non-cancelable operating lease agreements is
recorded on a straight-line basis over the life of the respective
leases. The excess rent expense over rent paid is accounted for as
deferred rent (Note 8).
Store Preopening and Closing Costs
Preopening costs (costs of opening new stores including grand opening
promotions, training and store set-up costs) are expensed as incurred.
Costs associated with closing stores, consisting primarily of any
future net lease obligations, inventory liquidation costs and
nonrecoverable investment in fixed assets are recognized as operating
expense when the decision to close a store is made.
Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating losses and tax credit carryforwards.
Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates
is recognized in income in the period that includes the enactment date
(Note 7).
Stock Based Compensation
The Company has elected under the provisions of SFAS No. 123,
"Accounting for Stock Based Compensation", to continue using the
intrinsic value method of accounting for employee stock based
compensation in accordance with Accounting Principles Board No. 25,
"Accounting for Stock Issued to Employees." Under the intrinsic value
method, compensation expense is
F-9
recognized only in the event that the
exercise price of options granted is less than the market price of the
underlying stock on the date of grant. The fair value method generally
requires entities to recognize compensation expense over the vesting
period of options based on the estimated fair value of the options
granted. The Company has disclosed the pro forma effect of using the
fair value based method to account for its stock based compensation as
required by SFAS No. 123 (Note 10).
Dividend Accretion
The Company's Series B Preferred Stock had an increasing rate dividend
feature (Note 9). Accordingly, dividends on Series B Preferred Stock
were recorded using the effective interest method to recognize the
dividends ratably over the estimated period in which the stock would
have been outstanding. The Series B Preferred Stock was converted to
common stock in November 1998 and, therefore, no additional dividends
have been accreted since fiscal 1998 (Note 3).
Earnings (Loss) per Common Share
The Company computes earnings (loss) per share in accordance with SFAS
No. 128, "Earnings Per Share." Under the provisions of SFAS No. 128,
basic earnings (loss) per share is computed based on the weighted
average shares outstanding. Diluted earnings (loss) per share is
computed based on the weighted average shares outstanding and
potentially dilutive common equivalent shares. Common equivalent shares
are not included in the computation of diluted loss per share for the
fiscal years ended January 30, 1999 and January 31, 1998 because the
effect would be anti-dilutive.
Use of Estimates
Management of the Company has made a number of estimates and
assumptions relating to the reporting of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period to prepare these financial statements in
conformity with generally accepted accounting principles. Actual
results could differ from those estimates.
Reclassifications
Certain prior period amounts have been reclassified to conform their
presentation to fiscal 1999 financial statements.
New Accounting Pronouncements
In December 1999, the Securities and Exchange Commission (the "SEC")
issued Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in
Financial Statements." This SAB summarizes the SEC's view in applying
generally accepted accounting principles to revenue recognition in
financial statements. This SAB was amended by SAB No. 101A, which
defers the effective date for all registrants with fiscal years that
begin between December 16, 1999 and March 15, 2000, to allow for the
adoption of implementing during the second quarter of fiscal 2000.
Management has reviewed the impact of SAB No. 101 on the company's
financial statements, and does not believe that its adoption will have
a material impact on the Company's financial statements.
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities,
which establishes accounting and reporting standards for derivative
instruments and hedging activities. SFAS No. 133 requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair
value. This Statement was amended by SFAS No. 137 which defers the
effective date to all fiscal quarters of fiscal years beginning after
June 15, 2000. SFAS No. 133 is effective for the Company's first
quarter in the fiscal year beginning February 4, 2001 and is not
expected to have a material effect on the Company's financial position
or results of operations.
F-10
2. SPECIAL CHARGES
During fiscal 1998, the Company recorded charges to operations in the
amount of $1.0 million for costs related to the merger of its
wholly-owned subsidiary, General Textiles, Inc. into the Company and
the Recapitalization (Note 3). In addition, the Company recorded
special charges in the amount of $2.4 million in connection with hiring
the current President and CEO of the Company. In fiscal 1997, the
Company recorded special charges to operations in the amount of $1.8
million pertaining to the separation from the Company of the former
President and CEO.
3. RECAPITALIZATION
In fiscal 1998, the Company initiated a multi-phased plan to
restructure its capitalization (the "Recapitalization"), which included
restructuring the subordinated and junior subordinated debt in a manner
that removed an estimated excess cash flow calculation previously used
to determine the timing and amounts of payments and replaced that term
with a fixed debt payments schedule. The debt restructuring resulted in
an extraordinary charge of $2.8 million, net of tax benefit, in the
first quarter ended April 30, 1998 (Note 6).
On July 31, 1998, the Company's two operating subsidiaries, General
Textiles and Factory 2-U, Inc., merged to form General Textiles, Inc.
(the "Subsidiary Merger").
On November 23, 1998, the Company carried out a Recapitalization in
which all of the Company's outstanding shares were converted into a
single class of Common Stock. Under the Plan of Recapitalization, each
outstanding share of Pre-Recapitalization Common Stock was converted
into .30133 shares of Common Stock, each outstanding share of Series A
9-1/2% Cumulative Convertible Preferred Stock (the "Series A Preferred
Stock") was converted into one share of Common Stock and each
outstanding share of Series B Junior Convertible, Exchangeable
Preferred Stock (the "Series B Preferred Stock") was converted into
173.33 shares of Common Stock. In connection with this conversion, the
Company recorded a reduction to net income applicable to common
stockholders in the amount of $2.8 million pertaining to the conversion
of Series A and Series B Preferred Stock to Common Stock pursuant to
the Plan of Recapitalization, in accordance with SFAS No. 84, "Induced
Conversions of Convertible Debt." The amount of the reduction
represents the fair value of Post-Recapitalization Common Stock
transferred in excess of the fair value of common stock issuable
pursuant to the original conversion terms of the Preferred Stock. In
conjunction with the Recapitalization, General Textiles, Inc. was
merged into Family Bargain Corporation (the "Family Bargain Merger")
and the Company's name was changed to Factory 2-U Stores, Inc.
The last phase of the Recapitalization was a rights offering in which
800,000 shares of Post-Recapitalization Common Stock were sold to
existing stockholders at $13 per share. The Company received proceeds
of $10.0 million, net of $400,000 of related expenses.
F-11
4. LEASEHOLD IMPROVEMENTS AND EQUIPMENT
Leasehold improvements and equipment consist of the following:
January 29, January 30,
IN THOUSANDS 2000 1999
------------- -------------
Furniture, fixtures and equipment $ 35,609 $ 20,367
Leasehold improvements 7,891 5,820
Automobiles 748 460
Equipment under capital leases 1,047 3,800
-------- --------
45,295 30,447
Less accumulated depreciation and amortization (17,870) (12,260)
-------- --------
$ 27,425 $ 18,187
======== ========
5. ACCRUED EXPENSES
Accrued expenses consist of the following:
January 29, January 30,
IN THOUSANDS 2000 1999
------------- -------------
Accrued compensation and related costs $ 7,882 $ 5,925
Sales tax payable 5,128 4,094
Other accrued expenses 9,265 10,132
----- ------
$ 22,275 $ 20,151
======== ========
6. LONG-TERM DEBT AND REVOLVING CREDIT FACILITY
Long-term debt and revolving credit facility consist of the following:
January 29, January 30,
IN THOUSANDS 2000 1999
------------- -------------
Revolving credit facility, interest at prime
plus 0.75% (9.25% at January 29, 2000 and 8.50%
at January 30, 1999) payable monthly, principal due
in March 2000 $ - $ 1,843
Installment note payable to a finance company,
interest at prime plus 3% (10.75% at January 30, 1999)
payable monthly, principal payable monthly in
installments of $33,333, paid off in February 1999 - 1,000
Junior subordinated notes, discounted at a rate of 10.0%,
principal payments in annual installments ranging from
$1.0 million to $3.0 million, final balloon payment
of $5.3 million due May 2005 11,067 10,930
------ ------
Total long-term debt and revolving credit facility 11,067 13,773
Less current maturities (1,000) (2,000)
-------- -------
Long-term debt and revolving credit facility,
net of current maturities $ 10,067 $ 11,773
======== ========
F-12
Revolving Credit Facility
At January 29, 2000, the Company had a revolving credit facility under
which it could borrow up to $50.0 million at the prime rate plus 0.75%,
subject to limitations based on inventory levels. At that time, the
Company had no outstanding balance and approximately $28.5 million of
availability. The Company was not in compliance with the current ratio
covenant as of January 29, 2000.
Subsequent to year end, the Company entered into a new $50.0 million
revolving credit facility with another financial institution and
terminated the prior revolving credit facility. Under the new revolving
credit facility, the Company may borrow up to 70% of its eligible
inventory and 85% of its eligible receivables, as defined, not to
exceed $50.0 million. The new credit facility also provides a $5.0
million subfacility for letters of credit. Interest on the credit
facility is at the prime rate, or at the Company's election, LIBOR plus
2.0%. Under the terms of the new credit facility, the interest rate may
increase or decrease subject to earnings, as defined, on a rolling four
fiscal quarter basis. Accordingly, prime rate borrowings could range
from prime to prime plus 0.50 and LIBOR borrowing from LIBOR plus 1.50
to LIBOR plus 2.50. At March 3, 2000, the prime interest rate was
8.75%. The new credit facility expires on March 3, 2003, subject to
automatic one-year renewal periods, unless terminated earlier by either
party. The Company is obligated to pay fees equal to 0.125% per annum
on the unused amount of the new credit facility. The new credit
facility is secured by a first lien on accounts receivable and
inventory and requires the Company to maintain specified levels of
tangible net worth in the event that its borrowing availability is less
than a specified amount.
Subordinated Notes
In fiscal 1998, the Company exchanged existing Subordinated
Reorganization Notes and Junior Subordinated Reorganization Notes for
New Subordinated Notes and New Junior Subordinated Notes that
eliminated an estimated excess cash flow calculation previously used to
determine the timing and amount of payments and provided a fixed debt
payment schedule. In accordance with Emerging Issues Task Force 96-19,
the Company accounted for the exchange of the old notes as an
extinguishment of debt, and, in connection therewith, recorded an
extraordinary loss, net of tax benefit, of $2.8 million. This loss
represented increases in the present value of the principal amount of
the old notes and fees paid to the lenders. The fees included the
issuance of 22,600 shares of pre-recapitalization common stock and
warrants to purchase 82,690 shares of pre-recapitalization common
stock, both stated at fair market value when they were issued. The New
Subordinated Notes totaled $3.3 million and were fully paid on December
8, 1998.
The New Junior Subordinated Notes are non-interest bearing and are
reflected on the Company's balance sheets at the present value using a
discount rate of 10%. As of January 29, 2000, the New Junior
Subordinated Notes had a face value of $16.3 million and a related
unamortized discount of $5.3 million, resulting in a net carrying value
of $11.1 million. The discount is amortized to interest expense as a
non-cash charge until the notes are paid in full. The Company made a
principal payment on the New Junior Subordinated Notes of $1.0 million
during fiscal 1999. Additional principal payments are scheduled on
December 31, 2000 ($1.0 million), on December 31, 2001 and December 31,
2002 ($2.0 million), on December 31, 2003 and December 31, 2004 ($3.0
million) and a final payment on May 28, 2005 ($5.3 million).
Management believes that the Company's sources of cash, including the
new credit facility, will be adequate to finance its operations,
capital requirements and debt obligations as they become due for at
least the next twelve months.
F-13
7. INCOME TAXES
Significant components of the provision for income taxes are as
follows:
January 29, January 30, January 31,
IN THOUSANDS 2000 1999 1998
-------------- ------------ -----------
Federal Income Tax Provision
Current $ 6,592 $ 2,857 $ -
Deferred (302) (1,914) -
----------- ---------- ---------
$ 6,290 $ 943 $ -
----------- ----------- ---------
State Income Tax Provision
Current $ 1,822 $ 698 $ -
Deferred (73) (385) -
---------- ---------- ----------
1,749 313 -
---------- ---------- ----------
$ 8,039 $ 1,256 $ -
========== ========= ===========
The principal temporary differences that give rise to significant
portions of the deferred tax assets and liabilities are presented
below:
January 29, January 30,
IN THOUSANDS 2000 1999
------------- -------------
Deferred tax assets
Net operating loss carryforwards $ 9,426 $ 11,495
Compensated absences and bonuses 1,227 463
Deferred rent 1,304 1,126
Closed store accrual 593 1,141
Excess of tax over book inventory 520 506
Other 346 330
Accrued expenses 1,285 73
-------- --------
Total gross deferred tax assets 14,701 15,134
Less valuation allowance (10,711) (11,495)
-------- --------
Net deferred tax assets 3,990 3,639
-------- --------
Deferred tax liabilities
Leasehold improvements and equipment,
principally due to differences in depreciation
recognized on fixed assets 774 800
-------- -------
Deferred tax liabilities 774 800
-------- -------
Net deferred tax asset $ 3,216 $ 2,839
======== ========
The Company has established a valuation allowance due to lack of
historical earnings and annual limitations on the usage of net
operating loss carryforwards.
F-14
The difference between the expected income tax expense (benefit)
computed by applying the U.S. federal income tax rate of 35%, 34% and
34% to net income from continuing operations for fiscal 1999, 1998 an
1997, respectively, and actual expense is a result of the following:
January 29, January 30, January 31,
IN THOUSANDS 2000 1999 1998
-------------- ------------ ------------
Computed "expected" tax expense
(benefit) $ 7,168 $ 2,180 $ (44)
Amortization of goodwill 657 658 638
Utilization of net operating losses (784) (2,017) (1,551)
Merger costs - 410 -
Business credits (52) (150) -
State income taxes, net of federal
income tax benefit 1,059 374 -
Other, net (9) (199) 957
--- ----- ---
$ 8,039 $ 1,256 $ -
========== ========= ========
At January 29, 2000, the Company had net operating loss carryforwards
for federal income tax purposes of approximately $26.4 million that
expire starting in fiscal year 2012 and for state income tax purposes
of approximately $4.0 million that start expiring in fiscal year 2002.
8. LEASE COMMITMENTS
The Company operates retail stores, warehouse facilities and
administrative offices under various operating leases. Total rent
expense was approximately $22.0 million, $18.0 million and $17.3
million, including contingent rent expense of approximately $447,000,
$240,000 and $128,000, for fiscal years ended January 29, 2000, January
30, 1999 and January 31, 1998, respectively.
Rent expense is recorded on a straight-line basis over the life of the
lease. For fiscal years 1999 and 1997, rent expense charged to
operations exceeded cash payment requirements by approximately $364,000
and $153,000, respectively, and resulted in an increase to the deferred
rent liability for the same amount. For fiscal 1998, cash payment
requirements exceeded rent expense charged to operations by
approximately $362,000, resulting in a decrease to the deferred rent
liability for the same amount.
The Company is also obligated under various capital leases for
leasehold improvements and equipment that expire at various dates
during the next two years. Leasehold improvements and equipment and
related accumulated amortization recorded under capital leases are as
follows:
January 29, January 30,
IN THOUSANDS 2000 1999
------------- -------------
Leasehold improvements $ 81 $ 344
Equipment 966 3,456
--- -----
1,047 3,800
Less accumulated amortization (535) (1,172)
----- -------
$ 512 $ 2,628
======= ========
F-15
At January 29, 2000, the future minimum lease payments under capital
leases and operating leases with remaining noncancelable terms are as
follows:
Capital Operating
IN THOUSANDS Leases Leases
------------- -------------
Fiscal year:
2000 $ 280 $ 18,784
2001 180 17,001
2002 20 13,709
2003 - 11,785
2004 - 8,940
Thereafter - 11,618
------ ------
Total minimum lease payments 480 $ 81,837
========
Less amount representing interest (rates ranging
from 9.0% to 14.8%) (37)
Present value of capital lease obligation 443
Less current maturities (251)
------
Long-term capital lease obligation $ 192
=======
9. STOCKHOLDERS' EQUITY
Prior to the Recapitalization, the Company was authorized to issue
Series A Preferred Stock, Series B Preferred Stock and Common Stock. In
connection with the Recapitalization, the Company converted all shares
of its Series A and Series B Preferred Stock into Post-Recapitalization
Common Stock and effected a reverse stock split, which converted all
shares of its Pre-Recapitalization Common Stock into .30133 shares of
Post-Recapitalization Common Stock (Note 3). There were 12,390,817 and
12,106,175 shares of common stock outstanding at January 29, 2000 and
January 30, 1999, respectively.
Series A and Series B Preferred Stock
The Company has 7,500,000 shares of preferred stock authorized, of
which 4,500,000 are allocated to Series A Preferred Stock and 40,000
are allocated Series B Preferred Stock. At January 29, 2000 and January
30, 1999, no shares of preferred stock were outstanding.
Prior to the Recapitalization, the Series A Preferred Stock ranked
senior to the Series B Preferred Stock and the common stock with
respect to the payment of dividends and distribution of net assets upon
liquidation, dissolution or winding up. Cumulative dividends were
payable quarterly at the rate of $.95 per year on April 30, July 31,
October 31, and the last Friday in January if, as and when declared by
the Board of Directors. Series A Preferred Stock was convertible, prior
to redemption, at the option of the holder, into shares of common stock
at a conversion price subject to adjustment under certain circumstances
pursuant to anti-dilution provisions.
F-16
The Series B Preferred Stock ranked junior to the Series A Preferred
Stock and senior to the common stock with respect to the payment of
dividends and the distribution of assets upon liquidation, dissolution
or winding up. The Series B Preferred Stock was convertible, at the
option of the holder, only after all the Series A Preferred Stock was
converted or redeemed. The conversion price per share was subject to
adjustment under certain circumstances pursuant to anti-dilution
provisions. Each share of Series B Preferred Stock was entitled to
voting rights equivalent to the number of common shares into which it
is convertible. The Series B Preferred Stock was to pay no dividend
until January 2002.
During fiscal 1998, the Company placed 1,824 shares of its Series B
Preferred Stock for notes receivable in the amount of $2.0 million from
management of the Company. The notes receivable from management of the
Company for the purchase of Series B Preferred Stock are due in 2002
and 2003, accrue interest at 8% per annum and require annual interest
and principal payments equivalent to 16.25% of the annual bonus of each
purchaser and a balloon payment of the unpaid principal and accrued
interest at maturity. All but one of the notes are full-recourse notes
and they were all secured by the Series B Preferred Stock issued in
return for the notes. The notes are now secured by the
Post-Recapitalization Common Stock into which the underlying Series B
Preferred Stock was converted. As of January 29, 2000, the total of
such notes receivable from management of the Company was $2.7 million.
10. STOCK OPTIONS AND WARRANTS
At January 29, 2000, warrants to purchase 82,690 common shares were
outstanding. These warrants have an exercise price of $19.91 and expire
in May 2005. During fiscal 1999, the Company repurchased 49,769
warrants which had an exercise price of $6.22 for $288,000.
Additionally, the Company repurchased 113,000 warrants which had an
exercise price of $16.50 at a purchase price of $169,000; holders of
108,000 warrants with an exercise price of $16.50 exercised those
warrants; and 99,000 warrants with an exercise price of $16.50 expired
on July 14, 1999.
In July 1999, the holder of a warrant to purchase 83,000 shares of
common stock for $16.50 per share exercised the warrant. The Company
issued to the warrant holder 12,316 shares of common stock, based on
the fair market value of 83,000 shares of common stock at the time of
exercise less the exercise price.
The Company has a stock option plan, the Amended and Restated Family
Bargain Corporation 1997 Stock Option Plan. Options may be granted as
incentive or nonqualified stock options. The Company may grant up to
1,807,980 options under this Plan. The options are issued at fair
market value with exercise prices equal to the Company's stock price at
the date of grant. Options vest over three to five years; are
exercisable in whole or in installments; and expire from five to ten
years from the date of grant.
F-17
The Company's Board of Directors has granted stock options to members
of the Board and to Company management. A summary of the Company's
stock option activity and related information is as follows:
Number of Weighted average
options * exercise prices *
----------------------------------------
Outstanding February 1, 1997 117,268 10.12
Granted 908,947 7.14
Exercised -- --
Canceled (95,798) 11.38
---------- -----
Outstanding January 31, 1998 930,417 7.07
Granted 452,147 6.88
Exercised -- --
Canceled (57,667) 7.27
----------- ----
Outstanding January 30, 1999 1,324,897 7.00
Granted 438,232 17.70
Exercised (257,482) 6.90
Canceled (141,209) 7.86
----------- ----
Outstanding January 29, 2000 1,364,438 10.37
Exercisable at January 29, 2000 531,659 7.05
Exercisable at January 30, 1999 352,115 6.45
* Options for January 31, 1998 and February 1, 1997 have been converted
at .30133 per option under the Recapitalization.
The following table summarizes information about the stock options
outstanding at January 29, 2000:
Weighted- Weighted- Weighted-
average average average
Range of exercise Number contractual exercise Number exercise
prices outstanding life price exercisable price
--------------------- -------------- -------------- ------------- ------------- --------------
$ 3.36 to $ 6.72 362,038 5.3 $ 6.22 286,121 $ 6.21
$ 6.72 to $10.08 579,635 2.3 $ 7.56 235,038 $ 7.55
$10.08 to $13.44 183,615 9.0 $12.08 2,500 $11.63
$13.44 to $16.81 63,000 9.1 $15.07 3,000 $16.38
$16.81 to $20.17 23,250 5.5 $18.48 - $ -
$20.17 to $23.53 8,500 8.3 $21.59 2,500 $20.75
$23.53 to $26.89 112,400 9.2 $24.99 - $ -
$26.89 to $30.25 29,000 9.2 $28.29 2,500 $27.38
$30.25 to $33.61 3,000 4.7 $33.61 - $ -
---------- --------
1,364,438 531,659
========== =========
F-18
During fiscal 1997 and 1998, the Company granted options which, subject
to time vesting conditions, originally were to become exercisable in
25% installments when the Common Stock price reached the following
market price hurdles and maintained those prices for 60 consecutive
trading days: $19.91, $24.89, $33.19 and $49.78. In December 1998, the
Board of Directors removed the first two market price hurdles for those
optionees that were employees, making one-half of those options granted
exercisable only subject to time vesting conditions. As a result, the
Company recorded compensation expense in the amount of $82,000.
During fiscal 1999, the market price of the Company's stock was $19.91
or greater for at least 60 consecutive trading days; therefore, all
92,960 options with a market price hurdle of $19.91 became exercisable.
The Company recorded a non-cash compensation charge of approximately
$2,094,000 in connection with this event.
There are 258,107 remaining stock options outstanding that are subject
to price hurdles. Once the remaining specified market price hurdles for
the Company's common stock have each been achieved and maintained for
60 consecutive trading days, subject to time vesting conditions, 92,961
options will become exercisable at a market price hurdle of $24.89;
82,573 will become exercisable at $33.19; and 82,573 will become
exercisable at $49.78. When the market price of the Company's common
stock reaches $24.89, $33.19 and $49.78 for the specified periods of
time, the Company will be required to record aggregate non-cash
compensation expense in the minimum amounts of $1.6 million, $2.1
million and $3.5 million, respectively.
SFAS No. 123 "Accounting for Stock-Based Compensation" was issued by
the FASB in 1995 and, if fully adopted, changes the methods for
recognition of cost on plans similar to those of the Company. The
Company has adopted the disclosure-only provisions of SFAS No. 123. Had
compensation cost for stock options awarded under this plan been
determined consistent with SFAS No. 123, the Company's net income and
earnings per share would have reflected the following pro forma
amounts:
January 29, January 30, January 31,
2000 1999 1998
-------------- ------------ ------------
Net Income (Loss): As Reported $ 12,442 $ (5,338) $ (6,246)
Pro Forma $ 11,485 $ (6,249) $ (7,114)
Basic EPS: As Reported $ 1.02 $ (1.58) $ (1.27)
Pro Forma $ 0.94 $ (1.85) $ (1.45)
Diluted EPS: As Reported $ 0.97 $ (1.58) $ (1.27)
Pro Forma $ 0.89 $ (1.85) $ (1.45)
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting
restrictions and are fully transferable. Option valuation models also
require the input of highly subjective assumptions such as expected
option life and expected stock price volatility. Because the Company's
employee stock-based compensation plan has characteristics
significantly different from those of traded options and because
changes in the subjective input assumptions can materially affect the
fair value estimate, the Company believes that the existing option
valuation models do not necessarily provide a reliable single measure
of the fair value of awards from those plans.
The weighted-average fair value of each option grant is estimated on
the date of grant using the Black-Scholes option pricing model using
the following weighted-average assumptions: (i) expected dividend
yield of 0.00%, (ii) expected volatility of 103.33%, 106.89% and
1.388% for fiscal years 1999, 1998 and 1997, respectively,
(iii) expected life of three to five years, and (iv) risk-free
interest rate of 6.68%, 5.55% and a range from 5.45% to 6.88% for
fiscal years 1999, 1998 and 1997, respectively.
F-19
11. EMPLOYEE BENEFITS
The Company sponsors a defined contribution plan, qualified under
Internal Revenue Code Section 401(k), for the benefit of employees who
have completed twelve months of service and who work a minimum of 1,000
hours during that twelve month period. The Company makes a matching
contribution equal to 20% of participating employees' voluntary
contributions. Participants may contribute from 1% to 15% of their
compensation annually, subject to IRS limitations. The Company
contributed approximately $170,000, $134,000 and $132,000 in fiscal
1999, 1998 and 1997, respectively.
In December 1999, the Company established the Factory 2-U Stores, Inc.
Employee Stock Purchase Plan which allows eligible employees to acquire
shares of the Company's Common Stock at a discount from market price,
at periodic intervals, paid for with accumulated payroll deductions.
The discount is 15% of the lower of the market price per share as
quoted on the NASDAQ National Market on the first and last day of an
offering period. The Plan was approved by the Company's Board of
Directors on December 8, 1999 and is expected to be approved by the
Company's stockholders at the annual meeting of stockholders in June
2000. The Plan will terminate when all 350,000 shares available for
issuance under the Plan are sold although the Plan may be terminated
earlier by the Company at any time.
12. COMMITMENTS AND CONTINGENCIES
The Company is at all times subject to pending and threatened legal
actions that arise in the normal course of business. In the opinion of
management, based in part on the advice of legal counsel, the ultimate
disposition of these current matters will not have a material adverse
effect on the financial position or results of operations of the
Company.
The Company has entered into an employment contract with its President
and CEO, which defines his duties, compensation and severance in the
event of his termination of employment with the Company.
13. RELATED PARTY TRANSACTIONS
In March 1997, the Company entered into an agreement with Three Cities
Research, Inc. ("TCR") engaging TCR to act as financial advisor to the
Company. Under this agreement, the Company pays TCR an annual fee of
$50,000 and reimburses TCR all of its out-of-pocket expenses incurred
for services rendered, up to an aggregate of $50,000 annually. The
Company reimbursed TCR for out-of-pocket expenses in the approximate
amounts of $46,000, $48,000 and $47,000 during fiscal year 1999, 1998
and 1997, respectively. TCR controls approximately 33% of the Company's
outstanding common stock and certain principals of TCR are members of
the Company's Board of Directors.
F-20
14. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The results of operations for fiscal 1999 and 1998 were as follows:
First Second Third Fourth
IN THOUSANDS, EXCEPT PER SHARE DATA Quarter Quarter Quarter Quarter
------- ------- ------- -------
Fiscal 1999
Net Sales $85,099 $91,931 $104,551 $139,810
Gross profit 28,991 33,659 37,360 50,420
Operating income 1,105 2,715 3,514 15,418
Net income 334 1,211 1,706 9,191
Earnings per share:
Basic $ 0.03 $ 0.10 $ 0.14 $ 0.74
Diluted $ 0.03 $ 0.09 $ 0.13 $ 0.70
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
IN THOUSANDS, EXCEPT PER SHARE DATA
Fiscal 1998
Net Sales $66,495 $73,456 $84,978 $113,294
Gross profit 21,846 24,962 28,785 40,298
Operating income (loss) (1,437) 42 3,382 8,477
Income (loss) before extraordinary item (2,789) (1,077) 2,251 6,634
Extraordinary item (2,750) - - -
Net income (loss) (5,539) (1,077) 2,251 6,634
Net income (loss) applicable to common
stock (7,106) (2,669)
607 3,830
Basic earnings per share:
Income (loss) before extraordinary item $ (2.92) $ (1.77) $ 0.40 $ 0.42
Extraordinary item (1.86) - - -
Net income (loss) applicable to common
stock $ (4.78) $ (1.77) $ 0.40 $ 0.42
Diluted earnings per share:
Income (loss) before extraordinary item $ (2.92) $ (1.77) $ 0.23 $ 0.34
Extraordinary item (1.86) - - -
Net (income) loss applicable to common
stock $ (4.78) $ (1.77) $ 0.23 $ 0.34
F-21